by Adam Tooze
On March 30 the markets were rocked by news not from Greece but from Ireland. The bill for recapitalizing Ireland’s bankrupt banks was soaring. For Anglo Irish Bank alone, Dublin was now budgeting 34 billion euros, more than Ireland’s tax revenue in 2010. Soon Ireland’s deficit would be worse than that of Greece’s.38 In Ireland it was the banks pulling the sovereign down. In Greece the mechanism worked the other way around. Canny depositors in Greek banks were aware that their savings were invested in the government bonds that Athens was struggling to service. In the early months of 2010, 14 billion euros were withdrawn from Greek banks and shifted elsewhere in the eurozone. The first to move were the oligarchs moving huge sums by way of Cyprus, but they were soon followed by middle-class depositors pulling out a few thousand euros at a time.39 Bereft of sources of funding, the Greek banks turned to the Greek central bank, their local branch of the ECB, where Trichet continued to allow them to repo downgraded Greek government bonds. This was a vital life support system and it gave the central bank a whip hand not just over the Greek government but over Greek society and the economy at large. Without approval from Frankfurt there would be no money in the ATMs, but nor would there be any restructuring of Greece’s insupportable debt.
In April, as the troika argued over who would contribute what and how large the Greek bailout package would be, time ran out.40 A downgrade by the Fitch credit-rating agency sent Greek government debt yields surging to 7.4 percent. On the morning of April 22, Eurostat announced that its estimate of the Greek deficit in 2009 had now risen to 13.6 percent of GDP. Ireland’s was even larger, at 14.3 percent. Spreads on Greek bonds surged to 600 basis points, raising the borrowing rate to 9 percent, effectively shutting Greece out of the market. The moment had come to reach for the last resort. Urged on by both Schäuble and Geithner, the Greek government triggered the emergency mechanism. Greece needed a lot of money and there was no time to lose.
It was a coincidence but a symbolic one. On the evening of April 22, hours after the Eurostat release had rocked the markets, the world’s financial elite were gathered in Washington, DC, for the spring IMF meeting. The evening’s entertainment was at the Canadian embassy and it was time for some frank talk. The crisis had moved beyond the European arena. The eurozone now posed a threat to global financial stability. Since March China had been demanding action to defend the value of global investments in euro-denominated assets.41 As Alistair Darling, Britain’s Chancellor of the Exchequer, recalled, the mood was urgent: “You can’t overstate the fact that America, with increasing incredulity and anxiety, was watching Europe’s inability to act. . . . The message was, ‘Why can’t you take action? You know you’ve got to do something.’”42 As the Financial Times put it, the failure of the eurozone to restore stability on its own terms meant that by April 2010, the “rescue” of the euro, “the ultimate expression of European integration, depended on outsiders in international institutions and the US administration.”
But no deal emerged from Washington. The troika was only beginning to haggle with Athens over the terms of a rescue loan. Markets were left hanging. On April 28, 2010, the bottom fell out. The official chronicle of the German finance ministry is, as one might imagine, a sober document. This is how it describes events in Europe’s sovereign bond and interbank money markets that day:
“The crisis becomes dramatically acute. Risk premiums for government bonds in some Eurozone member states such as Portugal, Ireland and Spain increase rapidly and reach levels equal to that which prevented Greece from accessing the financial markets in April. In an echo of the final dramatic phases of the financial crisis [of 2008], there is virtually no interbank lending between European banks. Within a very short period, there are overall signs of an acute pending systemic crisis.”43
What this official narrative disguises is Berlin’s own role in precipitating the “acute pending systemic crisis.” Ahead of vital regional elections in early May the public agitation in Germany against assistance for Greece was ferocious. The FDP, Merkel’s coalition partner, which saw its popularity among its free-market nationalist supporters plunging, played the anti-Greek card uninhibitedly, narrowing the chancellor’s room for maneuver. To remind Merkel of the global stakes, on April 28 Dominique Strauss-Kahn and Jean-Claude Trichet both flew into Berlin.44 But despite the increasing panic, there was no deviation from the minimalist script that Berlin had laid down on March 25. Indeed, Merkel stirred the fires of speculation by reminding the press that admitting Greece to the euro had been a mistake and that Germany’s contribution to whatever relief effort emerged would be a voluntary decision taken on terms decided in Berlin.45 It was not the kind of talk to calm markets. Greek spreads surged to 1,000 basis points, and by the end of the day Washington was sufficiently alarmed for Obama to place a personal call to the chancellery.46 Nor was Merkel’s the only phone ringing in Europe. The logs for Geithner and his staff recall almost daily contact between Washington and Berlin, Frankfurt and Paris.47 Governments from around the world were pressing the EU to act.
