Chapter 14: Greece 2010: Extend and Pretend, Crashed

Chapter 14 GREECE 2010: EXTEND AND PRETEND

In the summer of 2009, with the acute crisis in the banking sector having been cauterized, both the European and the American economies began to recover. But aftershocks continued. With the insulation provided by the Fed and the Treasury, in the United States these aftershocks no longer manifested as acute stress in the financial system, but in misery spread across millions of households struggling with unaffordable mortgage payments and houses that were no longer worth the debt secured on them. The wave of foreclosures of American homes did not reach high tide until early 2010. Debtors continued to default, in other words, but their disaster did not pose systemic risks. They were the powerless ones who received precious little support from the Obama administration or anyone else. The main props to the economy other than the open-handed liquidity provision of the Fed were the automatic stabilizers of the fiscal apparatus. They left a deep dent in public finances, not just in the United States but across the advanced economies. In 2010 this would trigger a global backlash demanding fiscal consolidation and a return to the agenda of fiscal sustainability that had been so widely touted before the crisis. Controlling the debt-to-GDP ratio would become a mantra. After the largesse of the 2008 bank bailouts came austerity, though not for the same people, of course. But money is fungible. Ultimately, health care, education and local government services were all entries in the same budget that had to accommodate the costs of the crisis.

In the eurozone the switchback from the largesse of the banking crisis to the austerity that followed would take on a particularly dramatic form, because in three of its smaller member states the fiscal impact of the crisis was overwhelming. In the wake of the 2008 crisis, Greece, Ireland and Portugal slid into an increasingly untenable budgetary situation. Of the three, the situations of Greece and Ireland were the most severe. Greece’s public debts were simply too large and needed to be restructured. Ireland was overwhelmed by the consequences of its panic-stricken announcement on September 30, 2008, that it was guaranteeing 440 billion euros of bank liabilities. Given the burdens that Greece and Ireland were under by 2009, the only reasonable way forward was to carry out a debt restructuring, also known as haircutting bondholders, or, more euphemistically, as private sector involvement (PSI). In Greece this would have to involve lenders to the state. In Ireland it was the banks’ creditors whose claims could not reasonably be met. As in any bankruptcy, this involved an infringement of property rights and would create uncertainty. The risk of contagion was serious. If Greece or Ireland restructured, who would be next? Given the weakened state of Europe’s banks, it might be dangerous to inflict further losses on them. And given the degree of their interconnection with the US financial system, that concern would not remain confined to Europe. It is not surprising, therefore, that the Greek and the Irish situations, followed by Portugal’s, should have caused political and financial stress and that this should have spread to both sides of the Atlantic. But what happened in the eurozone from 2010 was extraordinary.

The denial, lack of initiative and coordination that had characterized Europe’s first response to the banking crisis in September and early October 2008 was a harbinger of things to come. In the first phase of the crisis in the autumn of 2008, the stresses could still be contained at the national level. In 2010 they spilled over into a general struggle for the future of Europe. Europe’s single currency almost came apart. Greece, Portugal, Ireland and Spain were driven into depressions the likes of which had not been seen since the 1930s. Italy became collateral damage. France’s sovereign credit was put in jeopardy. Prime ministers were ousted. Political parties collapsed. Nationalist passions were stirred to the boiling point. The Obama administration faced the prospect that Europe’s new crisis might spill back on the United States. In the spring of 2009 France and Germany had lectured the UK and the United States about financial stability. A year later they were reduced to calling on the IMF to help not just Greece but the eurozone as a whole. And it was not enough. Two years later the eurozone crisis was still menacing global financial stability.

I

Viewed against the wider canvas of the global crisis stretching from Wall Street to Seoul, the troubles of Greece and Ireland were not unusual and we do not need to refer to idiosyncratic features of eurozone governance to explain them.¹ Ireland was an overgrown offshore banking hub. The costs of the bailout that Dublin saddled itself with were enough to have put even the most fiscally sound state in danger. It was Lagarde’s nightmare of October 2008 made real: a crisis in Europe’s highly integrated financial system too big for a host country to resolve alone. The politicians in Dublin were driven by panic and their intimate ties to the local banking community, but Merkel’s veto on any collective European solution made Ireland’s situation untenable. When on January 15, 2009, Dublin was forced to nationalize Anglo Irish Bank there were already rumors of an IMF intervention. Ireland’s sovereign bonds sold off and its default risk soared even above that of Greece’s.²

