But in reality, this is circular, because the credit rating is based on the rating agency's view of the willingness of the ECB to provide liquidity. The easy alternative would be for the ECB to operate a system of haircuts for the liquidity it offered against EU sovereign bonds based on their credit rating-which it sort of does. To avoid this, officials presented default as tantamount to leaving the euro area when there is, in fact, no economic or legal requirement that this should be so. The default would then be on the ECB holdings of the debt, with no discipline on the creditors and debtors, and forcing other member states to replenish the ECB's capital. Prior to a default, banks would pass on to the ECB all the bonds issued by the troubled sovereign that they held in return for the same liquidity as offered on other sovereign bonds. But this would not be possible if countries could default. To create a single financial system, it was thought necessary for the European Central Bank (ECB) to treat member state debt as largely equivalent to each other. In Europe there is an additional challenge. Debt crises also breed a debtor's defiance that can keep foreign creditors at bay. If you are small enough or uninteresting enough for international portfolios to suffer no loss by ignoring you, the return could be protracted. There are a multitude of potential complications. Over the course of financial history, international money often returns surprisingly fast after a default. In the shadow of default, creditors and borrowers act more responsibly. The shame of default often leads to new political leadership, which gives credibility to new fiscal commitments. The object is not to punish creditors, but to allow a country to quickly return to the capital markets. Once a country is in a fiscal mess, there are economic benefits to a default. Greece is the poster child of the anti-austerity cause. (This measure, which I learned from Charles Wyplosz, better captures the hole Greece fell into than annual GDP changes.) Greek debt was cut, but GDP fell even further. The sum of gross domestic product (GDP) shortfalls over the past seven years, the difference between each year's real GDP level and the 2007 level, is a staggering 135 percent. This is because the economic austerity that came with the first Greek bailout pushed the economy into a free fall. Greece did deliver a haircut to its creditors, but it was not enough. A Greek default in 2010 would have avoided Greece's fiscal troubles cascading into an existential moment for the European Union.
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