As the European financial crisis continues to percolate, by now a few irreducible facts are distressingly clear:

First, Greece has no hope of repaying its debts as they are now constituted. Thus, the much-contested 110 billion euro bailout plan and the wider subsequent trillion-dollar bailout proferred by the Eurozone countries and the IMF are doomed to fail for the simple reason that they offer only more lending to countries already drowning in debt. Greece has a primary deficit (meaning one that would persist for a number of years unless the country experiences spectacular economic growth) exceeding 6% of GDP and a budget deficit due to financing of the accumulated debt of at least another 4%, in addition to which it faces a GDP contraction for at least three years. Simple math shows that to have a stable debt/GDP ratio Greece must generate a budget surplus of at least 10%, which is basically impossible. A rising debt/GDP ratio together with contracting economy will make financing from private investors very doubtful.

Second, although Greece can default on most of its public debt with a unilateral act of parliament—and the political and economic realities to do this may yet prove irresistible—it would be much better for Greece, the IMF and the rest of the Eurozone if it avoided this. For Greece to give up and default in this way would mean not just horrific economic pain for its citizens but the threat of financial turmoil across Europe and possibly the world, since many major banks are implicated. In addition, the debt of Spain, Portugal, Ireland and possibly Italy and even the United Kingdom would be severely compromised. These governments at the very least would face much higher borrowing costs, making their defaults that much more likely. Since investors know this, there might also be bank runs.

So what is to be done? Greece cannot default, but it can “restructure.” To contrarians this may resemble a default, but many people are capable of maintaining the distinction when it is in their interest to do so, as was the case with New York City in the 1970s. Basically, Greece needs more favorable credit terms—lower interest and longer to pay. The balance sheets of European and other banks holding the restructured Greek bonds to maturity will not be impaired absent mark-to-market accounting, which may be on its way out just in time. In this way, the banks can preserve the useful fiction that they are solvent, until they become so with the help of cheap money from the European Central Bank. Many of Greece’s current bondholders may not agree to this plan but the risk of default would be much, much lower with the restructured rather than the original bonds.

Any such restructuring must be done in conjunction with the IMF and EU so that Greece doesn’t become a financial pariah—or rather, so that Greece can cease to be one. The impact of such a plan would be large; Carl Weinberg of High Frequency Economics figures that restructuring the Greek bonds that mature between now and 2019 into a single self-amortizing 25-year bond at 4.5% would save the country more than 140 billion euros over the next five and a half years. The improvement in servicing the country’s debt together with the ongoing rebalancing of its public finances will revise its credit profile and enable access to loans from private markets.

Does all this sound far-fetched? It shouldn’t. All parties have good reason to work together on it, since there is no palatable alternative. Besides, such a restructuring has succeeded elsewhere, including New York City.

The Financial Times reports that the European Central Bank (ECB) has warned of a “financial contagion” risk from concerns about the debt of some European governments. Many readers of this blog will recall that a similar concern was important in the late 1990s, when debt and currency problems seemed to spread among Asian and Latin American countries.

Financial contagion can occur in many ways. A modern financial system is highly interdependent, with financial corporations holding the liabilities of other financial corporations, often in foreign countries. Also, perceptions that a particular debtor might default on some of its debt can quickly lead to worries about similar debtors and financial instruments. For example, after the Penn Central Railroad went bankrupt in 1970, there was panic selling of commercial paper, leading to a near-collapse of the commercial paper market.

There are grounds for fears that the crisis that began in Greece could grow much further through some such contagion effect.  Indeed, another article in today’s FT describes how spreads between interest rates on the debt of financial and nonfinancial corporations and rates for government debt have generally widened in the past month in the United States and Europe. Draconian measures aimed at closing budget gaps could exacerbate the contagion effect, since they increase fears of sharply reduced growth around the world.

The Economist has published this obituary of the late economist, whose career included a lengthy stint as head of the Levy Institute’s Macro-Modeling Team. In the small world dept.:

After a spell in business and a few years at the Treasury, he was enticed to King’s College, Cambridge, which 61 years earlier another economist-aesthete, John Maynard Keynes, had joined as a lecturer, writing (with his mother’s help) a letter of resignation from the civil service to his boss, a Sir Arthur Godley. This man was to become the first Lord Kilbracken and eventually grandfather of Wynne.

In a paper called “Gender Segregation by the Clock,” Casey B. Mulligan of the University of Chicago has come out with some interesting new research on gender inequality in the labor market. It is a fascinating study showing that women are more likely to choose a regular 9 to 5 job. Prof. Mulligan says this may contribute to women’s lower earnings.

But did women really choose the work schedule that offers less pay? I am not sure. In our daily routine we have tons of household duties called unpaid work: cooking, cleaning, helping with homework, catching up with children, and perhaps most challenging of all, getting the little ones to bed. Kids often seem to have their strict schedule that parents have to follow (when they have to go, they have to go!). And moms happen to do most of the work at home.

Who pays mom for this work? Nobody. Similarly, who compensates the women who forgo higher earnings from longer hours, irregular hours and overtime?  I wonder why one should be punished for investing her time in raising productive workers for all of us.