Finally, in the first days of May, the deal was done. Greece agreed with the troika not only to slash its deficit but to aim for a surplus. It promised to deliver a turnaround in its budget balance of a staggering 18 percent of GDP.48 In 2010 alone the reduction of its deficit would be 7.5 percent of GDP. Every area of Greek public life would be touched, from ministerial contract cleaners to privatization of state assets. Everything was up for grabs. In exchange, Greece would receive a bailout far larger than previously conceived: 110 billion euros, of which 80 billion would come from the EU and 30 billion from the IMF, payable in quarterly installments over three years. The loans were at tough rates and it was clear that servicing them would create a repayment shock in 2013. But it was the best that the lending countries were willing to offer. Merkel promised an affirmative Bundestag vote for May 7. The question was whether the markets would give Europe that long.
Merkel presented the rescue package to the German Bundestag on Wednesday, May 5. It was, she declared, “alternativlos”—without alternative.49 Merkel’s rewording of Margaret Thatcher’s famous pronouncement—there is no alternative (TINA)—was to become notorious. Meanwhile, that same day Greece was rocked by a general strike that mobilized both main wings of the Greek labor movement and shut down transport and public services. In Athens protesters fought running battles with riot police. As the parliamentarians debated the austerity program in committee, a firebomb crashed through the window of a branch of Marfin Bank, setting the building alight and killing three staff members. Karolos Papoulias, the grizzled president of the Hellenic Republic and veteran of the Greek resistance in World War II, declared: “Our country has reached the edge of the abyss.”50 On May 6, the Greek parliament convened to vote through what was the most draconian austerity program ever proposed to a modern democracy. That morning, the ECB board was meeting in Lisbon and reporters e-mailed the news that the imperious Jean-Claude Trichet had refused even to discuss the possibility of stepping in to buy Greek bonds. Earlier in the week, on the back of the new fiscal program, the ECB had reluctantly agreed to continue repoing Greek debt, but actively buying bonds was a step too far.51 It was not what markets needed to hear.
When US trading opened—in the afternoon by European time—prices plunged. By one p.m. the market was down 4 percent. With the ECB refusing support, there was heavy trading in credit default swaps on Greek government debt. In a single day the Volatility Index (VIX), a measure of market uncertainty, surged by 31.7 percent. The euro plunged, losing 2.5 cents by early afternoon.52 What was going on between terminals on both sides of the Atlantic that afternoon would later become a matter of dispute in American courtrooms. But at 2:32 p.m. the market went into spasm.53 Half an hour later, by 3:05 p.m., the main American stock markets had given up 6 percent of their value, erasing $1 trillion from portfolios. As panicked traders fled to quality, demand for US Treasurys surged, driving yields down from 3.6 to 3.25 percent in a m
atter of minutes.
Thanks to the transatlantic time difference, news of the “flash crash” hit the BlackBerrys of the ECB board as they sat down to dinner in Lisbon. Eighteen months on from the Lehman crisis, it seemed that the delay in bailing out Greece was about to precipitate a second financial catastrophe. Even the head of the Bundesbank, the tough-talking Axel Weber, realized that the ECB could not maintain the hard line that Trichet had taken that morning. The “ECB must buy government bonds,” he exclaimed across the dinner table.54 For the conservative team at the head of the ECB, it was a dramatic moment. They understood that they needed to act. The world was watching. Athens was literally burning. Soon it might be Rome. But the ECB did not want to be the only buyer in the market. It was determined not to let Europe’s governments off the hook. It wanted austerity across the board. Furthermore, though the ECB might buy bonds to provide temporary support, what was needed, sooner rather than later, was a giant state-backed fund to provide confidence to the bond markets. Making European governments and taxpayers responsible for each other’s debts would create a nightmarish political entanglement, but it would at least reinstate the clear line between fiscal and monetary policy, on which the ECB founded its precious claim to independence.
