July 19th, 2015
After five years of punishing recession which wiped out a quarter of GDP and led to an alarming 60% rate of youth unemployment and 20% wage deflation, on July 5 the Greek people overwhelmingly voted against bailout conditions that only seemed likely to push them further into a downward spiral.
Then on Monday, a deal was presented which set draconian conditions for a third bailout worth €86 billion, and for liquidity support for Greek banks from the ECB which might avoid Grexit, but which exceeds the ferocity of the kind of post-war reparations meted out to a defeated enemy.
The loss of fiscal and legislative sovereignty signals an intervention that goes beyond the presence of an inspectorate of the creditors in Greece. There was no talk of growth plan and no firm commitment to debt rescheduling which will be considered only “if it is deemed necessary”. It was the culmination of a process which has studiously avoided some clear and crushing truths.
Since its election in January, the main message of the Syriza government to the Troika of creditors (the European Commission, the European Central Bank and the International Monetary Fund), has been that Greece is close to bankruptcy and is unable to meet its debt repayments. On June 30, Greece defaulted on a $1.6 billion loan repayment to the IMF. This came amid capital controls, bank holidays and a €60 limit on ATM withdrawals.
A Debt Sustainability Analysis, released by the IMF on July 5 and updated since gave the very same message as Syriza – that Greek debt was unsustainable. The IMF pointed to the need for “debt relief on a scale that would need to go well beyond what has been under consideration to date”. Until then the premise of the Greek creditors had been – and it continues to be the view of many in the Eurogroup – that Greek debt is sustainable if only the Greeks were less feckless and continued to tighten their belt. Faced with these kinds of racial slurs, it is important that some key facts are made clear.
How did Greeks borrow so much?
It is ordinarily not the business of private banks to hold large quantities of government bonds. But, in a chilling account, Viral Acharya and Sascha Steffen show how, despite differences in country risk ratings, the so called Basel II regulatory framework permitted banks to hold government debt with zero capital.
This zero-risk weight on government bonds combined with cheap short-term credit encouraged a roaring “carry trade”. What that essentially means is that banks would borrow money cheaply from central banks, use it to buy high-yielding debt from countries on the eurozone periphery and pocket the difference. Greek bonds gave the highest returns in the eurozone. It’s like you or I taking out a loan at a 1% interest rate to lend money to a struggling neighbour at 10%.
The problems only start, of course, when your neighbour can’t pay you back. The moral hazard grew with the private risk-taking behaviour by banks. Costs of failure were ignored and the banks ramped up their exposure to the periphery countries even as yield spreads – a measure of how risky the debt is – widened between March and December 2010.
Of course, this was not the only bit of debt mismanagement over the past decade. Housing bubbles were blown up too in Spain and Ireland as banking supervision failed to control a tempting era of cheap money for banks. We have seen plenty of examples of how bad regulations can fail to raise alarm bells even when the sums and the risks are equally vast. There was a flow of more than €1 trillion from banks in Germany and France to the periphery.
Further, given the lack of a single fiscal authority, there is a clear stabilisation problem for these hot capital flows between eurozone countries. In the absence of a flexible exchange rate it needs an institutional solution that reflects forethought and economic inventiveness at institutions such as the ECB, IMF or the EU. Otherwise adjustments will take the form of extreme GDP and wage deflation.
Bailouts swapped bank profligacy for the Troika
Greece had €350 billion of debt in 2010. Five years later that figure has hardly budged after a period in which the Troika effectively bailed out the mostly French and German banks which were owed money by Greece. This extraordinary step in 2012 may have avoided a so-called disorderly default – and it did at least see private investors accept the loss of half the money they were owed – but it eventually forced Greece into a worse position.
It was negotiating now with the IMF and eurozone partners who had stumped up taxpayer money to keep Greece solvent and were loath to let the country off the hook – for political reasons as much as economic.
Anil Kashyap of the Chicago Booth School of Business concluded that:
the stealth rescue of the non-Greek banks was completed with little public attention and the narrative that all the problems were self-inflicted by the Greeks became more pronounced.
But surely the buyout of private sector Greek debt was not simply to prevent a disorderly default by Greece? It could have been constructive. Troika ownership of Greek debt could have come with the kind of long-term 30 to 70-year maturity typical of UK and German war bonds held by the US in order to give them a chance to recover and grow. According to the Financial Times the average maturity on Greek debt at the beginning of 2015 was 16.5 years.
As noted by Jeromin Zettelmeyer, the debt buyback failed to significantly shift the payment profile into the future. There was bunching of payments at the short end of the maturity profile and a Sword of Damocles left hanging over the Greeks: Any slippage or a default, on payments to the ECB in particular, would invite the threat of Grexit.
It all smacks of an inability to face reality. The IMF had to maintain a fiction of the solvency of the Greek government in order to make a loan to Greece in 2010, but by 2012 it was clear even to board members including India and Brazil that, in order for Greece to pay the official creditors back, the debt rescheduling must make allowances for the macroeconomic conditions. Fast forward to this month and it is arguable that the explicit IMF acceptance of the need for debt relief was the crucial concession which at last won Greece some allies in France and Italy in the eurogroup.
Syriza has made a useful target, but for those who need evidence of the Troika medicine killing the patient, even before Alexis Tsipras' government came to power, then the following data from the World Bank can put things into perspective. Greek banks, despite their recapitalisation in 2012, experienced an accelerated growth of non-performing loans of 30% and more in 2013. This is the best indicator of a failing economy.
Greece Ratio of Nonperforming Loans to Total Loans (%) World Bank
Clearly, honest brokers and good economics in dealing with the Greek and eurozone crisis have been in short supply. The objective of the Troika should be to kickstart growth in Greece and make that the vehicle for debt repayments rather than aim to implement austerity and regime change which have sunk two previous governments and sent the Greek economy into a tailspin.