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Some bailout that turned out to be.

The European Stability Mechanism disbursed its final tranche of loans to the Greek government on Aug. 6. On Aug. 20, the program officially ended, although the loans are not expected to be fully repaid for another half-century.

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If their purpose was to support the Greek economy, the emergency loans must be considered a failure. Since 2008, the economy has shrunk by a quarter, and more than 400,000 Greeks have emigrated. House prices are down 43%. Bank credit to the private sector has contracted by a third. Fixed capital formation after depreciation has been consistently negative since 2010. More than €70 billion ($81.4 billion) worth of assets, including infrastructure, housing, and business plant and equipment, has been destroyed because of a lack of maintenance—a staggering loss for a €180 billion economy.

The outcome is less surprising when one realizes why the loans were originally made. The goal was never to help the people of Greece, or even the Greek government, but rather to help its creditors in the rest of Europe.

Greece’s Great Depression Cumulative net fixed investment Domestic bank credit by borrower Real gross domestic product, indexed Jan. 1995 = 100 Households Consumer loans General government Nonfinancial corporations Residential mortgages General government Corporations . billion €200 170 billion €350 175 160 300 150 150 250 125 140 100 200 130 75 150 50 120 25 100 110 0 50 100 -25 90 0 -50 ’10 ’05 2000 1995 2005 ’10 ’15 ’15 ’15 ’10 2000 ’05 Domestic bank credit by borrower Cumulative net fixed investment Real gross domestic product, indexed Jan. 1995 = 100 Nonfinancial corporations General government Households Consumer loans Residential mortgages General government Corporations billion 170 €200 billion €350 175 160 300 150 150 250 125 140 100 200 130 75 150 50 120 25 100 110 0 50 100 -25 0 90 -50 2005 ’10 ’15 ’15 ’05 2000 ’10 1995 ’15 2000 ’10 ’05 Real gross domestic product, indexed Jan. 1995 = 100 170 160 150 140 130 120 110 100 90 1995 ’10 ’15 2000 ’05 Sources: Hellenic Statistical Authority; Barron's calculations Cumulative net fixed investment Households Nonfinancial corporations General government billion . €200 175 150 125 100 75 50 25 0 -25 -50 ’15 ’10 2000 ’05 Sources: Hellenic Statistical Authority; Barron's calculations Domestic bank credit by borrower General government Consumer loans Residential mortgages Corporations billion . €350 300 250 200 150 100 50 0 ’10 2005 ’15 Source: Bank of Greece

After Greece joined the euro area in 2001, foreign investors poured in. This led to a boom in domestic consumption and investment. Greek residents spent far more than they earned, with the result that the current-account deficit ballooned from about 5% of gross domestic product in 1999 to 10% by 2006 and to 14% by 2008. Mortgage debt increased by a factor of seven. Inflation remained relatively tame—about 3.5% a year on average from 2002 through 2007—which suggests spending was broadly rising in line with productivity, even if the financing of that spending was clearly unsustainable.

While Greece’s private nonfinancial sector increased its debt by just as much as the Greek government, households and businesses mostly borrowed via long-term loans from domestic banks. The Greek government, however, borrowed mostly in the form of bonds that needed to be regularly rolled over. By the middle of 2009, the government owed more than €230 billion to non-Greeks—roughly 70% of its total financial obligations after excluding intragovernment lending. Meanwhile, the branches and subsidiaries of foreign-owned banks operating in Greece had ballooned to nearly €200 billion in assets.

