by Adam Tooze
Part III
EUROZONE
Chapter 14
GREECE 2010: EXTEND AND PRETEND
In the summer of 2009, with the acute crisis in the banking sector having been cauterized, both the European and the American economies began to recover. But aftershocks continued. With the insulation provided by the Fed and the Treasury, in the United States these aftershocks no longer manifested as acute stress in the financial system, but in misery spread across millions of households struggling with unaffordable mortgage payments and houses that were no longer worth the debt secured on them. The wave of foreclosures of American homes did not reach high tide until early 2010. Debtors continued to default, in other words, but their disaster did not pose systemic risks. They were the powerless ones who received precious little support from the Obama administration or anyone else. The main props to the economy other than the open-handed liquidity provision of the Fed were the automatic stabilizers of the fiscal apparatus. They left a deep dent in public finances, not just in the United States but across the advanced economies. In 2010 this would trigger a global backlash demanding fiscal consolidation and a return to the agenda of fiscal sustainability that had been so widely touted before the crisis. Controlling the debt-to-GDP ratio would become a mantra. After the largesse of the 2008 bank bailouts came austerity, though not for the same people, of course. But money is fungible. Ultimately, health care, education and local government services were all entries in the same budget that had to accommodate the costs of the crisis.
In the eurozone the switchback from the largesse of the banking crisis to the austerity that followed would take on a particularly dramatic form, because in three of its smaller member states the fiscal impact of the crisis was overwhelming. In the wake of the 2008 crisis, Greece, Ireland and Portugal slid into an increasingly untenable budgetary situation. Of the three, the situations of Greece and Ireland were the most severe. Greece’s public debts were simply too large and needed to be restructured. Ireland was overwhelmed by the consequences of its panic-stricken announcement on September 30, 2008, that it was guaranteeing 440 billion euros of bank liabilities. Given the burdens that Greece and Ireland were under by 2009, the only reasonable way forward was to carry out a debt restructuring, also known as haircutting bondholders, or, more euphemistically, as private sector involvement (PSI). In Greece this would have to involve lenders to the state. In Ireland it was the banks’ creditors whose claims could not reasonably be met. As in any bankruptcy, this involved an infringement of property rights and would create uncertainty. The risk of contagion was serious. If Greece or Ireland restructured, who would be next? Given the weakened state of Europe’s banks, it might be dangerous to inflict further losses on them. And given the degree of their interconnection with the US financial system, that concern would not remain confined to Europe. It is not surprising, therefore, that the Greek and the Irish situations, followed by Portugal’s, should have caused political and financial stress and that this should have spread to both sides of the Atlantic. But what happened in the eurozone from 2010 was extraordinary.
The denial, lack of initiative and coordination that had characterized Europe’s first response to the banking crisis in September and early October 2008 was a harbinger of things to come. In the first phase of the crisis in the autumn of 2008, the stresses could still be contained at the national level. In 2010 they spilled over into a general struggle for the future of Europe. Europe’s single currency almost came apart. Greece, Portugal, Ireland and Spain were driven into depressions the likes of which had not been seen since the 1930s. Italy became collateral damage. France’s sovereign credit was put in jeopardy. Prime ministers were ousted. Political parties collapsed. Nationalist passions were stirred to the boiling point. The Obama administration faced the prospect that Europe’s new crisis might spill back on the United States. In the spring of 2009 France and Germany had lectured the UK and the United States about financial stability. A year later they were reduced to calling on the IMF to help not just Greece but the eurozone as a whole. And it was not enough. Two years later the eurozone crisis was still menacing global financial stability.
