The cure for the crisis is a dose of American-style tough love, writes Martin Sandbu
The bankruptcy of the once great city of Detroit comes just a few years after that of General Motors, Motown’s legendary car manufacturer. Both collapses crystallise decades of accumulated failures, including a failure to look reality in the eye sooner.
They also symbolise the US’s big advantage over Europe: its greater willingness to let go of hopeless causes so that more successful activities have room to grow. The ability to let doomed ventures die is a sign of strength, not weakness. If Europe – especially the eurozone – wants out of the crisis, it should adopt American-style tough love.
It is natural to be rattled when giants buckle. The liabilities restructured by GM amounted to $172bn. Its host city faces debts of possibly $20bn, according to Detroit’s emergency manager Kevyn Orr. Much of this represents losses borne by people who were sure their claims would be honoured. That is no doubt unfair; and one cannot fault burned creditors for doing what they can to get others to make them whole, as Detroit unions now want the federal government to do.
By and large, however, the US is prepared to let the chips fall where they may; more so, anyway, than Europe. It was not always so – president Gerald Ford’sinfamous “drop dead” to New York City (which he never really said) in 1975 ended with rescue loans anyway. But in the past few years, the US has pointed banks (Lehman Brothers and many smaller ones), other systemic corporations (the car industry) and many municipal governments to the nearest bankruptcy court.
America matches this toughness with love. In the US, taking a risk and failing is not the end: there is honour in getting back up. Bankruptcy offers a new chance, and the culturally favoured response is to keep fighting. American economic dynamism owes much to this forgiving attitude to risk-taking.
Europeans regard insolvency with a much darker moral taint. To go bankrupt has traditionally been to be branded untrustworthy – a shame to hide by leaving business for ever, even (once upon a time) by taking leave of one’s life. This still shows up in such archaic rules as Ireland’s 12-year bankruptcy period (which is finally being reformed).
Paradoxically, this cultural allergy to failure leads not just to less risk-taking, but to policies that bail out those that do take big risks and lose. Europe finds the idea of default so intolerable that, in the current crisis, it has preferred to cover the debts of the bankrupt. It suffers as a result.
This was clear in the case of Greece. Creditor states insisted that a bailout was unacceptable. But the thought that a sovereign European state might not pay its debts proved more unacceptable still. So loans from the eurozone – and an International Monetary Fund bullied into participating – were spent to postpone the reckoning.
The same has happened with banks. In 2010, the Irish government did all it could to fill the holes in its banks’ balance sheets with taxpayer money rather than declare them insolvent, protect retail depositors and let creditors pick up the pieces. When Dublin realised it did not have enough taxpayer funds to do the job, its eurozone partners strong-armed it into borrowing from them to keep the bailout going. The aversion to bankruptcy disfigured policy towards banks in Spain and elsewhere, too.
Reality has forced Europeans to change their minds, as it usually does in the end.Greece’s sovereign debt was eventually restructured – but not before much of the benefit of restructuring had been lost, and not without the pretence that it was voluntary for bondholders. In Cyprus, although the amounts were small, the prospect of bailing out Russian depositors was too much to stomach for northern Europe.
Even these lessons are taking time to sink in. The US gave itself the power to wind down big banks, and impose losses on their creditors, in 2010. Most EU governments have still not got around to passing this crucial legislation. It will be years before they are forced to do so by Brussels, even though the need for a “bail-in” is agreed in principle.
How much the eurozone could have saved itself by embracing debt restructuring as a pragmatic policy from the start of the crisis is unknown. But years of missing growth – relative to the US’s modest but decent trot out of the crisis – is partly due to Europe’s remaining debt overhang. As debt balances in the US economy have come down steeply, people are spending again. Europe is held back by banks wobbling on top of capital cushions that are all too thin – the result of a refusal to convert debt into equity when other sources of capital dry up.
Europe can retort that the worst bankruptcy of them all – Lehman’s – showed the damage wrought by US willingness to let go. A fair point. But Americans and Europeans drew different lessons from this, too. The US has worked to end “too big to fail” (but still has a way to go). Until Cyprus, Europe did the opposite, treating even the smallest banks as if their bankruptcy would be as devastating as that of Lehman.
F Scott Fitzgerald wrote: “I once thought that there were no second acts in American lives, but there was certainly to be a second act to New York’s boom days.” Fitzgerald had in mind the 1929 crash that silenced the roaring Twenties. Europe must learn from the lesson America has shown many times: allow the second act to take place, and a third can follow in due course, as it did for GM, and as it surely will for Detroit.
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