If Greece had been in Hungary’s situation in 2008, a member of the EU but outside the eurozone, it would in all likelihood have joined the East Europeans in the first round of IMF crisis programs.³ It was not that Greece was directly caught up in the transatlantic financial crisis. Its banks had regional interests at most. The crisis reached Greece by way of its export and tourism sectors. Then automatic fiscal stabilizers kicked in. Tax revenues slumped. None of this was unusual in 2008–2009. What set Greece apart was the precariousness of its fiscal position when the crisis struck. It bears repeating that Greece had not used eurozone membership to go on an outsized borrowing binge. The bulk of its debts were piled up in the 1980s and 1990s as its two main parties, PASOK (social democrat) and New Democracy (Christian democratic), lured voters with the promise of West European modernity and affluence.⁴ In 2006 Greece’s debt level relative to GDP was lower than it had been when it joined the eurozone in 2001. But it was not reduced by much and would have been worse but for fiddling. Athens’s failure was not to have used the exceptional period of rapid growth and low interest rates to substantially reduce its debt burden. Any sudden surge in the deficit, any upward hike in interest rates, was likely to topple it from just about managing to insolvency. That is precisely what happened in 2008. In response to the crisis, the conservative New Democracy government abandoned all fiscal restraint, and at the same time, interest rates for Greece as a weaker sovereign borrower surged.

In July 2009 Athens alerted the Eurogroup to the fact that its deficit might be heading toward 10 percent of GDP or more. But at that point neither side thought it convenient to go public. The break came on October 4, when the Greek electorate turfed out the center-right New Democracy party and gave a large majority to a reform-minded PASOK government. Two weeks later George Papandreou’s administration broke the silence.⁵ Athens announced to Eurostat, the European statistical agency, that its deficit would exceed 12.7 percent. At a stroke the budget revisions for 2009 took Greece’s debt burden from 99 to 115 percent of GDP. Deficits running into the tens of billions adding continuously to the existing stock of debt, combined with surging interest rates, would soon make the problem impossible to contain. In 2010 alone Greece was due to make repayments totaling a massive 53 billion euros. That would have placed a strain on any borrower. But Greece’s problems were not due to illiquidity. It was insolvent. To actually stabilize its debts it would, according to one calculation, need to raise tax revenues by 14 percent of GDP and cut expenditure by the same amount. That was politically impossible. What Greece needed to do was to restructure, to agree with its creditors to reduce their claims. To do anything else, to add new loans to an already insupportable debt burden, would postpone the problem but at the price of increasing its scale.

Of course, restructuring was an unpopular option with the creditors. As recently as 2007 Greece’s bonds had traded at virtually the same yield as Germany’s. They were widely held. At the end of 2009, of Greece’s 293 billion euros in public debt outstanding, 206 billion were foreign owned, 90 billion were held by European banks and roughly the same amount by pension and insurance funds. For those claims to be written down would relieve the burden on Greece. But it would also tumble Greece out of the club of respectable European borrowers. At an earlier moment in its history PASOK might have turned a national bankruptcy into a liberating rupture.⁶ By 2009 it was no longer that kind of political party. Restructuring would involve Athens in humiliating negotiations with its creditors. It would most likely involve the IMF. Indeed, restructuring was not just unpopular, it was unspeakable. If you hoped somehow to postpone the inevitable and muddle through, the crucial thing was to preserve confidence. Even mentioning the possibility of restructuring was likely to precipitate a panic, shut off short-term funding and make immediate default inevitable. In due course, however, whatever tactic you adopted, the math was inexorable. Greece’s debts were too heavy and growing ever more so. Restructuring was inescapable. But rather than a clean cut, what transpired was a prolonged and agonizing rearguard action clouded by obfuscation and the endlessly repeated tactic of “extend and pretend.”

Where did this twisted path begin? As good a place to start as any is in the spring of 2010, when Greek prime minister Papandreou visited Paris for meetings with President Sarkozy and his government. The French made clear that they did not want a crisis. Nor did they want to hear talk of restructuring. They wanted to mobilize funds to bail out the Greeks. Since the turmoil of the fall of 2008, when Budapest had been driven into the arms of the IMF, a secret committee of the larger European states had been meeting to discuss how the eurozone would respond if one of its members was sucked into a Hungarian-style crisis.⁷ Paris and the European Commission were united in wanting a Europe-wide solution. To the Greeks this was no doubt reassuring. As would be true throughout the eurozone crisis, there was little or no anti-bailout hysteria in France.⁸ Though the French would contribute almost as much in per capita terms to every eurozone rescue measure as Germany, and only fractionally less in overall terms, the issue was never politicized to the same degree. But that begs the question, why was Paris so willing to consider throwing good money after bad in Greece?