I
Viewed against the wider canvas of the global crisis stretching from Wall Street to Seoul, the troubles of Greece and Ireland were not unusual and we do not need to refer to idiosyncratic features of eurozone governance to explain them.1 Ireland was an overgrown offshore banking hub. The costs of the bailout that Dublin saddled itself with were enough to have put even the most fiscally sound state in danger. It was Lagarde’s nightmare of October 2008 made real: a crisis in Europe’s highly integrated financial system too big for a host country to resolve alone. The politicians in Dublin were driven by panic and their intimate ties to the local banking community, but Merkel’s veto on any collective European solution made Ireland’s situation untenable. When on January 15, 2009, Dublin was forced to nationalize Anglo Irish Bank there were already rumors of an IMF intervention. Ireland’s sovereign bonds sold off and its default risk soared even above that of Greece’s.2
If Greece had been in Hungary’s situation in 2008, a member of the EU but outside the eurozone, it would in all likelihood have joined the East Europeans in the first round of IMF crisis programs.3 It was not that Greece was directly caught up in the transatlantic financial crisis. Its banks had regional interests at most. The crisis reached Greece by way of its export and tourism sectors. Then automatic fiscal stabilizers kicked in. Tax revenues slumped. None of this was unusual in 2008–2009. What set Greece apart was the precariousness of its fiscal position when the crisis struck. It bears repeating that Greece had not used eurozone membership to go on an outsized borrowing binge. The bulk of its debts were piled up in the 1980s and 1990s as its two main parties, PASOK (social democrat) and New Democracy (Christian democratic), lured voters with the promise of West European modernity and affluence.4 In 2006 Greece’s debt level relative to GDP was lower than it had been when it joined the eurozone in 2001. But it was not reduced by much and would have been worse but for fiddling. Athens’s failure was not to have used the exceptional period of rapid growth and low interest rates to substantially reduce its debt burden. Any sudden surge in the deficit, any upward hike in interest rates, was likely to topple it from just about managing to insolvency. That is precisely what happened in 2008. In response to the crisis, the conservative New Democracy government abandoned all fiscal restraint, and at the same time, interest rates for Greece as a weaker sovereign borrower surged.
In July 2009 Athens alerted the Eurogroup to the fact that its deficit might be heading toward 10 percent of GDP or more. But at that point neither side thought it convenient to go public. The break came on October 4, when the Greek electorate turfed out the center-right New Democracy party and gave a large majority to a reform-minded PASOK government. Two weeks later George Papandreou’s administration broke the silence.5 Athens announced to Eurostat, the European statistical agency, that its deficit would exceed 12.7 percent. At a stroke the budget revisions for 2009 took Greece’s debt burden from 99 to 115 percent of GDP. Deficits running into the tens of billions adding continuously to the existing stock of debt, combined with surging interest rates, would soon make the problem impossible to contain. In 2010 alone Greece was due to make repayments totaling a massive 53 billion euros. That would have placed a strain on any borrower. But Greece’s problems were not due to illiquidity. It was insolvent. To actually stabilize its debts it would, according to one calculation, need to raise tax revenues by 14 percent of GDP and cut expenditure by the same amount. That was politically impossible. What Greece needed to do was to restructure, to agree with its creditors to reduce their claims. To do anything else, to add new loans to an already insupportable debt burden, would postpone the problem but at the price of increasing its scale.
Of course, restructuring was an unpopular option with the creditors. As recently as 2007 Greece’s bonds had traded at virtually the s
ame yield as Germany’s. They were widely held. At the end of 2009, of Greece’s 293 billion euros in public debt outstanding, 206 billion were foreign owned, 90 billion were held by European banks and roughly the same amount by pension and insurance funds. For those claims to be written down would relieve the burden on Greece. But it would also tumble Greece out of the club of respectable European borrowers. At an earlier moment in its history PASOK might have turned a national bankruptcy into a liberating rupture.6 By 2009 it was no longer that kind of political party. Restructuring would involve Athens in humiliating negotiations with its creditors. It would most likely involve the IMF. Indeed, restructuring was not just unpopular, it was unspeakable. If you hoped somehow to postpone the inevitable and muddle through, the crucial thing was to preserve confidence. Even mentioning the possibility of restructuring was likely to precipitate a panic, shut off short-term funding and make immediate default inevitable. In due course, however, whatever tactic you adopted, the math was inexorable. Greece’s debts were too heavy and growing ever more so. Restructuring was inescapable. But rather than a clean cut, what transpired was a prolonged and agonizing rearguard action clouded by obfuscation and the endlessly repeated tactic of “extend and pretend.”
