I want to return again briefly to how the traditional distinction of liquidity and insolvency in a crisis applies to sovereign states such as Greece. Liquidity is usually thought of as a gap in information that causes investors, creditors, depositors or others to suddenly question an institution’s financial position. In the classic bank run, the information gap becomes a self-fulfilling prophecy of insolvency; in other cases, insolvency is discovered, not made, as information becomes available and indicates that the institution is genuinely not solvent. But in either case, insolvency is a condition of an institution, such as a bank or financial institution, discovered or made in the present.
In the case of sovereign states, the analogy is apt, but not entirely so. Sovereign states, even when they default on their obligations, do not simply disappear “into” (much less “in”) bankruptcy the way a private firm would, unless the firm had the deus ex machina of a government bailout. States don’t just go away, their assets sold off and distributed out to the creditors. The question of solvency or insolvency – the urgent information gap that has driven much of the recent Greek debt crisis – is not so much a question of solvency today, as whether a state can muster the political will to be solvent into the future.
Questions of political will across a long time horizon are by their nature deeply uncertain, not least from an investor’s point of view. So it seems likely that in the absence of a flat out guarantee from a trusted party – the EU or its leading members – liquidity issues (including not just risk premiums, but much volatility in debt pricing, reflecting genuine uncertainties) will trouble Greece, and other shaky euro economies. The special sovereign uncertainties arise as investors seek to bridge an information gap that is fundamentally about the special solvency issue for a sovereign state – long term political will. Can a trillion-dollar euro fund allay the uncertainties, not just today, but over the required time horizon?
(Whatever the answer to that question, it seems to me that Professor Anna Gelpern, whose Roubini blog post I earlier referenced, is right in saying that Greece does not have much reason to seek a restructuring at this point in time.)