Crashed
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Berlin’s refusal to stick to the bailout script was worrying for the French and shocking for the Greeks. But it should have been no surprise. Article 125 of the Maastricht Treaty banned mutual bailouts. The Lisbon Treaty that finally came into operation in December 2009, just as the Greek crisis exploded, had reinforced the primacy of nation-state responsibility. It also barred the route to the mutualization of debt, which might have allowed a European consortium to share the burden of backstopping some portion of Greece’s liabilities. In a crucial judgment on the Lisbon Treaty delivered on June 30, 2009, the German constitutional court had put a further obstacle in the way of any further moves toward EU integration.17 Karlsruhe insisted on a stiff test of democratic accountability before any further competences could be transferred to Brussels. What Berlin would agree to on February 11, 2010, was last resort, ultima ratio support for the euro as such. What that meant for a “bad apple” like Greece was unclear. Certainly, Greece should slash its deficits and engage in labor market reform to boost growth. But Germany was in no mood for a bailout. The vast majority of German politicians and public opinion appeared to be willing to let the markets have their way with both Greece and its creditors. If a debt write-down was necessary, so be it. If Athens was unable to pay, then there was support in Germany across the entire political spectrum for the debts to be restructured at the expense of the banks.18 Polls showed that two thirds of those who supported assistance for Greece also demanded that banks must contribute to the package.19 These calls were reinforced by lobby groups such as the league of German taxpayers that demanded private sector involvement.20 It was a harsh and high-risk approach, whose appeal to the German public was consistent with the fact that they tended to blame “other people’s” banks and to underestimate the exposure of their own country’s financial institutions.
This was the basic dilemma of the eurozone debt crisis. Greece needed a write-off. The Germans were not opposed and favored haircutting the creditors. But Greece’s PASOK government did not want to pay the price for a problem in large part created by its predecessor. It wasn’t just the state’s debts that would have to be restructured but the Greek banking system too. The entire Greek social and political fabric was at stake. The French opposed a write-off and Paris had backing not just from other European debtor nations but from the ECB as well. The ECB was aghast at the prospect of a sovereign default in the eurozone. What about the risks of contagion? Surely what Greece needed was a healthy dose of financial discipline. That was a popular answer. Austerity was the medicine forced down Greek throats for years to come. But the budget adjustment required was unrealistic and its impact on the Greek economy was devastating. As restructuring was, in the end, inevitable, the question ought to have been how to make it safe, how to build a framework within which debts could be written down and losses inflicted on creditors without unleashing a general panic. The problem was that to even say this out loud was to risk triggering a run before the safety net was ready. While engaging in extend-and-pretend and denying the need for restructuring, it was hard to generate momentum for any collective European effort at institution building. And it could not be done without Germany, which, though it did not shrink from restructuring Greece and its creditors, was anything but enthusiastic about putting in place the mechanisms necessary to make restructuring safe.
The German reluctance was shortsighted but understandable. Already by the spring of 2010 it was clear that a comprehensive solution to the problem of the sovereign debt crisis required (1) an aggressive recapitalization of Europe’s banks to allow them to survive the losses, an undertaking on which Europe was lagging behind the United States already in 2009; (2) a European fund to back this bank recapitalization because otherwise the effort might destabilize the fragile finances of smaller states, a proposal already vetoed by Berlin in October 2008; (3) the ECB would need to stabilize bond markets either by providing liquidity to Europe’s banks or by active purchases along the lines of the Fed’s programs, though outright monetization of debt was barred by the ECB treaty and conservative opinion in Germany abhorred any such intervention; (4) a European TARP, backstopped by the budgets of national governments to buy the sovereign debts of the weakest European states, a proposal blocked by the Lisbon Treaty’s ban on mutualization. It was to make all of this somewhat less inconceivable in political terms that one arrived back at financial discipline (5). Taxpayers in solvent northern counties such as the Netherlands and Finland, but above all Germany, would need to know that they were not being taken advantage of. Before there could be any mutualization of liabilities, there would need to be an agreement on fiscal rules. The bar had been set in May 2009 by Germany’s debt brake constitutional amendment. Anything less was a compromise as far as Berlin was concerned. It was the working through of these interlocking problems that would make the road to containment, let alone resolution of the Greek debt crisis, such an agonizing one. All the while the financial markets looked on with a mixture of anxiety, impatience and an eye to the speculative profits to be made by trading on uncertainty.