PS–It would be interesting to compare the earnings of women who chose 9 to 5 jobs with the earnings of men who made the same choice.

A new report from the International Monetary Fund has turned attention, at least temporarily, from Greece to the larger potential problem of Spain, where unemployment is roughly 20 percent. A nice (if unsettling) summary:

Spain’s economy needs far-reaching and comprehensive reforms. The challenges are severe: a dysfunctional labor market, the deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness. Ambitious fiscal consolidation is underway, recently reinforced and front-loaded. This needs to be complemented with growth-enhancing structural reforms, building on the progress made on product markets and the housing sector, especially overhauling the labor market. A bold pension reform, along the lines proposed by the government, should be quickly adopted. Consolidation and reform of the banking system needs to be accelerated. Such a comprehensive strategy would be helped by broad political and social support, and time is of the essence.

The report, along with the government takeover of a faltering savings bank, seemed to get investors worried, even though neither was all that much of a surprise. Nonetheless, the cost of insuring Spanish debt rose, albeit to levels still far below that of Greece.

On the other hand, Spain was able to sell three- to six-month T-bills today, attracting bids worth more than twice the total offering. But the interest rate was a lot higher than in April. And last week a sale of 12 to 18 month T-bills fizzled.

From today’s NY Times:

The cost of public pensions has been systemically underestimated nationwide for more than two decades, say some analysts. By these estimates, state and local officials have promised $5 trillion worth of benefits while thinking they were committing taxpayers to roughly half that amount.

As Dimitri Papadimitriou said on this blog recently, we are facing a multidimensional pension crisis in this country. A coherent national retirement system–truly comprehensive Social Security obviating private pensions–might have avoided these runaway state and local pension obligations, which may yet end up on the federal balance sheet.

The International Policy Centre for Inclusive Growth has issued a report on an unintended consequence of women-empowering microfinance: an increase in child labor. The report underscores the importance of unpaid work–work performed mostly by women. A development program, small or big, should consider the constraint that unpaid care duties impose on women, and provide assistance through a social care system. As a saying goes, “It takes a village to raise a child.”

An earlier Levy post outlined America’s multi-dimensional pension crisis. Now comes this paper from economist Joshua Rauh, who says that at least seven states may be unable to pay their public-pension obligations during the next decade–and by 2030 that number could reach 31 states.

Barring reforms, Rauh says, a federal bailout could be needed, possibly exceeding $1 trillion. In the paper, he gives a sense of the magnitude of the problem: “The gap between assets and already-promised liabilities in state pension funds alone was over $3 trillion at the end of 2008.”

What is to be done? Part of the answer, Rauh writes, is that states might give public employees defined contribution plans–and bring into the Social Security system the quarter of state and local workers now outside of it.

Jan Kregel and Rob Parenteau, respectively senior scholar and research associate at the Levy Institute, offer this analysis of the current crisis in Europe, observing that investor behavior in this case isn’t just moved by animal spirits or orneriness:

This is about more than just testosterone counts. Some wing of the professional investing world is beginning to see the design flaws built into the eurozone from day one. And once the spy these flaws, they begin to realize the nature of the solution is something utterly different than what they are witnessing being rolled out before their very eyes. In the following 11 points, we highlight some of the key aspects of the eurozone predicament using the financial balance approach developed by the late Wynne Godley which we have explored in previous blog submissions, papers, and book chapters. Until more investors and policy makers can understand the true nature of the various predicaments facing the eurozone, and the inherent design flaws exhibited in the European Monetary Union and the (In)Stability and (Lack of) Growth Pact, odds are precious time will simply be wasted trying to make believe the shock and awe fix is already in.

Read the rest here.

Getting medical insurance out of the workplace would have been a grand idea. But bowing to practicality, the Obama administration pushed through a good-enough plan that leaves it there.

Let’s not make the same mistake twice when it comes to pensions. America and its retirees are facing a multi-dimensional pension crisis—one that, even more than health-care, requires severing the connection between the workplace and the social safety net.

Like health insurance, employer-provided pensions are regarded as the natural course of things in this country, but it wasn’t always so. It all started during World War II, when the government clamped down on wages. Benefits were a way of getting around the restrictions to increase compensation, but they persisted for good reasons. Paying workers with benefits rather than cash had tax advantages, and promising something 30 years into the future is always more appealing to employers than paying higher wages today.

But the system has bred serious problems, all of them getting larger by the day. First, individuals and their employers are terrible retirement planners. Companies have every incentive to make rosy assumptions that let them under-fund their plans, while employees, increasingly left to their own devices with 401(k)s and other such self-funded plans, probably don’t save enough.

Then there’s the problem of investing. Neither employers nor employees are very good at managing the money they do save. As Yeva Nersisyan and Levy Senior Scholar L. Randall Wray have shown, from 2007 to 2008, private pensions and IRAs lost roughly $2.9 trillion that people were counting on for their old age.

Defined-benefit plans—the nice, old-fashioned kind funded by employers—may have made sense when workers stayed put for years. Nowadays, though, people change jobs a lot more often and through no fault of their own. Employees fall victim to technology or downsizing every day. Yet vesting requirements persist, which means that these days more and more of your work-life won’t get you much pension credit. continue reading…