Institute for Financial Transparency

Shining a light on the opaque corners of finance


Varoufakis: choice between the sensible and the toxic

In Transparency Games, I discuss at length the choice policymakers face in responding to a financial crisis.  The choice is between the Swedish Model (under which the real economy is protected and banks are required to absorb the losses on the excess debt in the financial system) and the Japanese Model (under which banks are protected at all costs and the real economy is crushed under the burden of the excess debt).

In his Guardian column, Yanis Varoufakis, the former Greek finance minister, confirms the choice between the Swedish and Japanese models.  He lays out the choice when dealing with a country like Greece that cannot repay all of their debt as being between the sensible and the toxic:

the sensible one, that any decent banker would recommend – restructuring the debt and reforming the economy; and the toxic option – extending new loans to a bankrupt entity while pretending that it remains solvent.

The sensible choice, aka the Swedish Model, acknowledges the existence of losses upfront and focuses on protecting the real economy from losses in the financial system.  The toxic choice, aka the Japanese Model, protects the banks and puts the burden of paying for this excess debt on the real economy.

Since 2008, with the exception of Iceland, global policymakers have made the toxic choice.  Bankers were bailed out of the consequences of their decisions.  In this case, their decision to lend Greece more money than it could afford to repay.  The losses were transferred to the taxpayers where the issue now became “when” would these losses be realized, how large would the losses become before they were realized and how much damage was done to the real economy before the losses were realized.

In Transparency Games, I discuss why requiring banks to provide transparency effectively stops global policymakers from making the toxic choice.  First, the market uses the information transparency discloses to exert discipline on the banks to recognize their losses.  Second, when there is a dollar figure attached to the losses, it is much harder for politicians to find any support for transferring these losses to taxpayers.  This is particularly true when the banks could retain these losses and continue to support the real economy.