What government with a population of 37 million, a GDP of $1.8 trillion and a widely derided political class has great trouble paying its debts?


No, California.

Greece is only 1/4 that size. It has a population of 11 million. Its GDP is around $0.4 trillion.

But yes, Greece, like California, does have a great deal of trouble paying its debts. In fact, the more Greece is bailed out, the more financial trouble it gets into.

That figures. Greece is what Queen Elizabeth I would have called a "hardy beggar." In other words, intimidating in its distress — because viewed as too big to fail.

Those more schooled in macroeconomics tend to excuse this by saying that Greece is a victim: While it chose its own disastrous fiscal policy, and did its own crooked accounting — it is saddled with a currency, the euro, that it can't control and whose value doesn't respond directly to the Greek economy.

So maybe if California, rather than being saddled with the dollar, had its own currency, the "calachma," it would endure less economic distress. The calachma would depreciate, California's balance of trade would improve, and presto chango, all would be well.

But there is no calachma for California, nor a drachma for Greece. So, how come, given all these similarities between the two, and California's much larger size, Greece but not California has achieved the formidable and fearsome status of "TBTF"?

California isn't TBTF simply because people in Washington have made utterly clear that they're not going to bail out any state or local government at all.

In defense of the EU's doing the opposite and throwing more and more money into the black hole in Greece, the argument is made that a Greek default would generate crushing market pressures on Portugal, Spain, Italy...larger and larger dominoes would inevitably fall, resulting in a worldwide catastrophe. And if not, then anyhow the result would be much more expensive than a bailout — because the whole EU would have to pay higher interest rates.

But it was similarly argued that if the U.S. allowed any state or locality to fail, then the entire municipal bond market would collapse-likewise leading to a worldwide catastrophe. Despite California's economic weight, and despite the enormous volume of debt it owes to financial institutions that have bought municipals, this TBTF argument was rejected. Most likely a municipal bailout was judged impractical because if the U.S. ever started them, these bailouts would soon require more money than we could print — and catastrophe would not be averted.

This is exactly what is now playing out in Europe. Having learned they are TBTF, Greece and the others will "need" more and more money until the EU runs out of it. Bailouts are a more destructive contagion than defaults, because the germ of moral hazard proliferates exponentially.

The California narrative demonstrates that the no-bail-out alternative is better. Having been told they were not TBTF, California and other U.S. governmental units were able to focus on their remaining choices. California had long lived with a constitutional requirement for balanced budgets, and already experienced repeated budgetary crises, including government shutdowns. Spending less and continuing to make debt payments obviously are once again the best choices.

Germany, however, won't let Greece fail, and for an utterly damnable reason: Bank regulators allowed European banks to load up on Greek and other dubious sovereign euro debt, during the period when this debt offered slightly higher yields than stronger countries' euro debt.

Now, German government debt, no matter in what currency, can be considered a riskless asset for German banks — the same as U.S. Treasury debit is riskless for U.S. banks. Namely, if the debt of a bank's home country defaults, then that bank will be insolvent anyway. But there never was any reason to consider Greek debt, any more than Peruvian debt, to be riskless or low risk for a German bank to own.

The European bank regulators effectively rendered Greece TBTF when they allowed their banks to invest in it so heavily. That is where the slipping started. For any country's banking system and economy, systemic risk must be assessed on an aggregate basis — in this case, in terms of the total amount of Greek and similar debt owned.

American regulators could not imagine that home prices and commercial real estate prices would decline so much as to turn vast volumes of good bank assets into bad bank assets. (Some still can't!) European regulators could not imagine sovereign default within the Euro zone. Wishful thinking trumps rationality, again and again.

Without regulating asset quality and concentration at the bank and national levels, there's little safety to be gained by Forever Demanding Increased Capital, which is what "FDIC" has been said to stand for.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of Providian Financial Corp. He can be reached at akahr@creditbuilders.us.com.