President Sarkozy never missed an opportunity to score points at the expense of Anglo-Saxon finance. All the more embarrassing that in Greece it was France’s banks that were most exposed. Paribas was the largest foreign holder of Greek debt. Credit Agricole had a large exposure through a Greek subsidiary. And the most fragile bank of all was Dexia.⁹ But why, we have to ask, was Paris so acutely concerned? The balance sheet of BNP Paribas was solid enough to absorb losses in Greece. Dexia’s direct exposure to Greece came to only 3 billion euros. Under normal conditions, that was hardly a life-threatening amount. The fact that it was a matter of concern was due, first of all, to the dire state of Dexia’s balance sheet. It was truly a weak link and no one in 2010 wanted to fix it. The public would not stand for another bank bailout. And the concerns went far beyond Dexia and its ilk. The entire business model of Europe’s biggest banks, even French national champions like BNP Paribas, was a cause for concern. They continued to rely on wholesale finance. If their credit began to fail, they were at the mercy of commercial paper and repo markets. Confidence in funding markets had not recovered from the shocks they had suffered since 2007. A shock to confidence in the eurozone might lead to a general withdrawal of funding. What was at stake was not just Greece, but the far larger network of cross-border debt, in which France’s stake, like that of other rich country lenders, was truly enormous.

Altogether, foreign bank lending to what became known as the eurozone periphery—Greece, Ireland, Portugal and Spain—topped $2.5 trillion. Of that total, France’s banks had c. $500 billion at stake and Germany’s banks had roughly the same. Most of that lending and borrowing was not to governments. Spain and Ireland had been swept up in the gigantic real estate inflation that was now painfully deflating. In Spain, in particular, there was reason to fear for the stability not of the government’s finances but of local mortgage lenders. Beyond the periphery, what was even more worrying was Italy’s public debt. Italy’s budgetary situation was far more tightly controlled than that of Greece’s. Indeed, prior to the crisis, it had been running primary surpluses (ahead of debt interest payments). But its debt level was worryingly high, and in May 2008 the Italian premiership had been taken by Silvio Berlusconi, who, despite his business credentials and his conservative coalition partners, was regarded as a dangerous opportunist. No one wanted the flames of panic to leap to Italy. Beyond Italy was Belgium and then France itself. It was this three-tiered structure of debt that drove the politics of the eurozone crisis from the French point of view: the small bankrupt sovereign debtors—Greece and Portugal—at the bottom; then the victims of the real estate boom with big liabilities from the banking crisis—Ireland and later Spain; and finally the really big public debtors, led by Italy. As far as Paris was concerned, the long-term sustainability of Greece’s debt was less important than holding this giant pyramid in place.

Note:

(1) other exposure includes derivative contracts, guarantees and credit commitments

(2) figures for sectoral exposure for Italy for 1st quarter 2010 calculated by applying proportions reported for Q4 2010

(3) figures for other exposure to Italy for Germany, Spain and France calculated by applying proportions relative to total foreign claims for Q4 2010

Sources: BIS Consolidated Banking Statistics and *BIS Quarterly Review,* September 2010, http://www.bis.org/publ/qtrpdf/r_qt1009.pdf.

It was no doubt reassuring to Athens to receive such a sympathetic welcome in Paris. But it should have set off alarm bells. Should Greece wish to be the place where France fought its battle for the eurozone’s financial stability? Was a bailout designed to minimize the risk to Europe’s over-expanded banks and to avoid embarrassment for politicians likely to be in the best interests of Greek taxpayers? The risks to Greece were obvious. On the French side too one might wonder whether, if the aim was to solidify the eurozone, the best tactic was to delay a straightforward and thorough resolution of Greece’s huge debt burden. If it was a question of picking a line of defense, was Greece really where one would choose to make one’s stand? To use the ugly metaphor that would soon circulate widely in the eurozone, might it not have been better to amputate the gangrenous limb, to push Greece aggressively toward restructuring?¹⁰ There were risks on both sides. Paris opted for extend-and-pretend.

On the German side it looked, at first, as though a similar attitude might prevail. Germany’s banks, like France’s, were heavily exposed to the weaker eurozone borrowers. The logic of systemic stability was not lost on Berlin.¹¹ In February 2009, when pressure first built against Greece and Ireland, Finance Minister Peer Steinbrück had calmed markets by announcing: “If one country of the eurozone gets into trouble, then collectively we will have to be helpful. The euro-region treaties don’t foresee any help for insolvent countries, but in reality the other states would have to rescue those running into difficulty.”¹² A year later, when Papandreou’s government was looking for help, Josef Ackermann, the energetic CEO of Deutsche Bank and president of the IIF, was to hand. He traveled to Athens in early 2010 to offer a public-private loan of 30 billion euros.¹³ It is conceivable that with both Berlin and Paris on board, applying a sticking plaster might have calmed markets and reduced yields to the point where Greece could limp on. But the debt was piling up inexorably. And what would have happened when the eurozone was hit by the next shock, from Ireland or Portugal? For an insolvent borrower new debt is a makeshift, not a solution.

