Christian Science Monitor
June 18, 2011
The more I read about the Greek debt crisis, the more convinced I become that policy makers are looking at an insolvency problem but seeing a liquidity problem. Getting this wrong is a great way to make a bad situation both worse and more protracted.
In a liquidity crunch, your banks are sitting on bad loans and are too undercapitalized to do much about it. Your credit markets freeze and your economy tanks. But your government and central bank are able to leap into the lurch and become the banking system for awhile, reflating the private system until it can run on its own again. That’s pretty much what the TARP did.
For something like that to work—and I’m not saying it was the best or only way for us to have gone—a few things need to be in place. Your government must be able to reliably borrow at favorable rates (and lenders must believe you can later pay them back), your banking system must be able to get back into borrowing and lending markets once their balance sheets recover, and if your currency can adjust to help boost external growth, that’s nice too.
If none of those things are in place, misdiagnosing insolvency as illiquidity can prolong a disaster and waste a lot of money along the way. I would argue that these conditions were, in fact, present in the US case. They are not in the Greek case.
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