The Crisis

Yet today economic discord threatens the much-cherished vision of a politically unified Europe. The economic institution designed to unify Europe became an instrument of political conflict.  On the heels of the 2008 Lehman-Brothers banking crisis in the United States, the fault lines of the Eurozone crisis emerged. On October 16, 2009, the Greek government announced that its public debt represented approximately 10% of its GDP, later estimated at a more accurate 12.7% of GDP.[i] This far exceeded the figures that the previous administration relayed to the Eurozone in 2005 and sparked a cascading panic about the Greece’s future and that of the Eurozone. Investors lost confidence in Greece, dumping its government bonds in droves, and spiking its borrowing costs to unsustainable levels. From early to mid-December 2009, the three largest credit ratings agencies, Fitch, Moody’s, Standard and Poor’s downgraded Greece’s credit rating. The spread between German 10-year bunds and Greece’s 10-year bond increased from 16 basis points to 194 basis points.

Before the introduction of the Euro, governments in countries such as Ireland, Greece, and Spain paid interest premiums to borrow funds. After the Euro’s introduction, all member countries experienced a convergence in borrowing costs. Government officials from core countries reassured banks that bonds from every country were created equal, so banks lent to these countries, lowering the costs of borrowing. A decade of growth ensued in which countries capitalized on the greater access to liquidity, fueling increased government expenditure and a housing market boom.  During this time, Germany’s economy became more competitive relative to other euro member economies. Germany consistently ran current account surpluses, meaning it was a net lender to the rest of the world and the Eurozone, as seen in Figure 1. It slowly became apparent that the economies of all the countries sharing the euro were different and not all bonds issued by these governments were of the same caliber.  Fearing that some countries would not be able to pay back the debts, governments raised interest rates for lending to weaker countries, which in turn damaged the banks that loaned to them. Two interrelated problems, the fallout of the sovereign debt crisis and the banking crisis, threatened the Euro.

There existed few precedents for economic entities on the scale of the Eurozone, much less policy precedents it could follow to repair a member state’s economy while balancing the welfare of the others. At its inception, the founders of the Eurozone had not foreseen the divergence of any one country’s economy and thus they had not furnished any institutional safety net. This begged the question: would the European Commission choose to rescue the Greeks, restoring faith in the vision of a united Europe at the expense of others’ economies? Or would Greece be forced to exit the Eurozone with a crippled economy, threatening the integrity of the Euro? Article 104b of the founding treaty of the Eurozone, the Treaty of Maastricht indicated that bailouts between member states of the Euro would not be permitted.[ii]

For several months, Brussels deliberated on the feasibility of a bailout package. The failure to intervene in one of the Euro’s member economies would send the message that even the strongest Eurozone economies lacked faith in the Euro– a message that would surely incite speculative runs against it. Yet Greece was not the only country with its head on the chopping block – doubts arose about the other highly indebted economies of Ireland, Italy, Portugal, and Spain. Should European leaders extend a financial assistance deal to Greece, the weight of these other countries’ debts would fall upon them as well.  While European leaders floundered between rhetoric of solidarity and rhetoric that labeled Greece’s mounting debt crisis as a domestic problem, Greek leaders wrestled with a reluctant public to take ownership of the situation. Tough language concerning impending budget cuts began appearing in their speeches – a foreign concept to a people accustomed to being indebted for almost half a century. Prime Minister George Papandreou, a socialist candidate elected only a few weeks earlier, presented the Greek Stability and Growth Programme to the European Union on January 14, 2010 to cut spending by 2.8% of its GDP in 2012. Notably, the plan implemented measures to reduce tax evasion, increased indirect taxes, cut government expenditures on public sector employees’ wages, and would cut expenditures relating to social services and pension funds by up to 10%.[iii]  On February 24th, Greek protestors flooded the streets of Athens, clashing with riot police; a sight that further frightened uneasy investors, causing bond prices to slump further. The calls of Greece’s leadership for financial restraints backfired: government bond holders watched with bated breath as talk of austerity failed to rein in domestic resistance, to no avail. If the Greek government could not appease its public, it probably exerted even less control over its debts.

The decline of the Greek economy could no longer be written off as a domestic problem for Greece to handle. European leaders offered rhetoric of solidarity in public addresses to assuage market spectators, yet promised no remedies to reassure them. Why? The European people, particularly the Germans; resented the notion of their government which had avoided excessive deficits, financing the countries with high deficits. Media depicted the Greeks as indulgent and dishonest, accusing them of financing a plush lifestyle on the dime of hard-earned German labor.  In such a charged political clime, no European leader could propose a rescue package without also proposing an accompanying punishment. German Chancellor Angela Merkel, facing an impending May election, promised that the Greeks would have to earn any German-backed bailout package by cutting back on spending for several years.

In the absence of meaningful European action, Greece turned to the International Monetary Fund (IMF). This move affronted European leaders – ECB President Jean-Claude Trichet denounced IMF intervention as “inappropriate”. The IMF typically functions as the last resort for failing, impoverished states. The potential embarrassment of an IMF-sponsored rescue of a Eurozone country shamed European leaders into action. On March 25, 2010 amid growing tensions, a panel to be known as the Troika consisting of officials from the European Union (EU), the International Monetary Fund (IMF), and the European Central Bank (ECB) stepped in to offer liquidity relief to Greece in exchange for the implementation of austerity measures. The Troika’s bailout package offered an interest rate of 5%, below the market rate of 7%. 110€ billion was lent to Greece for the next three years, 80€ billion in bilateral loans from other Eurozone countries and 30€ billion from the IMF.[iv]

While the IMF’s loan circumvented the legal issues of the bailout package, the question of Greece’s economy and the Euro’s future remained dubious. Greece’s total government debt amounted to 300 billion euros, and it needed to pay back maturing bonds by the end of May. Thus on April 27, 2010 Standard and Poor’s (S&P) downgraded Greece’s credit rating to junk bond status (Jack Ewing and Jack Healy, “Cuts to Debt Rating Stir Anxiety in Europe,” New York Times, April 27, 2010, accessed February 17, 2016). It warned that holders of Greek debt could face up to a 50% to 70% loss in their investments should Greece default on its debt obligations. Fears about Greece’s economy spread to countries with similar characteristics – Portugal, Italy, Ireland, and Spain.

[i] Breugel. 2015. Euro Crisis (blog). Breugel.

[ii] Matthew Lynn. 2011. “The Debts Fall Due.” In Bust: Greece, the Euro, and the Sovereign Debt Crisis, 127-148. Hoboken, New Jersey: John Wiley & Sons.

[iii]  Georgios P. Kouretas and Prodromos Vlamis. (2010).  “The Greek Crisis: Causes and Implications.”Panoeconomicus, 4 , pp  397.

[iv] Breugel. 2015. Euro Crisis (blog). Breugel.