In any case, by the spring of 2010 the counterfactual was moot. When Germans went to the polls on September 27, 2009, after a bitterly fought campaign, they threw Steinbrück and the SPD out of office. Angela Merkel continued as chancellor, but now in coalition with the free-market, tax-cutting FDP.¹⁴ They were more to the chancellor’s ideological taste, but she was now operating from a far narrower political base and would have to pay even more attention to the home front. To the satisfaction of conservatives, Steinbrück was replaced as finance minister by Wolfgang Schäuble. Schäuble was a committed European integrationist of the 1980s Helmut Kohl generation. As a Christian conservative of the cold war era he had a capacious strategic vision for the EU as an upholder of Western civilization in an age of globalization.¹⁵ For Schäuble, the Rechtsstaat, the legally bound state, was the anchor of his conception of the West, and as finance minister the debt brake anchored in the constitution was his particular legal preoccupation. The CDU’s new coalition partner, the FDP, was a probusiness, tax-cutting party, so that constrained Schäuble on the revenue side. What Germany and Europe needed was fiscal discipline. If Greece could not make the grade, then Schäuble since the 1990s had been an unapologetic advocate of a vision of a multispeed Europe, in which a core group set the pace while less competitive and disciplined nations brought up the rear. On February 11, 2010, the Merkel government shocked markets by agreeing with its partners to take emergency measures to support the euro as such, but vetoing any specific offer of help for Greece. As one EU official told journalists, “Germany is stepping totally on the brakes on financial assistance. On legal grounds, on constitutional grounds and on principle.”¹⁶

Berlin’s refusal to stick to the bailout script was worrying for the French and shocking for the Greeks. But it should have been no surprise. Article 125 of the Maastricht Treaty banned mutual bailouts. The Lisbon Treaty that finally came into operation in December 2009, just as the Greek crisis exploded, had reinforced the primacy of nation-state responsibility. It also barred the route to the mutualization of debt, which might have allowed a European consortium to share the burden of backstopping some portion of Greece’s liabilities. In a crucial judgment on the Lisbon Treaty delivered on June 30, 2009, the German constitutional court had put a further obstacle in the way of any further moves toward EU integration.¹⁷ Karlsruhe insisted on a stiff test of democratic accountability before any further competences could be transferred to Brussels. What Berlin would agree to on February 11, 2010, was last resort, ultima ratio support for the euro as such. What that meant for a “bad apple” like Greece was unclear. Certainly, Greece should slash its deficits and engage in labor market reform to boost growth. But Germany was in no mood for a bailout. The vast majority of German politicians and public opinion appeared to be willing to let the markets have their way with both Greece and its creditors. If a debt write-down was necessary, so be it. If Athens was unable to pay, then there was support in Germany across the entire political spectrum for the debts to be restructured at the expense of the banks.¹⁸ Polls showed that two thirds of those who supported assistance for Greece also demanded that banks must contribute to the package.¹⁹ These calls were reinforced by lobby groups such as the league of German taxpayers that demanded private sector involvement.²⁰ It was a harsh and high-risk approach, whose appeal to the German public was consistent with the fact that they tended to blame “other people’s” banks and to underestimate the exposure of their own country’s financial institutions.

This was the basic dilemma of the eurozone debt crisis. Greece needed a write-off. The Germans were not opposed and favored haircutting the creditors. But Greece’s PASOK government did not want to pay the price for a problem in large part created by its predecessor. It wasn’t just the state’s debts that would have to be restructured but the Greek banking system too. The entire Greek social and political fabric was at stake. The French opposed a write-off and Paris had backing not just from other European debtor nations but from the ECB as well. The ECB was aghast at the prospect of a sovereign default in the eurozone. What about the risks of contagion? Surely what Greece needed was a healthy dose of financial discipline. That was a popular answer. Austerity was the medicine forced down Greek throats for years to come. But the budget adjustment required was unrealistic and its impact on the Greek economy was devastating. As restructuring was, in the end, inevitable, the question ought to have been how to make it safe, how to build a framework within which debts could be written down and losses inflicted on creditors without unleashing a general panic. The problem was that to even say this out loud was to risk triggering a run before the safety net was ready. While engaging in extend-and-pretend and denying the need for restructuring, it was hard to generate momentum for any collective European effort at institution building. And it could not be done without Germany, which, though it did not shrink from restructuring Greece and its creditors, was anything but enthusiastic about putting in place the mechanisms necessary to make restructuring safe.

