by Adam Tooze
As Draghi reminded the readers of the Financial Times shortly after taking over at the ECB, he was a veteran of Italy’s tough stabilization efforts of the 1990s.70 In August 2011 Draghi cosigned Trichet’s ultimatum to Berlusconi demanding changes to Italy’s public services and labor markets. Draghi shared with his predecessor both the frustration over Rome’s evasiveness and the foot dragging of the rest of Europe’s governments. On December 1, 2011, Draghi marked the beginning of his ECB presidency by appearing before the European Parliament to throw his weight behind the Merkel-Sarkozy plan for fiscal discipline.71 And his sympathy with German demands for “reform” was unfeigned. As Draghi told the Wall Street Journal in February 2012, Europe’s social model that prioritized job security and social welfare was “already gone.” What, after all, did talk of a social model mean when 50 percent of Spanish youth were unemployed?72 Europe’s labor markets would have to be reinvented, presumably along the lines of Germany’s Hartz IV agenda. In his grad student days at MIT in the 1970s, Draghi recalled, his American professors had marveled at Europe’s willingness to “pay everybody for not working. That’s gone.” For the new head of the ECB there was “no feasible trade-off” between labor market reform and fiscal austerity. “Backtracking on fiscal targets would elicit an immediate reaction by the market,” and Draghi made clear that he had no intention of softening that discipline. In December 2011 in conversation with the Financial Times, he refused to discuss putting the ECB behind the EFSF as the ultimate guarantor of the EU’s firewall. Nor would he countenance talk of QE for Europe. He started his term in office by insisting that Trichet’s bond-buying program, the securities market program, was neither “eternal nor infinite.”73 Indeed, given Draghi’s subsequent reputation, it bears repeating that as of 2012, his first year in office, bond buying by the ECB ceased. His priority was to restore a “system where the citizens will go back to trusting each other and where governments are trusted on fiscal discipline and structural reforms.”
What Draghi was willing to do immediately was to prop up the banks.74 The swap lines were one mechanism. Another was to revive the ECB’s familiar device of cheap bank funding. With credit markets spooked, in 2009 and 2010 Europe’s banks had been forced to resort to increasingly short-term funding sources, which now needed to be rolled over. If they could not find new funding the eurozone was threatened by a major credit crunch.75 Already in October 2011 the ECB had announced that it would be offering liquidity to the European banking system in the form of the long-term refinancing operation (LTRO)—long-term loans at highly favorable interest rates.76 Draghi opened the spigot, offering financing at favorable rates over the unprecedentedly long term of three years and taking much lower grades of collateral.77 On December 21, 2011, 523 banks took 489 billion euros in funding. In February there were 800 takers for another 500 billion. Of the first tranche of the LTRO, 65 percent went to banks in the stressed periphery—Italy, Spain, Ireland and Greece.
Though Draghi hastened to explain that this was “obviously not at all an equivalent to the ECB stepping-up bond buying,” in due course the trillion euros in LTRO loans would feed back into bank purchases of sovereign debt.78 This raised demand in bond markets and lowered yields. It supported the sovereign debt market. It allowed banks to earn easy profits on the spread between the 1 percent charged by the ECB and the 5 percent on offer for those willing to hold Italian government bonds.79 But as in 2009, it came at a price. Rather than allowing Europe’s fragile banks to unload dubious assets in exchange for safe cash, as QE did in the United States, the ECB’s program added to their holdings of peripheral government debt.80 Spanish and Italian banks were particularly proactive. Banks and sovereigns were thus tied ever more closely together. And neither side was safe. On January 14 S&P conducted a review of its European sovereign ratings and downgraded seven of them. France and Austria lost their prized AAA rating. Portugal was reduced to “junk.” Within the eurozone only Germany, the Netherlands, Finland and Luxembourg retained their coveted AAA rating. Even the eurozone’s own bailout fund, the EFSF/ESM, was at risk of a downgrade. The Europeans protested, as had Washington following its downgrade by S&P, but this time the ratings agency was firm in its judgment. Months of negotiations had “not produced a breakthrough of sufficient size” to warrant optimism about the eurozone’s future.81 Despite the Sturm und Drang of the fall of 2011, the political impasse had not been broken. Control of the timeline was everything, and Berlin set the pace. At the G20, outside the Cannes Palais des Festivals on November 5, Merkel had opined: “The debt crisis will not be solved all in one go, [and] it is certain that it will take us a decade to get back to a better position.”82 That was revealing as to Germany’s time horizon, but the question was, did the rest of Europe have that long?
