As we are approaching the Greek election on 25.1.15, it would be useful to offer some background on the debt crisis and Greece’s troubles. This is an updated extract from my 2013 book Redefining the Market-State Relationship.
Background: Greece up till the first bailout in 2010
Shortly after a national election in 2009 which resulted in a change of government in Athens, Greece announced that its national debt and budget deficit had been misstated in the 2009 budget. In fact, the deficit shot up to 12.7% of GDP in 2009, while the national debt, according to the government’s own estimates, amounted in January 2010 to 125% of GDP (Reuters 2010). What followed these announcements was a crisis in the Greek bond market as investors lost confidence in the country’s ability to stay solvent, fearing that the banking crisis of 2008 is developing into a sovereign debt crisis in 2010. The practical failure of Dubai World in 2010 gave basis to these fears. This post focuses on Greece as an example of the political, legal and economic issues that the sovereign debt crisis has brought forward, marking a new stage in the world financial crisis.
Greece is still in 2015 a member of the European Union (EU) and of Economic and Monetary Union (EMU), having entered the Eurozone (as it is commonly referred to in the literature) on 1.1.2001. As such, the powers of the Greek government are restricted in economic management in the same way as for other Euro participating EU member states. As a result of entry to the EMU macroeconomic policy is severely restricted as the Greek government has no control over monetary policy. Faced with the legal restrictions on sovereignty imposed by the framework of the EMU, when presented with a loss of confidence in the markets Greece had very little room for manoeuvre. Countries with command of their monetary policy can deal with market pressures by devaluing their currency in order to maintain their export competitiveness. Such action is not open to members of the Eurozone who trade on the single currently, Euro. The only way a country can deal with a loss of competitiveness, without devaluing its currency, is by producing more efficiently, or by producing more cheaply. As efficiencies are difficult to achieve and time-consuming to implement, Greece has been pressured by its partners in the Eurozone to ‘reform’ its economy via cost savings. This means that Greece has to reduce wage spending which inevitably means that it has to lower the population’s standard of living. Such internal devaluation, it was hoped, would allow Greece to retain or to regain some of its lost comparative advantages, and mimic the effects of currency devaluation (which of course was not an option).
According to George Soros (Soros 2010), the risk premium on Greek government bonds (over the rates at which Germany borrows for example, known as ‘spreads’) hovered around 3 per cent in February 2010, depriving Greece of much of the benefit of Euro membership. Soros warned that a continuation of this phenomenon meant that there was a real danger that Greece would not be able to extricate itself from its predicament whatever measures it took. Further budget cuts would further depress economic activity, reducing tax revenues and worsening the debt-to-GDP ratio. Given these dangers, the risk premium could not revert to its previous level in the absence of outside assistance. This view was shared within Greece in the spring of 2010. Debt repayment levels were expected to outstrip earnings forecast on the basis of GDP growth for years to come. This meant that domestic capacity would not be enough to refinance the debt, and Greece would need to keep coming back to the markets to raise finance. Indeed, in the absence of external assistance either from EU countries, or the IMF, Greece was set to continue on a path of domestic recession and market punishment for years to come. Even with such assistance, duly offered in May 2010, the future for Greece looked bleak even before the endless depression that ensued.
Greece’s formerly dominant (self-proclaimed socialist) PASOK party had argued (successfully) in the 2009 election that a package of severe cuts and an enforced recession along the advice of international financial institutions (EU Commission, IMF) would damage long term prospects of growth and cause avoidable suffering. It proposed instead a phased reduction of state spending and a gradual recalibration of the macro-economic situation, cushioning the more vulnerable sections of the population. If this message sounds familiar to readers in the UK it is because it mirrors almost exactly the argument presented by the ailing Brown government in London on route to its own 2010 electoral Rubicon. The British Labour government in the Spring of 2010 was trying to forestall the opposition by suggesting that the ‘tough love’ policy of the Conservatives of immediate and deep cuts to state spending was likely to do more long term damage than good. In Greece, unlike in the UK no one seriously proposed a programme of harsh austerity and the proposal of one at the eve of the election by Prime-Minister Karamanlis was not taken seriously by anyone. However, despite its original intentions, as a result of the ballooning costs of borrowing, the new PASOK government performed a volte-face, declared a national emergency, and proceeded to announce (if not actually fully implement) a punishing programme of fiscal discipline sharply reducing expenditure across the public sector.
It could be argued that Greece did not have to go to the IMF, indeed it did not even have to formally request its European partners for help in order to be forced to implement what looks like the standard package of austerity and macroeconomic stabilisation so familiar from the years of World Bank-IMF structural adjustment. It had to implement a partly home grown, partly EcoFin (Economic and Financial Affairs Council, part of the Council of the European Union) recommended austerity package to appease ‘the market’ if it were to maintain its ability to borrow from private investors. It looked in the Spring of 2010 very close to a situation of jumping before being pushed. In fact in the face of un-abating pressure from the markets that brought the interest rates on Greek debt to unacceptable and unsustainable levels, the Greek government requested the activation of a IMF/EU drawn up rescue package, promising to sacrifice yet more sections of its vulnerable population hoping in the end to appease the unsettled markets.
Greece between 2010-12
As was predictable, and indeed predicted, the ‘assistance’ offered by the Troika of EU, IMF, ECB did not improve Greece’s fiscal position, both because the enforced retrenchment deepened the recession, and because the measures required were beyond the willingness and capacity of the Greek political establishment to implement. Greek society was equally unwilling to accept austerity and who can blame them? In the words of Keynes (1984:64)
‘There has never been in modern or ancient history a community that has been prepared to accept without intense struggle a reduction in the general level of money income.’