Where did this twisted path begin? As good a place to start as any is in the spring of 2010, when Greek prime minister Papandreou visited Paris for meetings with President Sarkozy and his government. The French made clear that they did not want a crisis. Nor did they want to hear talk of restructuring. They wanted to mobilize funds to bail out the Greeks. Since the turmoil of the fall of 2008, when Budapest had been driven into the arms of the IMF, a secret committee of the larger European states had been meeting to discuss how the eurozone would respond if one of its members was sucked into a Hungarian-style crisis.7 Paris and the European Commission were united in wanting a Europe-wide solution. To the Greeks this was no doubt reassuring. As would be true throughout the eurozone crisis, there was little or no anti-bailout hysteria in France.8 Though the French would contribute almost as much in per capita terms to every eurozone rescue measure as Germany, and only fractionally less in overall terms, the issue was never politicized to the same degree. But that begs the question, why was Paris so willing to consider throwing good money after bad in Greece?
President Sarkozy never missed an opportunity to score points at the expense of Anglo-Saxon finance. All the more embarrassing that in Greece it was France’s banks that were most exposed. Paribas was the largest foreign holder of Greek debt. Credit Agricole had a large exposure through a Greek subsidiary. And the most fragile bank of all was Dexia.9 But why, we have to ask, was Paris so acutely concerned? The balance sheet of BNP Paribas was solid enough to absorb losses in Greece. Dexia’s direct exposure to Greece came to only 3 billion euros. Under normal conditions, that was hardly a life-threatening amount. The fact that it was a matter of concern was due, first of all, to the dire state of Dexia’s balance sheet. It was truly a weak link and no one in 2010 wanted to fix it. The public would not stand for another bank bailout. And the concerns went far beyond Dexia and its ilk. The entire business model of Europe’s biggest banks, even French national champions like BNP Paribas, was a cause for concern. They continued to rely on wholesale finance. If their credit began to fail, they were at the mercy of commercial paper and repo markets. Confidence in funding markets had not recovered from the shocks they had suffered since 2007. A shock to confidence in the eurozone might lead to a general withdrawal of funding. What was at stake was not just Greece, but the far larger network of cross-border debt, in which France’s stake, like that of other rich country lenders, was truly enormous.
Altogether, foreign bank lending to what became known as the eurozone periphery—Greece, Ireland, Portugal and Spain—topped $2.5 trillion. Of that total, France’s banks had c. $500 billion at stake and Germany’s banks had roughly the same. Most of that lending and borrowing was not to governments. Spain and Ireland had been swept up in the gigantic real estate inflation that was now painfully deflating. In Spain, in particular, there was reason to fear for the stability not of the government’s finances but of local mortgage lenders. Beyond the periphery, what was even more worrying was Italy’s public debt. Italy’s budgetary situation was far more tightly controlled than that of Greece’s. Indeed, prior to the crisis, it had been running primary surpluses (ahead of debt interest payments). But its debt level was worryingly high, and in May 2008 the Italian premiership had been taken by Silvio Berlusconi, who, despite his business credentials and his conservative coalition partners, was regarded as a dangerous opportunist. No one wanted the flames of panic to leap to Italy. Beyond Italy was Belgium and then France itself. It was this three-tiered structure of debt that drove the politics of the eurozone crisis from the French point of view: the small bankrupt sovereign debtors—Greece and Portugal—at the bottom; then the victims of the real estate boom with big liabilities from the banking crisis—Ireland and later Spain; and finally the really big public debtors, led by Italy. As far as Paris was concerned, the long-term sustainability of Greece’s debt was less important than holding this giant pyramid in place.
