What is all the drama in Greece about?

Introduction

From late 2009 there has been growing concern surrounding growing debt levels of European Governments together with a wave of government debt downgrades of certain European states.

Fears of a sovereign debt crisis intensified during early 2010 making it difficult or impossible for Greece and several other European nations to re-finance their debts.

The Greek Sovereign Debt crisis has dragged out for well over two years and 11 million Greeks have experienced successive rounds of cutting whilst dealing with a stalling economy, high levels of unemployment, and unprecedented social and political turmoil.

Pressures and Influences on the European Sovereign Debt Crisis

Causes of the drama are complex and connected. The roots can probably be traced to easy credit conditions during the 2002–2008 period which encouraged high-risk lending. Simultaneous increasing asset prices provided opportunity to use further debt secured against these assets. This provided a significant increase in money available for investment during this period. The global pool of fixed income securities increased from about $36 trillion in 2000 to $70 trillion by 2007. This pool of money entered the global capital markets as investors searched for higher yields thereby generating a series of asset class bubbles across the globe.

Starting in late 2007 these asset bubbles burst, commencing with real-estate and moving to the debt and equity markets. The loss of value in assets was enormous causing significant trauma. Over-extended companies faced increasing pressure to restructure their balance sheets. Companies consolidated and contracted, resulting in a significant slow down in growth rates. Lack of growth in Europe was compounded by competitive pressures from several fronts: Relatively high wages, complex regulations and taxes, an aging population, technology which allows companies to do much more with fewer people, and manufacturing and services relocating to economies with cheaper labor and simpler regulation. The slow down in economic growth has placed fiscal strain on European states as their spending increased and tax revenues declined.

As companies sought to protect themselves from failure they turned to their governments for help. Increased government debt levels are due in part to the large bailout packages provided to the financial sector during the Global Financial Crisis and the global economic slowdown afterwards. Some argue that private debt was simply converted to public debt. The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. In the same period the average government debt rose from 66% to 84% of GDP.

Some argue that fiscal irresponsibility on behalf of the Greek authorities is a significant contributor to the crisis and that the Greek government increased its commitments to public workers in the form of extremely generous pay and pension benefits. One report suggested that Greeks drove the most Porsche’s in Europe whilst working the shortest hours and declaring the lowest taxes. It is also claimed that whilst members of the European Union agreed in 1992 to limit the size of their debt levels, Greece circumvented these rules and masked their deficit and debt levels by complex currency and credit derivative structures designed by prominent U.S. investment banks.

As the crisis took hold in Europe it soon became clear that all European nations were at risk of financial contagion brought on by the interconnection in the global financial system. Simply put: If one nation defaults on its sovereign debt or enters into recession, that places the banking systems of creditor nations at risk. All European nations (indeed the entire world) face economic fall-out in the event of a financial crisis in one country. In Europe this has played itself out as nations express outrage at the “ill-disciplined” spending of the Greeks yet simultaneously needing to protect Greece from the consequence of its behavior lest the subsequent collapse hurt their interests.

Whereas the United Kingdom or the USA are able to “print money” in order to pay creditors and ease their risk of default (referred to as “quantitative easing”). Such an option is not available to individual member states in the EU. By “printing money” a country’s currency is devalued relative to its trading partners, making it exports cheaper, in principle leading to an improving balance of trade, increased GDP and higher tax revenues in nominal terms. The euro zone was created in part to reduce member state competition by preventing countries from manipulating currency values to get relative advantage over its neighbors. Prior to the development of the crisis it was assumed by both regulators and banks that sovereign debt from the euro zone was safe. Whilst banks held bonds from stronger countries they also had substantial holdings of bonds from weaker economies such as Greece. Bonds from the weaker countries offered a small premium and seemingly were equally sound. As the crisis developed it became obvious that Greek, and possibly other countries’, bonds offered substantially more risk. Whilst it was difficult to fully comprehend the size of this risk, one measure provided a proxy to understanding sovereign debt risk and this was the S&P long-term sovereign ratings. During 2010 and 2011 S&P downgraded Greece’s sovereign debt rating to BB+ (April 2010) and then to CCC (June 2010). In each instance the market took note responding with declining prices.

