Tuesday 25 October 2016

Leather jackets and poor diplomacy no excuse to botch up Greece again

Like the Greeks, Irish taxpayers have unfinished business with the ECB

Published 21/06/2015 | 02:30

Greek Finance Minister Yanis Varoufakis
Greek Finance Minister Yanis Varoufakis

Tomorrow's emergency summit of eurozone leaders will consider whether a deal can be fashioned to keep Greece in the common currency area.

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Greece has already had two 'rescues', in 2010 and 2012, from the EU and the IMF. The country became the first casualty of Europe's common currency experiment and needs a solution, not another deal to extend-and-pretend.

The left-wing Greek government has been resisting another short-term fix and they have enjoyed widespread support outside Greece from economists and financial commentators of all political persuasions. The same economists and financial commentators were unhappy with the previous Greek rescue efforts, predicted their failure and have been proved right by events. Once a country with a weak economy gets into unsustainable debt burdens, it is always best to face the music and impose losses on foolish lenders. The victims are getting blamed.

The Greek election in October 2009 was won by the centre-left PASOK party which discovered over the following months that large debts had been hidden by the previous government. The budget deficit was also far bigger than had been reported. By the spring of 2010, Greece had lost its ability to borrow in the markets at reasonable cost. Government debt was around 120pc of GDP, well into the red zone.

The projected deficit for the year ahead was another 10pc and was not likely to fall in a hurry, since the economy had begun to contract. It was the judgment of economists at the IMF that the Greek public debt, owed almost entirely to private holders of government bonds, was unsustainable. They were overruled and the Troika was born to supervise a three-year programme of official loans with no haircuts for the unwise financiers of the Greek borrowing spree. A haircut for government bondholders at that point would have imposed consequential losses on creditors including the Greek domestic banks. Lenders to the Greek banks would have faced knock-on losses.

Rather than accepting the inevitability of losses for Greek creditors, the Troika lent €110bn in May 2010, enough to pay holders of maturing debt in full. This was the original sin of eurozone crisis mismanagement. Its critics included Karl Otto Pohl, the former president of Germany's Bundesbank, who refused to see it as a rescue of Greece:

"It was about protecting German banks, but especially the French banks, from debt write-offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24pc. Looking at that, you can see what this was really about - namely, rescuing the banks and the rich Greeks."

It was mainly the fault of Greek politicians that the unsustainable debts were accumulated in the first place. But lenders are always complicit in a debt explosion and were relieved of any share of the costs by the May 2010 Troika decision.

This was a particularly damaging capitulation by the IMF, which stretched its own rules in an unprecedented way: the IMF normally insists on haircuts for private creditors, sufficient to ensure debt sustainability, before it commits to a lending programme.

The Greek economy was already in a vertical nosedive in May 2010. The government cut spending and increased taxes in line with Troika recommendations. As predicted by the sceptics, the deficit did not close and the debt mountain continued to grow. By 2012 it was clear that a haircut of surviving government bondholders had to be faced, and this was duly executed to the tune of €105bn. This was the biggest sovereign default in world history and the first in Western Europe for 60 years. The 2012 deal arose because the 2010 deal failed. The need for another rescue now reflects the failure in turn of the 2012 deal.

Most Greek sovereign debt is now owed to the official lenders, the EU countries, the IMF and the European Central Bank. There are few private holders of Greek bonds left, since they have been paid off with the official loans and Greece has been unable to issue new bonds. Greece needs a new debt restructuring and this can only be at the expense of the official lenders. If you believe that foolish lenders should take losses, the EU, IMF and ECB are in the firing line.

The response of the European authorities has been to resist debt forgiveness and to blame the Greeks for failing to implement the ill-designed programmes of 2010 and 2012. In the most extreme versions, the Greeks have been caricatured as having flatly refused to reform. This is simply untrue: notwithstanding the contraction of the economy, the primary budget deficit has been virtually eliminated, an extraordinary turnaround in the circumstances. The bloated public service headcount has been slashed and there have been extensive reforms to the ill-designed pension system. In its June 2014 report on Greece, the IMF acknowledged the extent of the efforts made by the centre-right Samaras government replaced by Syriza in January and by its predecessor since 2010.

Syriza has unwisely reversed some reforms but the measures taken are minor in the overall scheme of things. The key Syriza demand is for some form of further debt relief and they are surely correct in this: with state debt around 180pc of GDP, the economy weak and bank liquidity draining away, there is no point in lending Greece more money to refinance an unaffordable debt burden.

Official lenders do not like to take haircuts. In the case of the IMF, a credit union for governments, the involvement in Greece has been disastrous. The fund never takes haircuts, it is supposed to impose them first on whoever extended too much credit to begin with. The fund rewrote its own rulebook in 2010 when it co-financed the extend-and-pretend bailout, the rescue lifeline, according to Karl Otto Pohl, for the French and German banks. It should forgive some of the Greek debts and send the bill along to the French and German governments, which should have stood behind their own banks in 2010 instead of off-loading the burden on the insolvent Greek Treasury.

The same manoeuvre, albeit on a smaller scale, was executed by Jean-Claude Trichet's ECB in the Irish programme, despite objections from IMF economists, who were once again overruled at political level. As Kevin Cardiff's evidence confirmed at the banking inquiry on Thursday, Irish taxpayers have unfinished business with the ECB. For the eurozone, the possible departure of Greece has been airily dismissed: firewalls are in place and we are continually reminded that Greece accounts for just 2pc of the eurozone's GDP.

The snag is that it will account for 100pc of the market's collective memory the next time a eurozone sovereign struggles to borrow. Bond yields will rise faster and bank deposits flee quicker next time round. If the next panic is in Ireland or Portugal or Slovenia, well and good. If it is in Spain or Italy, the far larger fire will face a far lower wall courtesy of the Greek exit.

As for Syriza, the options are capitulation to another long-fingering exercise likely to fail, or default and exit from the eurozone. It is remarkable that a new government, bearing no responsibility for the genesis of the latest crisis, should be faced with these horrible alternatives.

The government has been accused of poor diplomacy and their finance minister has been wearing leather jackets to meetings in Brussels. These are not good reasons for completing a hat-trick of botched financial programmes in a eurozone member state.

Sunday Independent

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