Everyone, even German Chancellor Angela Merkel, seems to be comparing the Eurozone crisis to Lehman Brothers’ collapse three years ago. According to this reasoning, the default of Greece (or Portugal, Ireland, Spain or Italy) could trigger market chaos, just as Lehman supposedly did in 2008. My own view of Lehman, as a few readers of this blog may remember, is that the conventional wisdom is mistaken in almost every respect. Lehman does seem to me a useful analogy, however. The reason Lehman’s collapse came as such a shock was that the decision to rescue Bear Stearns six months earlier seemed to signal that large troubled institutions would be bailed out. Everyone understandably expected a bailout, and was stunned when no bailout came. European leaders have boxed themselves into a very similar corner. Even now, few think that they will let Greece default, despite the fact that Greece is clearly insolvent and has no real prospect of repaying its debt.
In other contexts (states, large financial institutions, Argentina in the early 2000s), I have argued that a bankruptcy is likely to be a better solution than bailouts or a default. There are some good arguments for creating a European bankruptcy framework. European countries already have given up some of their sovereignty, for instance, so bankruptcy would only be a limited additional interference; and countries such as Italy may be too big to bail out. But I’m not sure if bankruptcy would be the right answer here. The banks of other European countries, especially France, hold large amounts of Greek debt. If a bankruptcy regime were in place and Greece used it, the bankruptcy would have serious knock on effects in these other countries. It’s not clear whether countries like France or the E.U. could plausibly contain the effects on the banking sector. I may eventually cast my own lot for bankruptcy here as elsewhere, but the overall case seems a little murkier.