Crashed

by Adam Tooze

  The bond market was no longer the principal arbiter of Greece’s financial fate. But for that it substituted the full weight of the troika, the IMF, the EU, the ECB and the national governments of Europe. It was now with them that Athens would have to negotiate its financial future. This had two sides.11 On the one hand, as nonmarket lenders, the Greek Loan Facility and the EFSF could decide on loan terms by political fiat. In 2010 the terms had been punitive. By the spring of 2012 the EFSF was offering Athens long-dated loans on concessionary terms. Though the headline debt figure remained exorbitant, annual debt servicing charges were more modest. On the other hand, without the “private cushion,” the politics of Greek debt were now stark. Concessions to Greece came directly at the expense of the troika, and that meant, above all, the taxpayers of the rest of Europe. Negotiations would be tough and overtly political. And they could not be avoided. The 2012 restructuring had not answered the question of Greece’s solvency. The question of restructuring would return.

  In 2009 when the crisis began, Greece’s public debt had stood at c. 299 billion euros.12 As a result of the crisis it had surged to 350 billion euros. The 2012 deal cut it back to 285 billion euros. But in the interim, as a result of the recession, the eurozone crisis and the policies demanded by the creditors, the Greek economy had crash-landed. Whereas in 2009 Greece’s GDP had stood at roughly 240 billion euros, in the course of 2012 it would slump to 191.1 billion euros.13 If Greece’s debts had been unsustainable in 2009, in 2012, even allowing for the concessions granted by the official creditors, it clearly still was. In the interim, Greek society had been battered beyond recognition.

  In 2008 Greek unemployment had been 8 percent. Four years later it was rising inexorably toward 25 percent. Half of young Greeks were without jobs. In a nation of ten million, a quarter of a million people were fed daily at church-run food banks and soup kitchens. Meanwhile, the Greek parliament had been reduced to a factory for decrees demanded by the troika. In the eighteen months following the May 2010 bailout, the Athens parliament had whipped through 248 laws, one every three days. By 2012 it wasn’t only the trade unionists and the Greek Left who were up in arms. Judges, military officials and civil servants were mounting resistance to the subordination of the Greek state. And there were other ways of expressing dissatisfaction and distrust. In the spring of 2012 the draining of funds from Greek banks accelerated at an alarming rate. As the election now scheduled for May 2012 approached, the euro system was discreetly sluicing billions in cash into Greece to preserve a veneer of normality. In total, 28.5 billion euros were quietly airlifted into Greece to disguise the size of the bank run.14

  On May 6 the population was finally given its say. The result was a spectacular demonstration of quite how deep disillusionment went.15 PASOK, the party that since the 1970s had been identified more than any other with Greece’s democratic transformation and which had had the misfortune of governing during the worst of the crisis, saw its vote share fall from 43.9 to 13.2 percent. The new left-wing movement, Syriza, together with the Communist KKE, garnered almost twice as many votes as PASOK. On the Right, New Democracy plunged from 34 to 18 percent, while the fascist Golden Dawn scored 7 percent. Even with the fifty-seat parliamentary bonus awarded to New Democracy as the leading party in the polls, no government could be formed. New elections were called for June 17. In the meantime, Greece hung in midair. There was no mandate for a government that was willing to accept responsibility for the measures that the Eurogroup insisted were essential for it to remain in the eurozone. As Schäuble and numerous other European politicians made clear, the Greek vote in June would be a referendum on its continued euro membership.16

  II

  The Greeks were not the only voters to deliver their verdict on the track record of Europe on May 6, 2012. That same day, in the second round of the French presidential elections, the voters rejected Sarkozy in favor of the Socialist, François Hollande.17 Sarkozy’s promise to hold France in line with Germany was not what the voters wanted. Hollande had campaigned on an antiprivilege, antibank platform, proposing taxes on higher earners and on financial transactions.18 He promised that he would renegotiate Merkozy’s fiscal compact of December 2011. The key to sound finances, as the new French government saw it, was not self-defeating austerity but growth. Crucially, Hollande gained not only the French presidency. The Socialists also won the National Assembly elections in June.19 There was a solid majority in France, it seemed, not for conformity to the Merkozy vision but for change.