Original Sin Too Big to Fail The Greek government's obligations Foreign claims on Greece by borrower Bank of Greece (intra-eurosystem loans) Long-term loans held by foreigners Financial corporations (excluding the Bank of Greece) Long-term debt securities held by foreigners Nonfinancial corporations General government All domestic Greek claims on Greek government excluding intragovernment debts Other foreign claims on Greek government billion €500 450 €350 billion 400 300 350 250 300 200 250 200 150 150 100 100 50 50 0 0 2000 ’05 ’15 ’10 ’05 2000 ’10 ’15 Too Big to Fail Original Sin Foreign claims on Greece by borrower The Greek government's obligations Bank of Greece (intra-eurosystem loans) Long-term loans held by foreigners Financial corporations (excluding the Bank of Greece) Long-term debt securities held by foreigners General government Nonfinancial corporations All domestic Greek claims on Greek government excluding intragovernment debts Other foreign claims on Greek government €500 billion 450 €350 billion 400 300 350 250 300 200 250 200 150 150 100 100 50 50 0 0 ’15 ’10 ’05 2000 ’05 ’10 ’15 2000 Original Sin The Greek government's obligations Long-term loans held by foreigners Long-term debt securities held by foreigners All domestic Greek claims on Greek government excluding intragovernment debts Other foreign claims on Greek government €350 billion 300 250 200 150 100 50 0 ’10 ’15 2000 ’05 Too Big to Fail Foreign claims on Greece by borrower Bank of Greece (intra-eurosystem loans) Financial corporations (excluding the Bank of Greece) Nonfinancial corporations General government billion €500 450 400 350 300 250 200 150 100 50 0 ’05 ’10 ’15 2000

The Greek government needed constant additional borrowing from abroad to service its debts. That was easy before the financial crisis, since Greece’s rapid growth and apparent convergence in living standards with the richer parts of Western Europe made it an attractive investment destination. After the crisis, however, foreign investors pulled back, hitting both the Greek government and Greece’s banks. While the banks had a large supply of foreign assets to help them repay their creditors, the government was less fortunate.

Had Greece been a country with its own currency, such as the Czech Republic or New Zealand, the central bank could have plugged the funding gap and prevented an abrupt collapse in spending. Membership in the euro area removed that option. The government and the banks owed debt in a currency the Bank of Greece could not print, and the European Central Bank was not keen on helping.

The textbook response would have been for the government to default on its debt and get a loan from the International Monetary Fund to help smooth out the adjustment. The amount of money required to buy time after a restructuring would not have been large compared with the nearly €300 billion that ended up being lent.

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That option was blocked, however, by a coalition of Greece’s “European partners” and the U.S. They were still traumatized by the bankruptcy of Lehman Brothers and had come to believe that its default had made the financial crisis far worse than it otherwise would have been. The result was a firm commitment to avoid any reduction in what the Greek government owed.

Their concern was not about what a default would do to Greece, but about what it would do to them. In addition to the €230 billion in potential losses on government debt, which by itself might have been enough to wipe out the capital of many large European banks, foreigners had another €120 billion in exposure to Greek banks. Greek banks did not have much exposure to Greek government debt—only about 8% of total assets in 2009—but it was still more than their total capital and loan-loss reserves.

Restructuring the government’s debt would therefore have required either the partial liquidation of the Greek banking system or an explicit bailout of Greece’s banks paid by someone else. Again, this should have been doable, but U.S. Treasury Secretary Timothy Geithner and ECB President Jean-Claude Trichet were terrified about how it might affect the still-fragile Euro-American financial system.

Instead, the result was a series of loans made to the Greek government so that it could repay its foreign private-sector creditors. As Yiannis Mouzakis of MacroPolis calculated in 2015, only €27 billion—or 11% of the money lent to the Greek government by the IMF and the European governments—was actually used to help cover the budget deficit and pay arrears to Greeks. By contrast, 70% of the “rescue” loans went directly out the door in the form of principal repayment, interest payments, and incentive payments to foreign bondholders. (The rest went to bank recapitalization.) As if that were not bad enough, the loans came with strict conditions to raise taxes and cut spending, exacerbating the downturn into a catastrophe on par with the Great Depression.

There was no political will in 2010 to spend hundreds of billions of euros to bail out Dutch, French, and German banks. To Greece’s eternal misfortune, however, there was enough “solidarity” to launder that Northern European bank bailout through the Greek government.

Write to Matthew C. Klein at matthew.klein@barrons.com