There have been accusations that speculators and hedge funds worsened the crisis by short-selling Euros. There is enough evidence to suggest that several hedge-funds managers launched “large bearish bets” against the euro in early 2010 whilst other “like-minded” hedge-fund managers triggered a wave of selling Euros, affecting a decline in the currency.

Greek Sovereign Deb Crisis Timeline (2009 to 2011)

In the mid 2000s Greece’s economy was strong and the government took advantage by running a large deficit, partly due to high defense spending. As the world economy cooled in the late 2000, Greece was hit especially hard because its main industries (shipping and tourism) are especially sensitive to changes in the business cycle. As a result, the country’s debt began to pile up rapidly.

In late 2009 Greece’s budget deficit forecast was revised from 8% of GDP to 12.7%. In 2010 this number was raised further to 15.4% renewing anxiety about excessive national debt. Frightened investors demanded higher interest rates from several governments with higher debt levels. This made it difficult for governments to finance further budget deficits and service existing high debt levels, particularly when economic growth rates were declining.

In April 2010 the Greek government requested financial help from its European partners. In response S&P slashed Greece’s sovereign debt rating to BB+ or “junk” status. Stock markets worldwide and the Euro currency declined in response. In support of their bailout request the Greek government announced a series of austerity measures. In May the euro zone countries and the IMF agreed to a three-year €110 billion loan conditional on the implementation of the austerity measures which were met with great anger by the Greek public, leading to massive protests, riots and social unrest throughout Greece.  In June 2010 S&P once again downgraded Greece’s sovereign debt rating – to CCC, the lowest in the world.

It was originally hoped thatGreece’s first austerity measures and the €110 billion support package would help Greece access private capital markets by 2012. Unfortunately this did not happen. The recession was harsher than originally feared and as a result tax revenues were lower than expected, making it even harder for Greece to meet its fiscal goals.

In early 2011 Greece sought a second round of bailout packages. Once again the request was met by conditions of further austerity measures. In June 2011 trade union organizations commenced a 48 hour labor strike, intended to pressure parliament members into voting against the austerity package. Despite resistance the second set of austerity measures were narrowly approved in late June 2011.

In July 2011 the EU met in Brussels, where euro area leaders agreed to extend Greek loan repayment periods and to cut interest rates. They also approved a new €109 billion support package, conditional on large privatization efforts. Later in the same year leaders of the 17 euro zone countries met in Brussels and agreed on a 50% write-off of Greek sovereign debt held by banks.

Greek Prime Minister - George Papandreou

In the face of continued resistance to the proposed austerity measures Greek Prime Minister George Papandreou in November 2011 proposed cabinet re-shuffle, and proposed that a referendum be held so that the Greek people would have the last say on the bailout. The crisis sent ripples around the world, upsetting financial markets around the world. Three days later the promised Greek referendum on the bailout package was withdrawn. In December of the same year a new national union government was formed (under leadership of Lucas Papademos) which continued seeking the $160 billion bailout plan contingent on the austerity measures.

Read the ABC Timeline of the crisis at: Greek Sovereign Deb Timeline

Current Situation

In the midst of ongoing debate and criticism the ECB, the IMF and the EU (lead primarily by Germany and France) have agreed a second bailout, of $160 billion bailout subject to austerity cuts that were demanded by increasingly frustrated euro zone financial leaders. Frustrated by a lack of agreement on the sacrifices they demand in return for the bailout the EU and IMF say they have had enough of broken promises and that the funds will be released only with the clear commitment of Greek political leaders that they will carry out the reforms. Greece has to persuade its deeply skeptical creditors that it has the will to implement dramatic reforms that will end years of fiscal profligacy and tame gaping budget deficits.