  And the mood was shared on the Left in Germany. Though they had coauthored Germany’s own debt brake, the SPD was alarmed by the disastrous development in the eurozone. They were soaring in the polls, and what the SPD demanded in 2012 was a new focus not on debt and fiscal sustainability but on growth. And this appeal received support from an unexpected corner: the IMF. The emphasis on the paradox of thrift in the G20 briefing for Mexico City was the first sign of a major shift in Fund thinking on fiscal policy.20 In the summer of 2012 its staff revisited the forecasts they had made in the spring of 2010 as the eurozone crisis began and discovered that they had systematically underestimated the negative impact of budget cuts. Whereas they had started the crisis believing that the multiplier was on average around 0.5, they now concluded that from 2010 forward it had been in excess of 1.21 This meant that cutting government spending by 1 euro, as the austerity programs demanded, would reduce economic activity by more than 1 euro. So the share of the state in economic activity actually increased rather than decreased, as the programs presupposed. It was a staggering admission. Bad economics and faulty empirical assumptions had led the IMF to advocate a policy that destroyed the economic prospects for a generation of young people in Southern Europe.

  The conservative coalition in Berlin was losing its grip. In the French presidential election Merkel’s engagement on the side of Sarkozy had been unabashed. She refused to make even a token appearance with Hollande, who was publicly challenging the fiscal compact. It was probably to Hollande’s benefit. Now Berlin would have to hold the line without its major European partner.22 Nor were Merkel’s problems only across the Rhine. At home, the popularity of the CDU-FDP government was sagging. The coalition had been built on the extraordinary surge in support garnered by the market-liberal Eurosceptic FDP in 2009 in the wake of the first phase of the crisis and the unpopular bank bailouts. By 2012 that support was fading. On May 13 the CDU faced important regional elections in Nordrhein-Westfalen (NRW).23 With a population of 17 million and a GDP almost three times that of Greece, NRW was the largest state of the Federal Republic. Home to the Ruhr, it was a former heavy industrial area struggling to find a place for itself in a world in which China, not Germany, made the steel. Tellingly, the polls in NRW were triggered early because of the inability of its regional government to draft a budget in conformity with the debt brake that the grand coalition had imposed on Germany in 2009.24 For Merkel, the result was devastating. The SPD surged. A new protest party, the Pirates, entered the regional parliament, and Merkel’s CDU slumped to 26 percent. It was by far the worst result for her party in this crucial state since the founding of the Federal Republic.25

  And then, as if to compound the political upheavals of May, the last aftershock of the real estate crisis struck, in Spain. Along with Ireland, Spain had the distinction of experiencing one of the most extreme housing bubbles in the world. When that burst, the effect, as in Ireland, was devastating. The difference is that Spain is big—with a population of more than 45 million, compared with Ireland’s 4.5 million. Before the crisis, Spain’s economy was comparable in size to that of the state of Texas. So the bursting of the Spanish bubble was an event of macroscopic proportions. As the housing market collapsed, Spain’s unemployment rate shot up. Of the 6.6 million increase in unemployment in the eurozone between 2007 and 2012, 3.9 million was accounted for by Spain—60 percent of that grim total. As bad as Greece’s situation was, it was small by comparison and accounted f
or only 12 percent of the increase in eurozone unemployment. Most catastrophic of all was Spain’s youth unemployment rate, which by the summer of 2012 had surged to 55 percent.26 Even allowing for an extensive black economy, it was a deeply dismaying statistic.

  Unlike Dublin, Spain’s social democratic government managed to keep the travails of its mortgage banks—the regional cajas—out of the headlines in the first phase of the global crisis.27 A bailout fund took many of the worst loans off their books. In 2010 the weakest cajas, many of them entangled with Spain’s two leading political parties, were aggregated in a bad bank, Bankia/BFA. The number of cajas was cut from 45 to 17, but at the price of creating a larger and more dangerous entity. At 328 billion euros, Bankia’s balance sheet ran to 30 percent of Spanish GDP. Not surprisingly, despite endorsement by global investment banks, the attempt to sell Bankia shares to global investors was an embarrassing flop. In November 2011, as the crisis reached its height, the socialists called a snap election, which handed power to a new conservative government headed by the People’s Party of Mariano Rajoy. It is unclear whether Rajoy’s cabinet grasped the severity of the situation. Perhaps Spain’s Christian Democrats hoped for solidarity from Berlin. If so they were disappointed and Madrid’s tone toward the EU became more belligerent.28 New loss provisions called for from the Spanish banks were inadequate to calm the markets. By the spring of 2012 only huge injections of liquidity from the ECB were keeping Spain’s financial system afloat. But maintaining liquidity was not the same as restoring solvency. On May 9, 2012, Bankia declared that it was on the point of bankruptcy and urgently needed recapitalization. By May 25, with Bankia under new management, the figure had risen to 19 billion euros in new capital.29 With its economy already depressed, the last thing Spain needed was a new round of banking crises, and it would be even worse if a bank bailout spiraled, Irish style, into a bank-sovereign doom loop. Following the Bankia announcement, yields on Spanish public debt surged to 6 percent and then began to inch up toward 7 percent, above which Spain’s debt burden would begin to snowball as rising debt service costs further inflated the deficit.

