Legal Commentary

John Mauldin: ?The same market forces that work in Illinois can work in Greece?

By Jim Lindgren

A few weeks ago at Minyanville, John Mauldin wrote:

The EU is backed into a corner. They have this treaty that says governments will act in certain ways. Greece is flaunting that treaty. Everyone acts as if Greece defaulting on its debt would be the end of the EU. Will the EU force Greece to withdraw if they don?t control their budget? Upon reflection, I?m not so sure.

Let?s take that proposition to the US. What if Illinois defaulted on its debt? Would we kick them out of the Union? Hardly. A default would mean a severe loss of credit, a forced retrenching, and a severe economic crisis in Illinois. The losses would be serious for banks and investors. There would be negotiations on how to deal with the debt, who gets a haircut on their bonds, what pension assets and expenses would be cut, and so on. A crisis? Yes. End of the world? No.

So what if Greece does default? The banks and those who lent them the money would take a loss of some amount. The cost of borrowing for Greece would rise dramatically, if they could even get into the debt market. If they actually cut their budgets enough to deal with the deficit in a responsible way, it would mean, at best, a severe and prolonged recession. If Stratfor is right about deficits reaching 15% of GDP, it could mean a depression. They have no good choices.

It?s doubtful that German and French voters will be happy with any bailout using their tax money that doesn?t impose serious cuts in Greek budgets, with realistic controls as a condition for the bailout. Can Greece live with that? We?ll see. . . .

But is it so unthinkable that Greece could simply default and then be forced by the market to get realistic about its deficits? The same market forces that work in Illinois can work in Greece.

But if the EU does bail out Greece, what then of Ireland, which is making the tough choices? Will Portugal be next? If Greece is allowed to fail, or better, actually shows some fiscal discipline, that bodes well for the EU in the long run. It will be a lesson that each nation is responsible to maintain its own house.

The line ?The same market forces that work in Illinois can work in Greece? jumped out at me.

So far I see no evidence that Illinois has changed its wasteful ways, let alone come up with a plan to deal with its existing debt.

Nor is fiscal responsibility necessarily on the horizon. And in a very close Illinois primary for governor, the apparent Republican winner (Bill Brady) is viewed as the weakest of the three top Republican vote-getters for the general election. Indeed, many observers assumed that Gov. Pat Quinn (Dem.) would be an almost certain loser in the fall ? until the Republicans nominated the weakest of the possible candidates. Now it might be close.

I have been wondering about the effects of an Illinois or California default on its bonds. Would it really be such a disaster as to merit a federal bailout?

Full post as published by The Volokh Conspiracy on February 27, 2010 (boomark / email).