Greek protesters burn a German flag in Athens

The demands of the euro zone leaders need to be seen against the reality that Greek politics remain highly unstable. Without a clear leading political party decisions need to be agreed by a coalition of three parties (the troika) including the far-right LAOS party and the far-left socialist PASOK party. Leaders of the three coalition parties are reluctant to agree to even more cuts to wages, jobs and pensions. In fact for the early part of February 2012 the parties seamed to lose their will-power and repeatedly postponed meetings with regards to the austerity reforms. Previous cuts have sparked riots and strikes, and with unemployment already at 20 per cent, the extra austerity measures are expected to cause more social unrest. In early February 2012 Greek protesters voiced their opposition to the EU by burning a German flag in Athens. The evolving crisis has led to the resignation of six members of the Greek cabinet, including the deputy foreign minister. Furthermore a Greek general election is expected in April of this year.

In addition the situation is fuelled by time pressures: The full package must be agreed with Greece and approved by the EU, IMF and European Central Bank by 15 February so legal paperwork can be completed in time to avoid a default by Greece on March 20 bond redemption when Athens must repay nearly $18 billion in maturing debt.

The Greek national sentiment is highly volatile. The number of dissenters is growing with many describing the austerity requirements as a humiliating demand. Unions and employers’ associations in Greece strongly oppose cuts in private sector wages, warning it would deepen a recession, already in its fourth year. Some experts argue the best option for Greece and the rest of the EU should be to engineer an “orderly default” on Greece’s public debt which would allow Athens to withdraw simultaneously from the euro zone and reintroduce its national currency the drachma at a debased rate. Some parties however argue that if Greece were to leave the euro, the economic and political impact would be devastating. Some suggest an exit would lead to a 60 percent devaluation of the new drachma accompanied by hyperinflation, military coups, and possible civil war. In turn default would create conditions of uncontrolled economic chaos and social explosion. The country would be drawn into a vortex of recession, instability, unemployment and protracted misery.

Parliament was scheduled to vote on the bill on Sunday 12 February. In turn the two major Greek labor unions called a 48-hour strike for Friday and Saturday to protest against the proposals and union official moved through Athens calling for people to take part in the demonstration. More than 100 000 protesters marched to the parliament to rally against the drastic cuts, facing off against some 3 000 police. Inevitably rioters torched buildings, and looted shops. Riot police fought running battles with protesters who hurled stones and petrol bombs. Dozens of police officers and at least 50 rioters people were injured with a further 50 being arrested whilst over 30 buildings were torched in the capital. Riots spread to other Greek towns and cities, including Corfu, Crete and Thessaloniki.

The Austerity Plan

Despite the drama parliament approved the austerity measures early on Monday morning (Feb 13) paving the way for Greece’s European partners and the International Monetary Fund to release $160 billion in new rescue loans.

In summary the elements of the austerity plan that were agreed to include:

• €4.5 billion budget cuts this year
• 22 per cent cut in minimum wage
• 150 000 jobs cut from state sector by 2015
• Pension cuts worth 300 million Euros this year
• Laws to make it easier to lay off workers
• Health and defense spending cuts
• The legislation also approves a bond-swapping deal with private creditors that will allow Greece to shave off at least 100 billion Euros of its 360-billion-euro debt.

Concluding Comments

I think we need to understand the current set of activities in Greece in the context of social, political, and economic reform. The rules of government are changing and social welfare governments that give enormous financial opportunities to its aging population are simply no longer viable. They will find themselves under increasing pressure as open-ended liabilities outpace the declining sources of revenue.

The media has portrayed every successive event in the unfolding Greek Sovereign Debt drama as “the solution” to the problem. And markets throughout the world have responded in volatile fashion. The reality is we need to view the current situation from a longer time and process perspective. The current $160 billion bailout and its associated austerity plan are not the “Silver Bullet”. There is still a long road of economic and political reform ahead for the Western European social welfare states including but not limited to Greece, Spain, Italy, Belgium, and ultimately even France and Germany.

For a summary about the crisis read: Quick Guide to Greek Sovereign Debt Crisis