Wednesday, July 08, 2015

What Demands May Greece's Creditors Make, Consistent With Democracy?

by Michael Dorf

Much of the discussion by commentators sympathetic to this past Sunday's Greek "no" vote on the referendum whether to accept Europe's terms offered in exchange for additional credit and the ensuing negotiations yesterday has been couched in terms of democracy. (This brief blog post by Paul Krugman is a good example.) Germany, the ECB, and (behind the scenes) the private banks to which so much of the Greek debt is ultimately owed were and are, in this view, unfairly attempting to leverage Greece's economic vulnerability to obtain political results: either the outright fall of PM Tsipras and Siriza or, at the very least, a change of policy that is dramatically inconsistent with their core commitments and the now-twice-expressed clear preference of Greek citizens.

Is that an accurate characterization? Maybe, but it depends on a number of unstated assumptions about what creditors may fairly demand of debtors, both in general and in the special case of sovereign debt. Here I'll try to unpack those assumptions with a hypothetical example.

Suppose Angela lends Alexis $100,000 so that Alexis can open a restaurant that serves Greek cuisine. Under the terms of the loan, Alexis will pay Angela 5% annual interest on the outstanding principal for ten years, plus any principal payments he chooses to make, with the remaining principal to be fully paid back in a balloon payment at the end of 10 years. The loan instrument also permits Angela to demand full principal repayment if Alexis is delinquent in his interest owed. At the end of year 1, Alexis makes his $5,000 interest payment but pays no principal. At the end of year 2, Alexis tells Angela that the restaurant is still not making a profit but that reviews have been good, the customer base is growing, and that he would like to delay payment for the year so that he can use the $5,000 he would otherwise pay her for advertising and marketing. Angela agrees in writing to a "one-time" delay. After year 3, Alexis tells Angela more or less the same thing. Worse, Angela learns that instead of spending on advertising and marketing, Alexis spent $5,000 in year 3 on a "team-building" retreat for himself and his wait staff. Angela has had it with Alexis. She tells him he must either pay the $10,000 in interest (the delayed year 2 payment plus the year 3 payment) or she will demand full repayment of the principal. Alexis cannot afford either option. Angela then says that she will forgive the year 2 and year 3 interest payments but only if Alexis relinquishes control of the day-to-day operations of the restaurant to a manager she will install, Otto, who plans to replace the dolmades and other Greek delicacies with a menu featuring potato pancakes, sauerkraut, spargel, and other German stalwarts.

Angela's proposal could well be ill-advised. Converting a Greek restaurant to a German restaurant will likely sacrifice most of its value as a going concern. However, perhaps Angela has good reason to think that a German restaurant managed by Otto will provide a better chance at maximizing her payout than either continuing to permit Alexis to operate a Greek restaurant or demanding full principal repayment, which would (let's assume) result in bankruptcy and liquidation. If so, then her plan makes financial sense.

From Alexis's perspective, of course, Angela's offer is a bitter pill. In order to avoid bankruptcy he must relinquish control of the restaurant of his dreams and watch as it becomes something else entirely.

But does that make Angela's offer unfair? I'm inclined to say no. Alexis accepted Angela's terms when he took the original loan. Assuming that there was nothing unfair about the original terms, now that things have gone south, Alexis could declare bankruptcy and walk away or, if he thinks that a German restaurant run by Otto is better than nothing, accept Angela's offer.

To be sure, this sort of logic has its limits. Alexis might also prefer to permit Angela to raise his first-born son than to see his restaurant go bankrupt, but that doesn't mean that Angela may condition debt relief on Alexis's relinquishment of Alexis Jr.

In my own field, this sort of puzzle concerns what are called "unconstitutional conditions." Courts and scholars struggle to articulate sensible principles that distinguish between permissible and impermissible conditions. I emphasize struggle. For example, in partly invalidating the Medicaid expansion under Obamacare in 2012, the Supreme Court seemed most struck by how much money was at stake, finding that this factor--together with a mysterious distinction between "old" and "new" money even when all the money was in the most relevant sense "new", as Justice Ginsburg explained in dissent (on this point)--turned what would have been an otherwise permissible carrot into an impermissibly coercive stick.

Nonetheless, there does seem to be something intuitively appealing to distinguishing between kinds of conditions. The Spending Clause cases also distinguish between conditions that are permissibly germane to the purpose for which the funds are allocated and those that are not. Using that idea as a guideline, we might say that Angela's insistence on running the restaurant the way she thinks will make money (even if she is mistaken about that) is legitimate because related to the purpose of the loan, while asking for Alexis, Jr. is not.

Turning back to the actual debt crisis, are European demands for continued Greek austerity more like installing Otto or demanding Alexis, Jr.? The question is challenging because austerity both is clearly germane to how Greece runs its economy and also strikes at the heart of matters of self-government in the political realm. Election contests are very often (indeed, some would say always) fought over such matters as taxes and spending. Thus, for the rest of Europe to tell Greece to raise taxes and cut pensions and other spending is both an economic and a political demand.

But of course that will almost always be the case where sovereign debt is at issue. Hence, to my mind, the issue is whether the ECB et al are going beyond the incidentally political into the gratuitously political in their demands. And the answer here appears to be no. Europe does not say, that as the price of a bailout, Greece must revise its formula for representation in the Greek parliament or change the appearance of its national flag.

One way to see the point would be to imagine a reversal. Suppose that Greece was having difficulty repaying its debts but that a conservative Greek government was stubbornly persisting in austerity policies. Now imagine that a Keynesian IMF offered Greece a bailout but only on the condition that Greece abandon austerity in favor of fiscal stimulus and low interest rates (bankrolled externally). I very much doubt that the people who are currently (rightly) critical of Europe's approach to Greece would say that such externally-mandated Keynesianism was anti-democratic.

Accordingly, I conclude that European demands for more austerity from Greece are "merely" stupid, cruel, and counterproductive, but not contrary to principles of democracy.