The Greek crisis emerged as an offspring of the financial crisis of 2007, the institutional and fiscal problems of the Greek economy, the institutional structure of the Eurozone and, crucially, the failed political management in the last months that led to the European Financial Stability Facility (EFSF) and the bailout agreement in May 2010. Since then, the Greek governments, along with the creditors, designed and implemented a program of fiscal austerity and institutional reform which lead to some positive fiscal results but also to an unprecedented crisis of liquidity, orientation and cohesion in Greek economy and society.

The financial crisis that erupted in the US in 2007 quickly spread to the rest of the world and especially to the financially developed economies, which were enmeshed in a complex network of interdependencies. As banks recorded losses and demanded new capital, governments bailed out these financial institutions by becoming shareholders at the expense of government budgets. These burdened government budgets raised the question: if governments bail out troubled banks, who will then bail out troubled governments? This question was relevant not only to governments which had bailed out their financial institutions such as Ireland, but also for governments with high levels of debt, large budget deficits and a long record of sovereign defaults such as Greece.

Greece was particularly vulnerable for many other reasons as well. Competitiveness was weak, a shadow economy was widespread, and the trade balance was negative. Moreover, Greece could not devalue its currency as it was a member of a monetary union in which the central bank was independent, focused only on battling inflation and without the power to act as a lender of last resort. This monetary union was not a fiscal union, but tried to achieve fiscal convergence by enforcing common fiscal rules on all its members, rules that were often broken by a lot of the union’s members. The monetary union was also facing challenges of cultural and institutional diversity among its members, thereby limiting the actual possibility of labor and capital mobility across the union (this is a major difference between the USA and the Eurozone).

Despite these weaknesses, the first seven years of the Eurozone were a period of steady economic growth for Greece, based on the low interest rates of the European Central Bank (ECB) which helped finance consumption, constructions and the Olympic Games of 2004. Then, in 2004, the first sign of weakness appeared as the conservative Greek government revised the statistics of national accounts in a way which demonstrated that the previous center-left Greek government had forged its way into the Eurozone a few years ago. When the global financial crisis broke up in 2007, Greece initially appeared protected and stable, largely because the Greek banks were not substantially exposed to toxic products of financial engineering. When the massive bailouts of failed banks by already leveraged government budgets presented the question of sovereign creditworthiness, however, Greece emerged as a potential source of crisis. Early signs were apparent in the beginning of 2009 when Standard and Poor’s downgraded the creditworthiness of the Greek government[1]. In the fall of 2009, Greek Prime Minister Kostas Karamanlis of the conservative New Democracy party was headed for early elections in October. His reelection platform asked for a fresh mandate in order to deal with the problems of the ailing Greek economy (his government had steadily increased public spending since they took over in 2004). The conservative party lost the elections to the PASOK center-left party of George Papandreou who claimed, pre-electorally, that there was enough money to sustain promises of increased public spending.

Just two weeks after the elections, Papandreou’s new government revised its forecast for the year-end budget deficit of 2009. The revision was quite impressive: while the previous government gave an estimate of just over 6%, the new government gave an estimate of 12.5%, when Eurozone rules impose a 3% maximum for budget deficits. In terms of international political communication, this revision was the beginning of the unprecedented crisis for Greece and the Eurozone. In the subsequent months, the reliability of Greek statistics was officially questioned by European authorities, credit ratings kept falling, government bond spreads kept going up, austerity measures were adopted to satisfy capital markets and Greece’s allies but the situation seemed like an unmanageable avalanche. The Greek government was trapped: it was acting to correct significant prior misstatements of its fiscal health but its acknowledgments of negative prognoses for the Greek economy made the situation even worse. Access to credit became further constrained, calling for more austerity measures which never managed to reverse the dynamics of the international debt markets for Greek bonds.