The German reluctance was shortsighted but understandable. Already by the spring of 2010 it was clear that a comprehensive solution to the problem of the sovereign debt crisis required (1) an aggressive recapitalization of Europe’s banks to allow them to survive the losses, an undertaking on which Europe was lagging behind the United States already in 2009; (2) a European fund to back this bank recapitalization because otherwise the effort might destabilize the fragile finances of smaller states, a proposal already vetoed by Berlin in October 2008; (3) the ECB would need to stabilize bond markets either by providing liquidity to Europe’s banks or by active purchases along the lines of the Fed’s programs, though outright monetization of debt was barred by the ECB treaty and conservative opinion in Germany abhorred any such intervention; (4) a European TARP, backstopped by the budgets of national governments to buy the sovereign debts of the weakest European states, a proposal blocked by the Lisbon Treaty’s ban on mutualization. It was to make all of this somewhat less inconceivable in political terms that one arrived back at financial discipline (5). Taxpayers in solvent northern counties such as the Netherlands and Finland, but above all Germany, would need to know that they were not being taken advantage of. Before there could be any mutualization of liabilities, there would need to be an agreement on fiscal rules. The bar had been set in May 2009 by Germany’s debt brake constitutional amendment. Anything less was a compromise as far as Berlin was concerned. It was the working through of these interlocking problems that would make the road to containment, let alone resolution of the Greek debt crisis, such an agonizing one. All the while the financial markets looked on with a mixture of anxiety, impatience and an eye to the speculative profits to be made by trading on uncertainty.

II

The search for a solution began in early 2010 in Schäuble’s finance ministry. Apparently without prior coordination with Angela Merkel’s chancellery, Schäuble proposed that the EU should establish a European Monetary Fund (EMF), able to conduct within the eurozone the kind of restructuring, stabilizing and disciplining role that the IMF played on the global stage.²¹ One version of the EMF idea, pushed among others by Deutsche Bank’s chief economist, Thomas Mayer, was for the fund to backstop debts up to a limit of 60 percent of a country’s GDP. Above that level debts would undergo restructuring, with bondholders taking a proportional and uniform haircut.²²

It was a strikingly ambitious proposal that reflected Schäuble’s deeply held federalist European commitments. He was keen to use the crisis to push forward the agenda of European integration left unfinished at Maastricht in 1992. If Berlin had thrown its full weight behind the idea of an EMF and if its budget had been set to an appropriate size—what were needed were hundreds of billions of euros—the crisis might have taken another course. If Berlin had risen to the challenge it is hard to see how the rest of the eurozone governments could have resisted. Something very much like this is what they would eagerly settle for in 2012. But this opportunity for German leadership on the crisis went begging. In the spring of 2010, Schäuble’s scheme was shot down, by friendly fire.²³ Chancellor Merkel was no European federalist. She had no desire to reopen the terms of the Lisbon Treaty for which she had fought so hard and which was only just coming into operation. She was not about to endow Brussels with its own monetary fund. She was far too skeptical of Europe’s capacity for self-discipline and she had the German constitutional court’s Lisbon ruling to think about. She understood that radical measures were necessary, but her own proposal, rather than creating an EMF, was simply to involve the IMF in disciplining the eurozone.

Forcing Greece to go to the IMF appealed to German conservatives.²⁴ The Fund, with its ambitious French managing director, Dominique Strauss-Kahn, was keen to be involved. But there was also hesitation. The IMF had already put tens of billions of euros into Eastern Europe. The eurozone would take even more. In a new age of globalization, was a deep engagement in Europe the right direction for the IMF to be headed? And in dealing with European countries with powerful representation on the Fund’s own board, could the Fund’s economists be certain that their expertise would prevail? Specifically, would the Europeans take the IMF’s advice on the question of restructuring? Did they even understand the policy that the IMF was duty bound to pursue? Following its disastrous experience in Argentina’s financial crisis in 2001, the IMF had established new rules.²⁵ The Fund would lend only to solvent borrowers, otherwise there must be restructuring. And if it was to lend, it would insist on lending early, before panic set in. Given the scale of speculative firepower that could be mobilized in leveraged financial markets, to lend once a run had started was likely to be both expensive and ineffectual. Given how far the Greek crisis had already progressed by the early months of 2010, it was hard to argue that it met either of these criteria.