The result was that Greece needed another bailout. The second bailout was indeed agreed at the end of 2011, but this time it also required the participation of the private sector in an effort to reduce Greece’s unsustainable level of debt. Bond holders of Greek debt were offered a swap of Greek bonds to new bonds issued by Greece having a face value equal to 31.5% of the face amount of the exchanged bonds; in addition investors were offered European Finance Stability Facility (EFSF) notes with a maturity date of two years or less from the Private Sector Involvement (PSI) settlement date and having a face value equal to 15% of the face amount of their exchanged bonds. The detachable GDP linked securities issued by Greece have a notional amount equal to the face amount of each holder’s new bonds (Greek Ministry of Finance 2012a). As a result of the terms of the offer, the notional haircut is 53.5 percent (Reuters 2012a). It is held that a restructuring is deemed successful when 90% or more of bondholders participate in an offering that is no less than 50% of the net present value of the debt (Hornbeck, 2010). On 9 March 2012 (Greek Ministry of Finance 2012b) 152 billion Euros worth of bonds had accepted the offer out of a total outstanding obligation of 177 billion.
After this deal went through with a lot of fanfare, the realisation dawned that the reduction in the debt burden achieved was nowhere near enough to bring the Debt to GDP ratio close to the 120% level the IMF considers the threshold for affordability. Data for 2011 showed Greek debt at 170.6 percent of GDP even though Greece reduced its deficit to 9.4 percent from 10.7 percent in 2010 and 15.6 percent in 2009 (Reuters 2012b). Faced with the prospect of the IMF withdrawing from the Greek rescue plans, the Europeans agreed on November 2012 yet another deal to cut Greece’s debt by €40bn, projecting a drop in debt to 124% of GDP by 2020 (involving cuts in the interest rate on official loans, extending their maturity by 15 years to 30 years, and granting Athens a 10-year interest repayment deferral). It was also agreed that €11bn of profits accrued through the European Central Bank’s purchase of distressed Greek government bonds would be returned and that Greece would engage in a debt-buyback scheme in order to bring privately held debt down (Wearden & Fletcher 2012). This debt-buyback involved repurchases of the debt restructured in March 2012 as part of the PSI haircut and amounted to 31.9 billion Euros, which would (if all the other projections are correct) reduce the Greek debt-to-GDP ratio by 9.5 percentage points by 2020. However, this is far from the end of the Greek debt saga. Already the projections for debt reduction are claimed to make inadequate allowances for the continuing depression. For example Greek forecasts of debt levels for 2013 rose from 167 per cent to 189 per cent of GDP within a period of six months alone (Mackintosh 2012). Even if projections were not wildly optimistic when the plans for new Greek debt-reduction steps were agreed among Euro zone finance ministers on November 27, the expectation was that the buyback would reduce the debt by 11 percent of GDP. This means that even if everything does go to plan, there is still the need for a new haircut or an extension of the buy-back to PSI holdouts (Reuters 2012c). The continuing deteriorating outlook for Greece (debt reached 175% in 2014 (Ernst & Young 2014)), even after the alleged achievement of a primary budget surplus in 2013, continues to fuel talk of an IMF withdrawal (Stevis 2013).
As mentioned earlier, anyone familiar with the history of sovereign defaults will be having an acute sense of déjà-vu. Greece’s troubles mirror to an extent the situation in Argentina a decade ago. Since Argentina fell victim to a debt crisis at the beginning of the Century its policy-makers attempted to negotiate a restructuring under the supervision of the IMF. After years of unsuccessful efforts, in 2004, Argentina announced that it would open a one-time bond exchange and passed domestic legislation mandating that it would never hold a future swap with a better offer. In January 2005, the country opened an exchange on over $100 billion in principal and interest on a diverse number of bond issuances whereby the bondholders were to receive a 67 percent haircut. In the end it restructured just over $62 billion with a 76 percent participation rate (Cohen 2011). Argentina is still working its way through the consequences of this restructuring in the markets and in the legal arena. We will also have the chance to reflect on the opportunities for litigation generated by forcing bondholders to take losses, and on how the decisions of courts and international arbitral tribunals affect states’ capacity to determine economic policy that benefits its population, as opposed to policy that aims to protect creditor interests.
What have we learned from the detail on Greece presented so far? Why is this presentation of Greece and its troubles necessary as part of a discussion on the global financial crisis and what does it tell us about economic policy and the role of law? One of the key themes of my work is the propensity of market-friendly legal frameworks to reduce policy discretion when it is most needed. At times of crisis, policy makers have the difficult task to address economic calamities while continuing to carry popular consent and to act for the benefit of their citizens. Institutional structures that prioritise the interests of investors however, or proclaim the superiority of market mechanisms in the distribution of benefits and costs of economic activities, create the risk that policy-making becomes disconnected from the popular will. Such disconnection is not an abstract evil, it carries a very real risk of the disintegration of the body-politic and threatens the survival of democracy and the maintenance of peace. It is exactly this descent into chaos that we are witnessing in Greece and this is why being familiar with the progress of Greece through this crisis can help us appreciate deficiencies in legal frameworks. This discussion assists therefore in explaining how constitutionalising market superiority risks everything, including the survival of the market itself.