In this context, the Greek government resorted to a support mechanism offered by the International Monetary Fund, the European Commission and the ECB which performed a supervisory role and provided technical support (the three institutions constituted the “Troika”). This was on April 23, 2010. The member-countries of the Eurozone provided the necessary capital so that the EFSF could issue bonds the proceeds of which were used to make a loan to Greece; this loan was 80 billion euros. The loan from the International Monetary Fund was 30 billion euros. The biggest part of these 110 billion euros was used to repay old debts to private creditors like German and French banks.

A few days later the political terms of the financing agreement were presented by the Minister of Finance, George Papaconstantinou. In exchange for lower interest rates than those that Greece was facing in the capital markets, the creditors asked for austerity measures like tax increases and salary cuts in the public sector; they also asked for an institutional rearrangement of the private and public sector of the Greek economy: deregulation of product, services and labor markets, along with a massive privatization of government assets. The program included a forecast of only a two year recession. The agreement with the lenders was drafted in a Memorandum of Understanding. The austerity and deregulation measures of the Memorandum were adopted by the ruling socialist party and LAOS, a Christian democrat party. All remaining parties of the left voted against the Memorandum. New Democracy, the leading opposition party, also voted against the Memorandum, on the argument that austerity would worsen the crisis. Instead, subsequently, New Democracy proposed a platform of reforms based on reducing and simplifying taxation, reducing employer contributions and supporting the housing industry. From that day on, Greek politics has been polarized between two rival camps: pro-Memorandum and anti-Memorandum.

The following year was a period of austerity, reforms, deepening recession and increasing social unrest. Yield spreads kept increasing, despite reforms and austerity, preventing Greece from accessing capital markets. In July 2011, tightening liquidity culminated in an EU decision to provide an additional loan alongside Private Sector Involvement (PSI), which meant that the creditors would accept 21% haircut in the face value of Greek bonds and accept new investment grade bonds in return. At the time the PSI was proposed, the market value of Greek bonds was well below 79% of face value so the involvement of the private sector in bearing the costs of restructuring through the PSI would have been limited. This haircut agreement was never implemented but, expectedly, it spurred downgrades by credit rating agencies. After a long summer of clashes with Troika officials and increasing liquidity problems, a new haircut agreement was reached on October 26, 2011. The new agreement was applicable to 206 billion euros of Greek bonds in face value and its objective was that the ratio of Greek government debt to GDP would reach a sustainability threshold of 120% by the year 2020. Notably, this target threshold was actually higher than the debt levels of 2008 which lead Greece to the crisis in the first place. The proposed agreement meant that private sector creditors would get approximately a 50% haircut on the face value of their bonds, in exchange for investment grade bonds; the 50% recovery rate on face value was a lot higher than the market value of Greek bonds at that time.

The second haircut agreement spawned fundamental changes in Greek politics. On October 27, 2011 the Greek government stated that they were very pleased with the agreement which they considered to be a major success. All opposition parties said that the new deal would entail new austerity measures and it would therefore make the situation worse. The following day, October 28th, was the Greek national holiday commemorating Greece’s refusal to the Italian ultimatum in World War II. That day unfolded in a unique, unprecedented manner for Greek society. Instead of celebrating as they had done for decades, people gathered to protest against the new agreement and the military parade was canceled. In this context, Prime Minister George Papandreou announced three days later that there would be a referendum over the new loan agreement. The Minister of Finance, Evangelos Venizelos, publicly supported the initiative for the referendum. The euro lost value, government MPs were publicly saying that the referendum was a bad idea and the government replaced the heads of armed forces; the situation was very turbulent. Two days later, the Prime Minister and the Minister of Finance went to Cannes and met, among others, the French President Nicolas Sarkozy and the German Chancellor Angela Merkel.

After the meeting, President Sarkozy — not the Greek government — announced that the referendum would be held on December 1^st and the question would be about the presence of Greece in the Eurozone (not the loan agreement). Before dawn, the Minister of Finance issued a statement against the referendum, arguing that the presence of Greece in the Eurozone should not be jeopardized. The New Democracy opposition asked for elections, instead of a referendum. Finally, within the next ten days: a few MPs withdrew their support for the government, Prime Minister Papandreou resigned and a new government was formed. The new government included PASOK, New Democracy and LAOS. The single mission of the government was to draft laws embodying the austerity measures and reforms that were prerequisites for the new loan — essentially a second Memorandum — and also complete the PSI process. The new Prime Minister was Lucas Papademos, the former Vice President of the ECB (recall, the ECB is a member of the Troika of creditors).