The next day, on May 7, 2010, the tone at the meeting of the European Council was apocalyptic. Commissioner Rehn and President Trichet delivered dire warnings. “It’s Europe. It’s global. It’s a situation that is deteriorating with extreme rapidity and intensity,” Trichet insisted. As the Financial Times reported, it came as a shock to the sometimes provincial European Council: “Leaders of smaller eurozone countries not fully plugged into world financial markets had, until this moment, not appreciated the gravity of the crisis. But even more experienced leaders appeared stunned.” “[Nicolas] Sarkozy was white with shock,” reported one ambassador. “I’ve never seen him so pale.”55 But despite the sense of crisis, and despite the deal on Greece, there was no agreement on creating a general security umbrella for the eurozone as a whole. Sarkozy pointed the finger back at the ECB. How could Europe’s central bank stand by while the credit of Europe’s governments was ruined? Why was the ECB not acting like the Fed or the Bank of England? “Sarkozy was screaming: ‘Come on, come on, stop hesitating!’” recalled one EU policy maker. Sarkozy was backed by Italy’s Silvio Berlusconi and Portugal’s José Sócrates, both of whom had reason to fear a general sovereign debt crisis. But Merkel, the Dutch and the Finns all pushed back. The ECB was independent. It must be free to act as it saw fit. Friday, May 7, ended without agreement. But after events on Wall Street, it was clear that something big had to be done before trading resumed in Asia on Monday, May 10. The Europeans were going to have to move from the national bailout for Greece toward providing a more comprehensive financial backstop for their entire currency zone. They could not expect to handle their problems state by state through bilateral agreements with the IMF. Whereas a few weeks earlier they had balked at coming up with a few tens of billions of euros, now they were going to have to contemplate far larger numbers.
Under huge pressure from governments around the world, Europe’s leaders reconvened on the afternoon of Sunday, May 9.56 Obama had worked the phones to Merkel and all the other key European leaders. Ben Bernanke called an impromptu conference call of the FOMC to approve the renewal of the swap lines to the ECB, the Bank of England, the Swiss National Bank and the Bank of Canada.57 Likewise, the G7 convened a conference call to coincide with the meeting of the European finance ministers. Japan, Canada and the United States were on the line. At this crucial moment Schäuble was hospitalized by an allergic reaction to a medication. So Spain took the chair, and France’s finance minister, Christine Lagarde, found herself as the liaison between the two groups. With two phones on the go at once, she had the EU 27 in one ear and the G7 in the other. The scale of the bailout fund agreed was enormous: 60 billion euros came from the EU Commission funds, 440 billion from the European governments. Dominique Strauss-Kahn offered to use the IMF’s resources to back the fund at the same ratio that had been employed in Latvia the previous summer. But whereas tiny Latvia had needed only a few billion euros, now the IMF pledged 250 billion. It was by far the largest commitment the IMF had ever made to any program. The $1 trillion pledged to the IMF at the London G20 that was supposed to mark the advent of a new age of global firefighting would be deployed to rescue Europe. The figures were impressive, but the all-important question was how the rescue fund would be constituted and financed. Was this a first step toward the mutualization of sovereign debts, and thus a radical step beyond Lisbon? Berlin was not going to concede anything of the sort.58 The entire deal hung in the balance until a Dutch participant with expertise in shadow banking suggested that the European Financial Stability Facility (EFSF) be incorporated as a private special purpose vehicle registered in the tax haven of Luxembourg. Eurozone governments would contribute capital on a country-by-country basis without assuming any overarching intergovernmental “European” commitment.
Even in this makeshift form, the EFSF would take months to put in place. What was needed when trading resumed on Monday morning was immediate support for Europe’s bond markets. That could come only from the ECB. The EFSF agreement satisfied Trichet. The governments were now serious. The question was whether he could carry the board of the ECB, and specifically whether he could win over the Bundesbank. After coming around to bond buying at the moment of panic on May 6, Axel Weber had subsequently had a change of heart. He did not want to risk breaking ranks with German public opinion and his German colleague on the ECB board, chief economist Jürgen Stark. On his way back to Frankfurt from Portugal, Weber retracted his agreement. Nevertheless, on Sunday, May 9, Trichet put the proposal to the vote and won majority approval. He then waited to make any public announcement until the early morning of May 10, when Europe’s governments were finally ready to present their ramshackle bailout fund.59 The ECB would not move first.