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The search for a solution began in early 2010 in Schäuble’s finance ministry. Apparently without prior coordination with Angela Merkel’s chancellery, Schäuble proposed that the EU should establish a European Monetary Fund (EMF), able to conduct within the eurozone the kind of restructuring, stabilizing and disciplining role that the IMF played on the global stage.21 One version of the EMF idea, pushed among others by Deutsche Bank’s chief economist, Thomas Mayer, was for the fund to backstop debts up to a limit of 60 percent of a country’s GDP. Above that level debts would undergo restructuring, with bondholders taking a proportional and uniform haircut.22
It was a strikingly ambitious proposal that reflected Schäuble’s deeply held federalist European commitments. He was keen to use the crisis to push forward the agenda of European integration left unfinished at Maastricht in 1992. If Berlin had thrown its full weight behind the idea of an EMF and if its budget had been set to an appropriate size—what were needed were hundreds of billions of euros—the crisis might have taken another course. If Berlin had risen to the challenge it is hard to see how the rest of the eurozone governments could have resisted. Something very much like this is what they would eagerly settle for in 2012. But this opportunity for German leadership on the crisis went begging. In the spring of 2010, Schäuble’s scheme was shot down, by friendly fire.23 Chancellor Merkel was no European federalist. She had no desire to reopen the terms of the Lisbon Treaty for which she had fought so hard and which was only just coming into operation. She was not about to endow Brussels with its own monetary fund. She was far too skeptical of Europe’s capacity for self-discipline and she had the German constitutional court’s Lisbon ruling to think about. She understood that radical measures were necessary, but her own proposal, rather than creating an EMF, was simply to involve the IMF in disciplining the eurozone.
Forcing Greece to go to the IMF appealed to German conservatives.24 The Fund, with its ambitious French managing director, Dominique Strauss-Kahn, was keen to be involved. But there was also hesitation. The IMF had already put tens of billions of euros into Eastern Europe. The eurozone would take even more. In a new age of globalization, was a deep engagement in Europe the right direction for the IMF to be headed? And in dealing with European countries with powerful representation on the Fund’s own board, could the Fund’s economists be certain that their expertise would prevail? Specifically, would the Europeans take the IMF’s advice on the question of restructuring? Did they even understand the policy that the IMF was duty bound to pursue? Following its disastrous experience in Argentina’s financial crisis in 2001, the IMF had established new rules.25 The Fund would lend only to solvent borrowers, otherwise there must be restructuring. And if it was to lend, it would insist on lending early, before panic set in. Given the scale of speculative firepower that could be mobilized in leveraged financial markets, to lend once a run had started was likely to
be both expensive and ineffectual. Given how far the Greek crisis had already progressed by the early months of 2010, it was hard to argue that it met either of these criteria.
Here again one can glimpse the possibility of an alternative path: Could Berlin have backed an IMF demand for immediate Greek restructuring? Certainly the Fund’s own retrospective analysis suggests that this would have been the better path.26 But Merkel’s veto on the European Monetary Fund idea suggests the main obstacle to any such strategy. She was not willing to contemplate the additional flanking measures that would be necessary to make a restructuring safe. And the proposal to involve the IMF rallied the rest of Europe against her. Indeed, Merkel’s own finance minister, Schäuble, let it be known that he would regard IMF involvement as a “humiliation” for Europe.27 For Sarkozy it was unthinkable that the IMF should be involved at all: “Forget the IMF. The IMF is not for Europe. It’s for Africa—it’s for Burkina Faso!” he told the Greek government in early March.28 The ECB, likewise, was absolutely opposed both to anything that entailed debt restructuring and to IMF involvement. It was bad enough for American mortgage-backed bonds to have unleashed the banking crisis. For Trichet it was simply unthinkable that the sovereign signature on eurozone public debt would not be honored in full. And to involve the IMF in Europe’s internal affairs was to add insult to injury. Trichet’s objection was not that the IMF was for Africa, but that it was “American.”29
Trichet had reason to be worried about the outside world, because when it came to the eurozone, it was to the ECB that all eyes turned. If the ECB was a central bank, like the Fed or the Bank of England, there was no need for there to be a sovereign debt crisis at all. Greece had not borrowed in dollars. It had borrowed in euros and had delegated the sovereign power to print its own currency to the ECB. Its fate and that of the entire rest of the eurozone was in Trichet’s hands. All the ECB had to do to stop the destabilizing surge in Greek interest rates was to do what central banks do all over the world: buy sovereign bonds. Of course, bond buying was no long-term solution. Greece needed restructuring, fiscal discipline and economic growth. But at stake was the financial stability of a vast economic area. The Greek public debt was a tiny part of Europe’s financial system. The treaties that founded the ECB limited its right to buy newly issued Greek debt. But it could buy outstanding bonds as part of a market stabilization effort. If the ECB did not intervene it was a matter not of economics but of politics and over the winter of 2009–2010 it seemed that Europe’s central bankers were determined to take a tough line. Rather than continuing the generous liquidity provision it had offered in 2009, the ECB allowed the LTRO scheme to expire.30 Then in April 2010 it began to discuss a new regime under which it would apply graduated repo haircuts to lower-rated sovereign bonds, limiting their attractiveness to banks.31 Trichet was engaged in the high-risk gamble of substituting pressure in the bond markets for the eurozone’s missing federal structures of fiscal and economic governance. With the ECB looking on, surging bond yields would force the Greeks to get serious about fiscal discipline and economic reform. In taking this line, Trichet was not only satisfying his own agenda. He was also appeasing the Bundesbank and its hawkish, monetarist head, Professor Axel Weber. Any kind of bond purchases by the ECB were seen in Germany as an inflationary menace. Furthermore, and more pertinently, they were understood to be a form of debt mutualization by stealth. By way of the balance sheet of the ECB, German taxpayers would end up as creditors to the rest of the eurozone.32 So too, of course, would all the other shareholders in the ECB. But it was Germany’s portion that German Eurosceptics worried about.