The PSI was successful at a rate of voluntary participation that reached 96.9%. After the completion of the PSI, the road for the new elections was open. One of the domestic effects of the PSI was that the haircut triggered major accounting losses in Greek banks that held government bonds. The banks were then recapitalized with the participation of the government, which borrowed money for this purpose. The government is scheduled to sell these shares within the next few years, thereby reducing government debt and re-privatizing the Greek banking sector.

In May 2012, the elections brought about major changes in Greek politics: PASOK dropped from 43.92% to 13.18%. SYRIZA, the coalition of radical left, was now the leading opposition for the first time, quadrupling its power since the last elections. Golden Dawn, an extremist, ultra-nationalist party got 6.97% (as opposed to 0.29% in the 2009 elections). New Democracy won the elections, with the promise to depart from the economic austerity of the Memorandum and apply their own program. No party won absolute majority in the parliament and new elections were arranged for June 2012. Between the two elections, European leaders addressed the Greek people and implicitly, but clearly, asked them not to vote for anti-Memorandum parties (essentially, this was about SYRIZA which could potentially win the elections). New Democracy won the elections again and formed a coalition government with PASOK and DEMAR, a left-wing, pro-reform party. The new government did not produce any substantial shift in the economic policy. SYRIZA was the leading opposition, leading the anti-Memorandum side of the political spectrum.

The next two and a half years were mostly a period of decreasing yield spreads and decreasing deficits (even a primary surplus was achieved in 2013). The lower spreads helped Greece return to the bond markets in April 2014, with a five year bond issue, at a coupon rate of 4.75%; Angela Merkel visited Greece the very next day of the bond issue and congratulated the Greek government on their fiscal and financial progress. Unemployment, however, surpassed 25% and the recession was ongoing. The government applied all the reforms and austerity measures of the Memorandum, despite the pre-electoral promise to renegotiate the political agenda with the creditors. Given the widespread disapproval of the fiscal policy, SYRIZA, with a fervent anti-Memorandum rhetoric, won in 2014 both the elections for the European Parliament and also the municipal elections.

The New Democracy led government did not complete its four year term. In March 2015, the term of the President of the Hellenic Republic (the head of State) was ending and the new President had to be voted by the two thirds of the MPs. No such majority was possible, and then the Parliament had to dissolve so that, after new parliamentary elections, the election of the President would be constitutionally possible even with a simple majority of the MPs. New elections were scheduled for January 25. SYRIZA won but did not achieve an absolute majority in the parliament. They formed a coalition government with ANEL, a right-wing party which held an anti-Memorandum agenda.

Last January, the Greek people voted against the austerity policy of the Memorandum; however, in the same vote, the Greeks also asserted their adherence to the Eurozone. Since this election, the management of the Greek economy has been a matter of an ongoing negotiation between the Greek government and its institutional creditors.

The Greek government is facing a difficult dilemma.

One option is to accept the measures which are proposed by its institutional creditors (the Troika). These are austerity measures (such as the reduction of pensions or the increase in the Value Added Tax) and also measures about the liquidation of state-owned infrastructures like ports and airports. A benefit of this policy option is that it would sustain some flow of liquidity to the Greek economy from the institutional creditors and it would probably go along with some monetary support for the Greek banks from the ECB. There are, however, two fundamental problems with this choice. The first problem is that similar policy measures have been applied in Greece since 2010 and they are associated with a six-year recession and a decrease in the GDP which exceeds 20% (2014 will probably be the first year of very sluggish growth since GDP growth turned negative in 2008), a severe deterioration of living conditions (one in four Greeks cannot afford proper heating in the winter) and, most importantly, a dissolution of social cohesion which is associated with unprecedented rise of political extremists. The second problem with accepting the measures that the creditors suggest is that these measures are fundamentally opposed to the pre-electoral commitments of the ruling coalition government which was elected on the promise to support financially the citizens who cannot make ends meet, by providing food, shelter and healthcare for the very poor. The ruling government also promised to abolish the previous policy agreement with Troika on austerity and deregulation. Breaking these electoral promises would likely severely undermine support for the government among the Greek MPs. Governmental stability would be seriously compromised.