Chapter 18
WHATEVER IT TAKES
In the first half of 2012 the rotating presidency of the G20 fell to Mexico. On Friday, January 20, 2012, a week after the S&P downgrade of eurozone sovereigns, finance officials from around the world assembled in Mexico City. On their agenda was a remarkable request. The eurozone members of the G20 were calling on the rest of the world to contribute $300–400 billion in additional funding to enable the IMF to backstop crisis fighting, not in an emerging market or in one of the less-developed countries of sub-Saharan Africa but in Europe. The non-European members of the G20, led by the United States, China and Brazil, considered the European request and turned it down. As Mexico’s deputy finance minister remarked to the press: “There is a recognition of the measures Europe has taken. But it’s also clear that more needs to be done.”1
Amid the din of world events, the incident barely warranted a headline. But the location of the meeting, the nature of the request and the response by the rest of the G20 add up to a remarkable historical denouement. It was also indicative of the precarious state in which the eurozone was left hanging by the bruising battles of 2011. The G20 and S&P concurred: The Europeans had not done enough. They had not squarely addressed the basic instabilities with regard to the sovereign bond market and bank recapitalization, which had sucked the IMF into its engagement in Europe back in 2010. They had eventually recognized Greece’s insolvency and were on the point of pushing through a debt restructuring. That was essential, but haircutting Greece’s creditors served only to increase pressure in bond markets. In political terms, Europe had satisfied the German insistence on austerity, which Berlin promised would open the door to further steps toward integration. But December 2011 revealed how reluctant Berlin was to actually make the next move. Meanwhile, the consensus that had been built around austerity policies in 2010 was beginning to crumble.
The European fiscal compact of December 2011 was imposed by force of Franco-German cooperation. But Sarkozy was up for reelection in May 2012, and his main rivals for the presidency, the Socialists, were campaigning against the agreement. That was predictable. What was less so was that the IMF itself would be calling for a rethink. In its briefing for the full meeting of finance ministers and central bank governors that would convene in Mexico City on February 25–26, 2012, the IMF’s headline was stark. The “overarching risk” to the world economy was of an intensified global “paradox of thrift.” As households, firms and governments around the world all tried to cut their deficits at once, there was an acute risk of global recession. “This risk is further exacerbated,” the IMF went on, “by fragile financial systems, high public deficits and debt, and already-low interest rates, making the current environment fertile ground for multiple equilibria—self-perpetuating outcomes resulting from pessimism or optimism, notably in the euro area.”2 The place where the paradoxes of thrift were most visible was Greece.
I
In the protracted struggle to get to the October 2011 debt deal for Greece, the entire discussion had revolved around the Greek budget and concessions to be made by its creditors. The 50 percent haircut had been forced through in the hope of getting Greece to a debt level of 120 per
cent of GDP. From there, according to the mandatory fiscal adjustment procedure specified in Sarkozy and Merkel’s fiscal compact, it would be possible to get Greece down to a debt ratio of 60 percent of GDP, the target originally specified in the Maastricht Treaty. The fiscal arithmetic was pleasing, but what it ignored were the feedback loops highlighted by the IMF. The problem in achieving debt sustainability was Greece’s collapsing GDP as much as it was its elevated debt level. By the time of the discussions in Mexico in early 2012, it was clear that the deal hammered out three months earlier was no longer viable, not because the Greek government or the creditors were reneging but because the Greek economy was contracting too fast.3
For many European governments, at this point enough was enough. They could not ask their parliaments to consider yet another Greek rescue. It was time to consider more radical options. Rather than trying to manage a negotiated restructuring, perhaps it would be better to leave Greece to its fate. An outright default might result in Greece tumbling out of the eurozone. But Greece would at least be free of its debts. And if new borrowing was shut off, Athens would be forced to adopt fiscal discipline as a matter of sheer survival. It was in early 2012 that top-secret planning began for the eventuality of a Grexit.4 Work on the so-called Plan Z would continue until August 2012, when it was finally stopped by Berlin. It was stopped because the upshot of the planning exercises was always the same. It would likely be ruinous for Greece, and the ramifications of Grexit for the rest of Europe were entirely unpredictable. They were unpredictable because Europe still had not built an adequate shield to protect the other fragile eurozone members from the fallout from a Greek bankruptcy. It was to reinforce and extend that inadequate safety net that the Europeans were applying to the G20 to support an expanded IMF facility. But the G20’s answer was clear. The rest of the world would regard Grexit as a failure not just of Greece, but also on the part of the larger European states that pretended to global standing as members of the G20. On February 19, 2012, Japan and China, in a rare show of unity, declared that they were willing to back the appeal for increased IMF funding, but only if the Europeans raised the cap on the ESM stability mechanism, to which the Bundestag was clinging.5 The Europeans must help themselves first.