Here again one can glimpse the possibility of an alternative path: Could Berlin have backed an IMF demand for immediate Greek restructuring? Certainly the Fund’s own retrospective analysis suggests that this would have been the better path.²⁶ But Merkel’s veto on the European Monetary Fund idea suggests the main obstacle to any such strategy. She was not willing to contemplate the additional flanking measures that would be necessary to make a restructuring safe. And the proposal to involve the IMF rallied the rest of Europe against her. Indeed, Merkel’s own finance minister, Schäuble, let it be known that he would regard IMF involvement as a “humiliation” for Europe.²⁷ For Sarkozy it was unthinkable that the IMF should be involved at all: “Forget the IMF. The IMF is not for Europe. It’s for Africa—it’s for Burkina Faso!” he told the Greek government in early March.²⁸ The ECB, likewise, was absolutely opposed both to anything that entailed debt restructuring and to IMF involvement. It was bad enough for American mortgage-backed bonds to have unleashed the banking crisis. For Trichet it was simply unthinkable that the sovereign signature on eurozone public debt would not be honored in full. And to involve the IMF in Europe’s internal affairs was to add insult to injury. Trichet’s objection was not that the IMF was for Africa, but that it was “American.”²⁹

Trichet had reason to be worried about the outside world, because when it came to the eurozone, it was to the ECB that all eyes turned. If the ECB was a central bank, like the Fed or the Bank of England, there was no need for there to be a sovereign debt crisis at all. Greece had not borrowed in dollars. It had borrowed in euros and had delegated the sovereign power to print its own currency to the ECB. Its fate and that of the entire rest of the eurozone was in Trichet’s hands. All the ECB had to do to stop the destabilizing surge in Greek interest rates was to do what central banks do all over the world: buy sovereign bonds. Of course, bond buying was no long-term solution. Greece needed restructuring, fiscal discipline and economic growth. But at stake was the financial stability of a vast economic area. The Greek public debt was a tiny part of Europe’s financial system. The treaties that founded the ECB limited its right to buy newly issued Greek debt. But it could buy outstanding bonds as part of a market stabilization effort. If the ECB did not intervene it was a matter not of economics but of politics and over the winter of 2009–2010 it seemed that Europe’s central bankers were determined to take a tough line. Rather than continuing the generous liquidity provision it had offered in 2009, the ECB allowed the LTRO scheme to expire.³⁰ Then in April 2010 it began to discuss a new regime under which it would apply graduated repo haircuts to lower-rated sovereign bonds, limiting their attractiveness to banks.³¹ Trichet was engaged in the high-risk gamble of substituting pressure in the bond markets for the eurozone’s missing federal structures of fiscal and economic governance. With the ECB looking on, surging bond yields would force the Greeks to get serious about fiscal discipline and economic reform. In taking this line, Trichet was not only satisfying his own agenda. He was also appeasing the Bundesbank and its hawkish, monetarist head, Professor Axel Weber. Any kind of bond purchases by the ECB were seen in Germany as an inflationary menace. Furthermore, and more pertinently, they were understood to be a form of debt mutualization by stealth. By way of the balance sheet of the ECB, German taxpayers would end up as creditors to the rest of the eurozone.³² So too, of course, would all the other shareholders in the ECB. But it was Germany’s portion that German Eurosceptics worried about.

Throughout the early months of 2010 the argument was deadlocked. Market pressure on Greece intensified. Foreign investors were unloading what Greek debt they could sell. Hard-liners in Europe might see this as a legitimate way of imposing discipline, but for investors the lack of resolution was unsettling. Who might be next? Ireland? Italy? For the Greek government it was, frankly, terrifying. On May 19, 2010, Athens was due to make payments of 8.9 billion euros. It was not obvious where they would find the cash. Desperate for a way out, the PASOK government looked for help from across the Atlantic.

In the spring of 2010 visitors from Europe bearing bad news were not welcome in the White House. The Obama administration had been closely following the developing Greek debt crisis and had appealed to the Europeans to act fast.³³ But it was itself mired in domestic political mud. Thanks to the botched Massachusetts special election in January following the death of Teddy Kennedy, the Democrats had lost their filibuster-proof majority in the Senate. The passage of health-care reform had become a grueling war of attrition. Dodd-Frank seemed stranded. The last thing the Treasury and the Fed needed was a new crisis. But by the spring of 2010 it was clear that the failure of the Europeans to deal with Greece was threatening precisely that.