The other option that the Greek government has is to reject the policies being proposed by its institutional creditors. If this route is taken and the creditors do not change their policy preconditions for extending credit, then the Greek government would face substantial liquidity issues. This problem is aggravated by the fact that the rise in Greek bond yields prevents refinancing through a bond issue in the capital markets, and planned reforms in the tax system will take some time before yielding any tangible benefits. In this case, the Greek government could resort to a referendum or to new elections in order to get a mandate for a new deal with the IMF and its partners in the Eurozone. This scenario may also entail tight monetary measures by the ECB with respect to the Greek banks until a final agreement is reached, driving Greece towards financial asphyxiation. This would also lead to radical changes in Greek politics and possibly the Eurozone as well.

The institutional creditors on the other hand also face a dilemma. One option is to deny any change in the reform agenda and to connect all financing to the agreements that were made with the previous Greek government.

The other option that the creditors have is to accept the new government’s agenda and amend the old agreement; then they would be adapting their policy recommendations to the democratic outcome of the electoral shift in Greece. However, they would also be sending the message to all electorates in the EU and internationally that long term lending agreements are open to substantial change according to electoral outcomes. Moreover, accepting the agenda of the Greek government would be tantamount to accepting that the reforms that the creditors have enforced in Greece have failed to produce the desired economic growth and development. This conclusion would bring about significant political shifts since the citizens of Eurozone countries that financed a part of the loans to Greece would be told that the entire project was badly planned.

A compromise between Greece and its creditors is also an available alternative. This would mean that the creditors grant Greece some of the much needed time and liquidity and, on the other hand, the Greek government would proceed with reforms that are institutionally different but financially equivalent to the ones that the creditors ask for. Such flexibility in reforms is related to the private sector’s involvement in the operation of currently state-controlled assets (purchase or lease), the targets of the new taxes (the poor or the rich) and the priorities of public expenditure (humanitarian crisis or armaments). However, institutionally different measures bear political symbolism, which is important for both Greece and its creditors: the regulation of labor relations is typical of reforms which do not carry immediate fiscal benefit or loss for the government but they present momentous issues with Greek party politics.

What Greece needs is both liquidity and time. Product and labor markets have been deregulated, public expenditure has been considerably reduced, government assets have been sold. Reforms have taken place (loan installments would not have been disbursed otherwise). The reforms have not lead to economic growth so far, largely because the Greek economy was drained from all reasonable sources of liquidity. What is needed is not the politically costly, additional deregulation but additional liquidity which is the indispensible energy for the operation of the Greek economy. In this direction, the role of the ECB is vital in supporting the liquidity of the Greek banks. Given liquidity and time, the Greek economy will be able to produce sustainable growth. Until the provision of the needed liquidity, precious time is lost for the emergence of a positive prospect for the Greek citizens and a favorable momentum for the Greek economy and the stability of the Eurozone.

ENDNOTES

[1] The question of sovereign debt in the Eurozone essentially came to fore with the nationalization of the Anglo Irish bank in January 2009.

This post comes to us from Akrivi Andreou, PhD Candidate in Finance, University of Piraeus – Department of Maritime Studies, Andreas Andrikopoulos, Assistant Professor of Finance, University of the Aegean – Department of Business Administration, and Christos Nastopoulos, PhD Candidate in Finance, University of the Aegean – Department of Business Administration. It relates to their recent article, entitled “A Critical-Realist Account of the Greek Crisis” and available here.