The ESM expansion would come at the end of March.6 Berlin blocked any truly dramatic move. But by counting the money already disbursed to Greece, allowing the EFSF facilities to continue and raising the combined lending limit of EFSF and ESM to 700 billion euros, Europe could claim that it was mobilizing a firewall of 800 billion euros or “more than USD 1 trillion.” It was a fudge that allowed the IMF board to sign off on continued support for Europe’s stabilization efforts. But what no one in Europe wanted to do in early 2012 was to renegotiate the Greek deal of October 2011.7 The governments had committed 130 billion euros and that was the limit. If Greece was sliding further away from sustainability, it was up to the Greek government to make further savings, and up to the creditors to make further concessions. A new round of negotiations with the IIF began in February, which yielded an increase in the haircut from 50 to 53.5 percent. What was left of the Greek debt would be exchanged for two-year notes backed by the EFSF and long-dated, low-coupon bonds. For this modest advance on the October program to offer any hope of fiscal sustainability, it would take extreme discipline on the part of Athens, and that begged the next question. Having ousted Papandreou as prime minister in a backroom coup after aborting his referendum proposal, the troika had fashioned for themselves a cooperative government in Athens. But by the same token, Papademos, the central banker turned prime minister, lacked legitimacy. Elections were scheduled for April 2012 and he would surely lose. The main opposition party, New Democracy, had presided over the onset of the crisis and had consistently refused to support Papandreou’s government in the negotiations since 2010. So that placed any new agreement with Athens in question from the start. How were the Greeks to be nailed down? With typical forthrightness, German finance minister Wolfgang Schäuble suggested that perhaps it would be better for the Greeks not to hold elections.8 Suspending Greek democracy would allow the key measures to be put through before the voters were given a chance to have their say. But that suggestion provoked outrage in Athens. So, instead, what the troika managed to extract was a promise from the hitherto evasive leader of New Democracy, Antonis Samaras, that if he were to take office he would abide by any deal negotiated by his predecessors. Whatever happened in the elections, the fiscal program would have priority. On that basis Greece and its creditors engaged in the latest round of extend-and-pretend.
To describe the debt restructuring of 2012 in these terms—as no more than a continuation of the makeshift measures that had characterized the Greek debt crisis from the beginning—may seem unduly dismissive. The restructuring that was forced on the creditors of Greece between February and April of 2012 was the largest and most severe in history, larger in inflation-adjusted terms than the Russian revolutionary default or Germany’s default of the 1930s.9 By April 26, 2012, 199.2 billion euros in Greek government bonds were converted in exchange for 29.7 billion in short-term cash equivalent notes drawn on the EFSF and 62.4 billion in new long-term bonds at concessionary rates. All told, Greece’s private creditors had conceded a reduction of 107 billion euros. Allowing for the much later repayment of the new long-term bonds, the net present value of claims on Greece was cut by 65 percent. In December 2012 the claims of private creditors were further reduced by a buyback of the recently issued long-dated bonds.
Greek Public Debt Before and After 2012 Restructuring
Dec ’09
Feb ’12
bn euros
Dec ’12
Feb ’12
% of debt
Dec ’12
Bonds held by private creditors
205.6
35.1
58.7
12.2
Treasury bills held by private creditors
15
23.9
4.3
8.3
EU/EFSF
52.9
161.1
15.1
56.0
ECB/National Central Banks
56.7
45.3
16.2
15.8
IMF
20.1
22.1
5.7
7.7
Total debt
301
350.3
287.5
100.0
100.0
Source: Jeromin Zettelmeyer, Christoph Trebesch and Mitu Gulati, “The Greek Debt Restructuring: An Autopsy,” Economic Policy 28, no. 75 (2013): 513–563.
The problem was that the funds to sweeten the deal and induce the creditors to engage in the “voluntary” write-down did not come out of thin air. Nor did the money to pay for recapitalizing the Greek banks in the wake of the restructuring, or to pay for the December 2012 buyback. All this was funded by new borrowing from the troika. Furthermore, the 56 billion euros in Greek bonds held by the ECB were exempt from the 2012 restructuring. So the overall reduction in Gre
ece’s debt burden was far less than advertised. As a result of the debt restructuring of 2012, Greece’s public debt was reduced from 350 billion to 285 billion euros, a 19 percent reduction. The really dramatic transformation was not in the quantity of debt but in who it was owed to: 80 percent was now owed to public creditors—the EFSF, the ECB or the IMF. In effect, Greece swapped a reduction of its obligations to private creditors of 161.6 billion euros for an increase in obligations to public creditors of 98.8 billion euros.
This substitution was the one constant in the endlessly shifting politics of Greek debt: public claims replaced private debts. And this is revealed even more starkly if we look not at stocks of debt but at flows of funds.10 Of the 226.7 billion euros that Greece was to receive in financing from European sources and the IMF between May 2010 and the summer of 2014, the vast majority flowed straight back out of Greece in debt service and repayment. Creditors in Greece and elsewhere received 81.3 billion euros in repayment of principal. Those creditors lucky enough to have debt maturing before the date of the restructuring were paid in full. It was precisely the arbitrariness of this outcome that led the IMF, under normal circumstances, to oppose emergency lending to insolvent debtors. For Greece they had made an exception on “systemic” grounds. On top of that, 40.6 billion euros were used to make regular interest payments, again to creditors in both Greece and the rest of the world. To sweeten the debt exchange of 2012, 34.6 billion euros were used to provide some incentive to those who had clung to their bonds. Recapitalizing the Greek banks, whose balance sheets were destroyed by the restructuring, took 48.2 billion euros. This meant that altogether, of the 226.7 billion euros in assistance loans received by Greece, only 11 percent went toward meeting the needs of the Greek government deficit and directly to the benefit of the Greek taxpayer.