  By May 2012 it was clear that Europe was once again sliding toward the edge. Bond market yields were rising around the periphery. It was a dire outlook. According to IMF figures, in the course of 2012 alone, Europe’s governments and banks needed to roll over and refinance debts amounting to an impressive 23 percent of GDP.30 They simply could not afford interest rates to surge out of control as a result of a panic in Spain.

  III

  It was the looming crisis in Spain that forced the question of comprehensive eurozone reform, which had been blocked by Merkel over the winter of 2011–2012, back onto the agenda. At the end of April, speaking to the European parliament, Draghi called for a political road map to frame further moves toward fiscal union. Meanwhile, France’s new president and Mario Monti’s embattled government in Rome were coordinating their positions. With Italy’s yields inching ominously upward, Monti needed a Europe-wide fix. Would the Spanish crisis result in a basic change in position or simply another iteration of German delaying tactics? If Merkel continued to veto any talk of sovereign debt pooling, would she be more flexible on the issue of bank recapitalization? Would a banking union with collective responsibility for banking supervision and bailouts finally unlock the door to a eurozone solution?

  On June 9, 2012, eurozone finance ministers agreed that the situation in Spain was so urgent that Madrid should be provided with 100 billion euros from EU resources to fund recapitalization.31 To stop the doom loop, however, what was required was a separate Europe-wide bank bailout fund that had the resources to intervene in and recapitalize banks directly. If instead the funds injected into the Spanish banks were booked to the Spanish government’s accounts, it risked amplifying the crisis. As if to prove the point, on June 14, 2012, Moody’s downgraded Spain to a rating of Baa3, one notch above junk. The future of the European Union, Spain’s foreign minister declared, would be played out in the next few days. And, as he reminded Berlin, when the Titanic sinks “it takes everyone with it, even those travelling in first class.”32 Indeed, the casualties list might stretch beyond Europe. Spain was not in Italy’s league. But from Spain the crisis could easily spread outward. As had repeatedly been the case since 2010, the eurozone’s failure to resolve its internal problems made Europe into the world’s problem.

  In May 2012 the telephone log of Tim Geithner at the US Treasury shows an ominous spike, with dozens of calls to Brussels, the IMF and eurozone finance ministers.33 At the Camp David meeting of the G8 on May 18–19 Obama took Merkel and Monti aside for an eyebrow-raising two-and-a-half-hour side meeting. In November 2011, at the G20 in Cannes, the eurozone had dominated the talks. Nine months later, as the G20 summit convened in the glaring sunlight of the gated Mexican resort of Los Cabos, Europe was still at the top of the agenda. The world’s policy experts, politicians and media had to come to terms with the fact that the eurozone’s problems were not only not fixed but getting worse by the day. The impatience was palpable. At a press conference on June 19 the questions put to commission president Barroso were so aggressive that he lost his cool. In response to a Canadian journalist asking about the risks to North America emanating from the eurozone, Barroso snapped back: “Frankly, we are not here to receive lessons in terms of democracy or in terms of how to handle the economy. . . . This crisis was not originated in Europe. . . . [S]eeing as you mention North America, this crisis originated in North America and much of our financial sector was contaminated by, how can I put it, unorthodox practices, from some sectors of the financial market.”34 And continuing in this self-righteous vein, Barroso added that Europe was a community of democracies. Finding the right strategy took time. Several of the G20 were not even democracies. What did Europe have to learn from them?