Once before, sixty-three years earlier, a political crisis in Greece had triggered a transformation in US policy. On March 12, 1947, after the British had declared their inability to defeat the Communist insurgency in the Greek civil war, President Truman announced the doctrine of containment, one of the opening moves in the cold war. That summer, Truman’s secretary of state, General George Marshall, would back up containment with his legendary promise of economic aid for Europe. In 2010 there was no antagonist like the Soviet Union to force the Obama administration’s hand. What made Greece into America’s problem was not a global clash of ideologies, but the money coursing through the circulatory system of transatlantic finance. America’s mutual funds had hundreds of billions of dollars at stake in Europe’s banks, above all French banks. It was those same banks that were exposed in Greece. And the US branches of those same European banks were also major lenders to US households and firms. Any eurozone financial crisis would blow back on America.

On March 9, 2010, a month after Germany blocked the push for a quick Greek rescue, President Obama and his top economic advisers, Larry Summers and Tim Geithner, took time to meet with the Greek prime minister and his delegation. Obama’s message was encouraging. Washington would vote its 17 percent share for IMF assistance and would throw its weight behind an approach to Merkel requesting aid from the EU.³⁴ Opposition to IMF involvement from France and the ECB would be overridden. But the White House made one thing clear. There could be no talk of debt restructuring. “We cannot have another Lehman,” Obama emphasized. Whether Greece’s debts were sustainable was not America’s concern. Washington’s priority was containing financial contagion. Restructuring could not be contemplated until the Europeans had found a way to stabilize bond markets and were ready to push through wholesale recapitalization of Europe’s banks. And given the Franco-German deadlock, no such agreement seemed likely.

It was from this force field of interests that the first iteration of extend-and-pretend emerged. Europe entered an emergency regime defined not by a single sovereign author, but by the absence of any such authority.³⁵ At an EU summit on March 25, 2010, overriding objections from both the French and the ECB, and with Washington on her side, Merkel forced through the involvement of the IMF.^{³⁶ It would be a joint EU-IMF action, as in the Baltics the previous year. But this time the ECB would be fully engaged. A committee of the EU, the ECB and the IMF would make up the soon to be infamous “troika,” dictating policy to Greece and the other “program countries.” What was ruled out was restructuring. On that Washington sided with the French and the ECB. Existing Greek debt would be paid off with new loans from the troika, whether or not the result was sustainable. The IMF would have to bend its operating procedures to the occasion. To satisfy Merkel’s insistence on the Lisbon rules, the “European” component would not consist of measures taken collectively via the central institutions in Brussels or jointly funded by the member states. That would require treaty change and might violate the line drawn by the German constitutional court. Instead, it would consist of individual national credits for Athens on a bilateral and voluntary basis coordinated through the Eurogroup, the powerful but informal meeting of the eurozone finance ministers. To avoid the appearance of a bailout—banned by Maastricht—the loans would not be on concessionary terms. Interest rates would be stiff and there would be a processing fee to compensate the lenders for their trouble. Finally, and most important, the support would not be provided preemptively to forestall a loss of market confidence. It would be offered only as an ultima ratio, if and when Greece lost access to the markets. It would be up to Greece, by means of austerity, to forestall that moment for as long as possible.}

For ordinary Greeks this meant pay cuts across the public sector. Contract workers were not renewed. The cap on dismissals from the private sector was lifted. The pension age was raised. VAT and other consumption taxes were hiked. An economy already under pressure was subjected to a further contractionary squeeze. A population that already had one of the lower standards of living in Europe was pushed further down the scale. The Greek labor movement mobilized in furious protest. But it was enough at least to satisfy the bond markets. In the last days of March 2010, Athens was able to issue a final tranche of long-term debt: 5 billion euros for seven years at just under 6 percent. Perhaps not surprisingly, investor demand was lukewarm.³⁷ Europe was preparing a safety net. The only question was when Greece would tumble off the ledge.

III

On March 30 the markets were rocked by news not from Greece but from Ireland. The bill for recapitalizing Ireland’s bankrupt banks was soaring. For Anglo Irish Bank alone, Dublin was now budgeting 34 billion euros, more than Ireland’s tax revenue in 2010. Soon Ireland’s deficit would be worse than that of Greece’s.³⁸ In Ireland it was the banks pulling the sovereign down. In Greece the mechanism worked the other way around. Canny depositors in Greek banks were aware that their savings were invested in the government bonds that Athens was struggling to service. In the early months of 2010, 14 billion euros were withdrawn from Greek banks and shifted elsewhere in the eurozone. The first to move were the oligarchs moving huge sums by way of Cyprus, but they were soon followed by middle-class depositors pulling out a few thousand euros at a time.³⁹ Bereft of sources of funding, the Greek banks turned to the Greek central bank, their local branch of the ECB, where Trichet continued to allow them to repo downgraded Greek government bonds. This was a vital life support system and it gave the central bank a whip hand not just over the Greek government but over Greek society and the economy at large. Without approval from Frankfurt there would be no money in the ATMs, but nor would there be any restructuring of Greece’s insupportable debt.