Over the days that followed, the markets calmed. Despite the opposition from Germany, the ECB’s promise to buy helped. There was less rush to sell if there was a purchaser of last resort. But to make this commitment manageable for the ECB, there was one further, unpublicized facet to the deal. Even if there was no immediate restructuring of Greek debt, the banks should not be permitted to offload their entire holdings of distressed debt. A concomitant of the ECB’s bond buying, insisted on with particular force by Merkel and Schäuble, was that all the eurozone finance ministries would pressure their leading banks to refrain from selling their holdings of Greek and other troubled bonds. The bargain was never complete. In Germany, Deutsche Bank led a group that agreed to hold on to the debt for three years.60 But many smaller banks refused to take the pledge. And rumors quickly spread that of the first 25 billion euros in bonds bought by the ECB, the vast majority had come from France.
The IMF put its imprimatur on the deal at a meeting of the board on Sunday, May 9, 2010. With Strauss-Kahn on the ground in Europe, the chair in Washington was taken by John Lipsky, a Bush appointee who had alternated time at the IMF with stints at J.P. Morgan. No one around the table at the IMF’s headquarters was pleased with the situation.61 It was an enormous engagement. It was profoundly disturbing that it was being undertaken to manage a crisis in Greece, a comparatively rich European country, at the behest of the EU. The Greeks were being lent vastly more than their quota, the capital contribution that normally limited a country’s IMF borrowing rights. The Fund was required to share control over the program with the other members of the troika, and its own experts were far from persuaded that Greece’s debts were sustainable. As they put it cagily: It was undeniable that “significant uncertainties around” the program made it “difficult to state categorically” that Greece would ever be able to pay back its debts. Normally this would be a red flag. Who, after all, would benefit from Greece taking on new loans from official lenders to pay off existing private debts it could not service? The outspoken Braz
ilian board member insisted that the program not be referred to as “a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders, mainly European financial institutions.”62
One could hardly ask for a clearer statement of the “bait and switch” substitution, by which a problem of excessive bank lending was turned into a crisis of public borrowing.63 But this substitution resulted less from a skillful ideological conjuring trick than from a lowest common denominator compromise between the main players in the Greek debt drama—Germany, France, the ECB, the IMF and the Obama administration. Certainly at the IMF there was little illusion about the compromises they were entering into. On May 9 the tone in the room at the IMF board meeting was so negative that Lipsky felt it necessary to put the opposite case. Lipsky was fully committed to the White House line. He was a devotee of Geithner’s logic of maximum force.64 Indeed, Lipsky liked to embarrass his cosmopolitan IMF colleagues by calling for the Fund to adopt not the Powell Doctrine but “shock and awe,” the title the US military gave to their devastating aerial assault on Baghdad in 2003.65 From the chair at the crucial meeting in Washington on May 9, Lipsky recognized the concerns and criticism of his colleagues, but pronounced himself “a little disturbed by the suggestion that the Fund program should obviously have involved debt restructuring or even default.” Restructuring “would have had immediate and devastating implications for the Greek banking system, not to mention broader spillover effects.” This was what was ultimately decisive.
The IMF board approved the disproportionate and risky Greek bailout not because it made sense in its own terms, or was good for Greece, but because on the track record to date, Europe’s inability to contain the Greek crisis meant that there was “high risk of international systemic spillover effects.”66 Instead of restructuring Greek’s unsustainable debts, what would be restructured were its entire public sector and its creaky economy. Heroic assumptions about cost cutting and efficiency gains were the ways in which the IMF squared the Greek program with its conscience. Perhaps if it were shaken thoroughly enough, “sclerotic” and “clientelistic” Greece could be jolted onto a higher growth path that would make its debts sustainable after all. Austerity and “reform” were the only items on the agenda that the otherwise divided parties to the deal could agree on. Whether this was economically effective or politically sustainable and what it would mean for the democratic politics of Europe was another matter altogether.