The Eurozone Debt Pyramid (in $ billions)
Note:
(1) other exposure includes derivative contracts, guarantees and credit commitments
(2) figures for sectoral exposure for Italy for 1st quarter 2010 calculated by applying proportions reported for Q4 2010
(3) figures for other exposure to Italy for Germany, Spain and France calculated by applying proportions relative to total foreign claims for Q4 2010
Sources: BIS Consolidated Banking Statistics and BIS Quarterly Review, September 2010, http://www.bis.org/publ/qtrpdf/r_qt1009.pdf.
It was no doubt reassuring to Athens to receive such a sympathetic welcome in Paris. But it should have set off alarm bells. Should Greece wish to be the place where France fought its battle for the eurozone’s financial stability? Was a bailout designed to minimize the risk to Europe’s over-expanded banks and to avoid embarrassment for politicians likely to be in the best interests of Greek taxpayers? The risks to Greece were obvious. On the French side too one might wonder whether, if the aim was to solidify the eurozone, the best tactic was to delay a straightforward and thorough resolution of Greece’s huge debt burden. If it was a question of picking a line of defense, was Greece really where one would choose to make one’s stand? To use the ugly metaphor that would soon circulate widely in the eurozone, might it not have been better to amputate the gangrenous limb, to push Greece aggressively toward restructuring?10 There were risks on both sides. Paris opted for extend-and-pretend.
On the German side it looked, at first, as though a similar attitude might prevail. Germany’s banks, like France’s, were heavily exposed to the weaker eurozone borrowers. The logic of systemic stability was not lost on Berlin.11 In February 2009, when pressure first built against Greece and Ireland, Finance Minister Peer Steinbrück had calmed markets by announcing: “If one country of the eurozone gets into trouble, then collectively we will have to be helpful. The euro-region treaties don’t foresee any help for insolvent countries, but in reality the other states would have to rescue those running into difficulty.”12 A year later, when Papandreou’s government was looking for help, Josef Ackermann, the energetic CEO of Deutsche Bank and president of the IIF, was to hand. He traveled to Athens in early 2010 to offer a public-private loan of 30 billion euros.13 It is conceivable that with both Berlin and Paris on board, applying a sticking plaster might have calmed markets and reduced yields to the point where Greece could limp on. But the debt was piling up inexorably. And what would have happened when the eurozone was hit by the next shock, from Ireland or Portugal? For an insolvent borrower new debt is a makeshift, not a solution.
In any case, by the spring of 2010 the counterfactual was moot. When Germans went to the polls on September 27, 2009, after a bitterly fought campaign, they threw Steinbrück a
nd the SPD out of office. Angela Merkel continued as chancellor, but now in coalition with the free-market, tax-cutting FDP.14 They were more to the chancellor’s ideological taste, but she was now operating from a far narrower political base and would have to pay even more attention to the home front. To the satisfaction of conservatives, Steinbrück was replaced as finance minister by Wolfgang Schäuble. Schäuble was a committed European integrationist of the 1980s Helmut Kohl generation. As a Christian conservative of the cold war era he had a capacious strategic vision for the EU as an upholder of Western civilization in an age of globalization.15 For Schäuble, the Rechtsstaat, the legally bound state, was the anchor of his conception of the West, and as finance minister the debt brake anchored in the constitution was his particular legal preoccupation. The CDU’s new coalition partner, the FDP, was a probusiness, tax-cutting party, so that constrained Schäuble on the revenue side. What Germany and Europe needed was fiscal discipline. If Greece could not make the grade, then Schäuble since the 1990s had been an unapologetic advocate of a vision of a multispeed Europe, in which a core group set the pace while less competitive and disciplined nations brought up the rear. On February 11, 2010, the Merkel government shocked markets by agreeing with its partners to take emergency measures to support the euro as such, but vetoing any specific offer of help for Greece. As one EU official told journalists, “Germany is stepping totally on the brakes on financial assistance. On legal grounds, on constitutional grounds and on principle.”16