  Clearly, old hierarchies died hard. But, equally clearly, Europe needed help. At Cannes, Obama had tried to work through Sarkozy to shift the German position. That had failed. Sarkozy would not risk a breach with Merkel. By the summer of 2012, Washington had more levers to bring to bear. Italy’s premier, Mario Monti, had visited the White House early in 2012 and was hailed by Time magazine as a potential savior of Europe.35 Though he was the godfather of the Bocconi school of neoclassical economics and a classic Italian free-market liberal, Monti had become convinced that the eurozone bond markets could no longer be trusted. Speculators were pricing into their assessment of Italian and Spanish bonds not the particular fiscal situation in those countries but the probability of a systematic breakdown. The talk was of “redenomination” risk and for that there could only be a collective solution. But to shift the eurozone into action, Monti needed allies. Washington was supportive. But it was the break in the Merkozy front in May 2012 that was decisive. Not only was the newly elected Hollande pressing for a new emphasis on stimulus and growth but officials in the French Treasury were coming around to the idea of a banking union. The speculative pressure they had seen unleashed in the autumn of 2011 when Dexia failed and France’s own credit rating was in doubt had convinced them that without risk pooling no one was safe.36 As a third, Monti and Hollande could count on Mariano Rajoy, Spain’s Christian democratic prime minister. Rajoy was no visionary. Indeed, he often gave the impression that he barely grasped the extremity of Spain’s situation. But there was no doubt that Madrid desperately needed the talk of a eurozone breakup to end.

  On the second day at Los Cabos, Obama and Monti sprang a trap. In a one-on-one meeting with Merkel, the American president presented the German chancellor with a plan that had been drafted by the Italians.37 The scheme proposed that for states that were running suitably responsible fiscal policies, the ECB or the ESM should put a cap on bond market yields. If yields rose above the threshold of sustainability, this would trigger intervention to restore a more normal level of interest rates. It would be a quasi-automatic mechanism that did not require intrusive inspection or supervision of the troika varie
ty. Merkel indignantly refused even to discuss the idea on the procedural grounds that it had not been cleared in advance with her staff. She would accept no proposal that blurred the line between monetary and fiscal policy from whatever source it came. For the Germans the “autonomy” of the ECB remained sacrosanct. The tone was tense and it was thought that it would be best to cancel the after-dinner plenary that had been scheduled at Obama’s request. Enough had been said in private conversations. No one wanted to repeat the scenes at Cannes.

  Once more Merkel had stopped a transatlantic push for emergency action. But pressure was now building on both sides of the Atlantic. On June 17, to general relief, the Greek election had clarified the political scene to the point at which a new government could be formed. PASOK was wiped out. Voters now clustered around New Democracy on the Right and Syriza on the Left.38 For those opposed to the troika Syriza was now the main choice. Samaras formed a government on June 20. A government was better than no government, but given Samaras’s track record during the crisis to date, it was hard to know what to expect. Would he stick to his commitment to honor the agreements of the Papademos government? The answer was far from obvious, and planning for the possibility of Grexit continued. In any case, by June 2012 Greece was no longer the main concern. If some concerted collective action plan was not put in place, Spain was in mortal danger and Italy would soon follow.

  Scrambling for leverage, Monti and Hollande convened a meeting in Rome on June 22 to agree on a Growth Pact for Europe, notionally to be worth 130 billion euros in investments and tax breaks. They knew that Merkel was vulnerable because her FDP coalition partners were trying to save their skins by rallying the Eurosceptic vote and opting out of the chancellor’s European policy. This left Merkel dependent on the opposition SPD, who were coordinating their position with the French Socialists.39 The SPD demanded German backing for a growth agenda as the price for their votes in the Bundestag. Further multiplying the fronts on which Merkel had to fight, on June 26 the so-called quadriga—European Council president Herman Van Rompuy, European Central Bank head Mario Draghi, European Commission president José Manuel Barroso and Eurogroup chair Jean-Claude Juncker—returned to the vision that Berlin had vetoed in December. They proposed a banking union backed by eurozone-wide deposit insurance and a joint crisis fund. Nor did they shrink from suggesting the need for shared debt issuance.40 Merkel’s response was not long in coming. Within twenty-four hours she used a meeting of her coalition partners, the FDP, to announce: “There will be no collectivization of debt in the European Union for as long as I live.”41 In Germany the drumroll against additional eurozone bailouts was mounting. Merkel’s room for maneuver was further tightened on June 21 when the Federal Constitutional Court ruled that in agreeing with France’s demand to bring forward the creation of the ESM to the summer of 2012, the government had violated the Bundestag’s right to prior consultation. The message was clear. There must be no backdoor bailouts.