Throughout the early months of 2010 the argument was deadlocked. Market pressure on Greece intensified. Foreign investors were unloading what Greek debt they could sell. Hard-liners in Europe might see this as a legitimate way of imposing discipline, but for investors the lack of resolution was unsettling. Who might be next? Ireland? Italy? For the Greek government it was, frankly, terrifying. On May 19, 2010, Athens was due to make payments of 8.9 billion euros. It was not obvious where they would find the cash. Desperate for a way out, the PASOK government looked for help from across the Atlantic.
In the spring of 2010 visitors from Europe bearing bad news were not welcome in the White House. The Obama administration had been closely following the developing Greek debt crisis and had appealed to the Europeans to act fast.33 But it was itself mired in domestic political mud. Thanks to the botched Massachusetts special election in January following the death of Teddy Kennedy, the Democrats had lost their filibuster-proof majority in the Senate. The passage of health-care reform had become a grueling war of attrition. Dodd-Frank seemed stranded. The last thing the Treasury and the Fed needed was a new crisis. But by the spring of 2010 it was clear that the failure of the Europeans to deal with Greece was threatening precisely that.
Once before, sixty-three years earlier, a political crisis in Greece had triggered a transformation in US policy. On March 12, 1947, after the British had declared their inability to defeat the Communist insurgency in the Greek civil war, President Truman announced the doctrine of containment, one of the opening moves in the cold war. That summer, Truman’s secretary of state, General George Marshall, would back up containment with his legendary promise of economic aid for Europe. In 2010 there was no antagonist like the Soviet Union to force the Obama administration’s hand. What made Greece into America’s problem was not a global clash of ideologies, but the money coursing through the circulatory system of transatlantic finance. America’s mutual funds had hundreds of billions of dollars at stake in Europe’s banks, above all French banks. It was those same banks that were exposed in Greece. And the US branches of those same European banks were also major lenders to US households and firms. Any eurozone financial crisis would blow back on America.
On March 9, 2010, a month after Germany blocked the push for a quick Greek rescue, President Obama and his top economic advisers, Larry Summers and Tim Geithner, took time to meet with the Greek prime minister and his delegation. Obama’s message was encouraging. Washington would vote its 17 percent share for IMF assistance and would throw its weight behind an approach to Merkel requesting aid from the EU.34 Opposition to IMF involvement from France and the ECB would be overridden. But the White House made one thing clear. There could be no talk of debt restructuring. “We cannot have another Lehman,” Obama emphasized. Whether Greece’s debts were sustainable was not America’s concern. Washington’s priority was containing financial contagion. Restructuring could not be contemplated until the Europeans had found a way to stabilize bond markets and were ready to push through wholesale recapitalization of Europe’s banks. And given the Franco-German deadlock, no such agreement seemed likely.
It was from this force field of interests that the first iteration of extend-and-pretend emerged. Europe entered an emergency regime defined not by a single sovereign author, but by the absence of any such authority.35 At an EU summit on March 25, 2010, overriding objections from both the French and the ECB, and with Washington on her side, Merkel forced through the involvement of the IMF.36 It would be a joint EU-IMF action, as in the Baltics the previous year. But this time the ECB would be fully engaged. A committee of the EU, the ECB and the IMF would make up the soon to be infamous “troika,” dictating policy to Greece and the other “program countries.” What was ruled out was restructuring. On that Washington sided with the French and the ECB. Existing Greek debt would be paid off with new loans from the troika, whether or not the result was sustainable. The IMF would have to bend its operating procedures to the occasion. To satisfy Merkel’s insistence on the Lisbon rules, the “European” component would not consist of measures taken collectively via the central institutions in Brussels or jointly funded by the member states. That would require treaty change and might violate the line drawn by the German constitutional court. Instead, it would consist of individual national credits for Athens on a bilateral and voluntary basis coordinated
through the Eurogroup, the powerful but informal meeting of the eurozone finance ministers. To avoid the appearance of a bailout—banned by Maastricht—the loans would not be on concessionary terms. Interest rates would be stiff and there would be a processing fee to compensate the lenders for their trouble. Finally, and most important, the support would not be provided preemptively to forestall a loss of market confidence. It would be offered only as an ultima ratio, if and when Greece lost access to the markets. It would be up to Greece, by means of austerity, to forestall that moment for as long as possible.
For ordinary Greeks this meant pay cuts across the public sector. Contract workers were not renewed. The cap on dismissals from the private sector was lifted. The pension age was raised. VAT and other consumption taxes were hiked. An economy already under pressure was subjected to a further contractionary squeeze. A population that already had one of the lower standards of living in Europe was pushed further down the scale. The Greek labor movement mobilized in furious protest. But it was enough at least to satisfy the bond markets. In the last days of March 2010, Athens was able to issue a final tranche of long-term debt: 5 billion euros for seven years at just under 6 percent. Perhaps not surprisingly, investor demand was lukewarm.37 Europe was preparing a safety net. The only question was when Greece would tumble off the ledge.
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