In April, as the troika argued over who would contribute what and how large the Greek bailout package would be, time ran out.⁴⁰ A downgrade by the Fitch credit-rating agency sent Greek government debt yields surging to 7.4 percent. On the morning of April 22, Eurostat announced that its estimate of the Greek deficit in 2009 had now risen to 13.6 percent of GDP. Ireland’s was even larger, at 14.3 percent. Spreads on Greek bonds surged to 600 basis points, raising the borrowing rate to 9 percent, effectively shutting Greece out of the market. The moment had come to reach for the last resort. Urged on by both Schäuble and Geithner, the Greek government triggered the emergency mechanism. Greece needed a lot of money and there was no time to lose.

It was a coincidence but a symbolic one. On the evening of April 22, hours after the Eurostat release had rocked the markets, the world’s financial elite were gathered in Washington, DC, for the spring IMF meeting. The evening’s entertainment was at the Canadian embassy and it was time for some frank talk. The crisis had moved beyond the European arena. The eurozone now posed a threat to global financial stability. Since March China had been demanding action to defend the value of global investments in euro-denominated assets.⁴¹ As Alistair Darling, Britain’s Chancellor of the Exchequer, recalled, the mood was urgent: “You can’t overstate the fact that America, with increasing incredulity and anxiety, was watching Europe’s inability to act. . . . The message was, ‘Why can’t you take action? You know you’ve got to do something.’”^{⁴² As the Financial Times put it, the failure of the eurozone to restore stability on its own terms meant that by April 2010, the “rescue” of the euro, “the ultimate expression of European integration, depended on outsiders in international institutions and the US administration.”}

But no deal emerged from Washington. The troika was only beginning to haggle with Athens over the terms of a rescue loan. Markets were left hanging. On April 28, 2010, the bottom fell out. The official chronicle of the German finance ministry is, as one might imagine, a sober document. This is how it describes events in Europe’s sovereign bond and interbank money markets that day:

“The crisis becomes dramatically acute. Risk premiums for government bonds in some Eurozone member states such as Portugal, Ireland and Spain increase rapidly and reach levels equal to that which prevented Greece from accessing the financial markets in April. In an echo of the final dramatic phases of the financial crisis [of 2008], there is virtually no interbank lending between European banks. Within a very short period, there are overall signs of an acute pending systemic crisis.”⁴³

What this official narrative disguises is Berlin’s own role in precipitating the “acute pending systemic crisis.” Ahead of vital regional elections in early May the public agitation in Germany against assistance for Greece was ferocious. The FDP, Merkel’s coalition partner, which saw its popularity among its free-market nationalist supporters plunging, played the anti-Greek card uninhibitedly, narrowing the chancellor’s room for maneuver. To remind Merkel of the global stakes, on April 28 Dominique Strauss-Kahn and Jean-Claude Trichet both flew into Berlin.⁴⁴ But despite the increasing panic, there was no deviation from the minimalist script that Berlin had laid down on March 25. Indeed, Merkel stirred the fires of speculation by reminding the press that admitting Greece to the euro had been a mistake and that Germany’s contribution to whatever relief effort emerged would be a voluntary decision taken on terms decided in Berlin.⁴⁵ It was not the kind of talk to calm markets. Greek spreads surged to 1,000 basis points, and by the end of the day Washington was sufficiently alarmed for Obama to place a personal call to the chancellery.⁴⁶ Nor was Merkel’s the only phone ringing in Europe. The logs for Geithner and his staff recall almost daily contact between Washington and Berlin, Frankfurt and Paris.⁴⁷ Governments from around the world were pressing the EU to act.

Finally, in the first days of May, the deal was done. Greece agreed with the troika not only to slash its deficit but to aim for a surplus. It promised to deliver a turnaround in its budget balance of a staggering 18 percent of GDP.⁴⁸ In 2010 alone the reduction of its deficit would be 7.5 percent of GDP. Every area of Greek public life would be touched, from ministerial contract cleaners to privatization of state assets. Everything was up for grabs. In exchange, Greece would receive a bailout far larger than previously conceived: 110 billion euros, of which 80 billion would come from the EU and 30 billion from the IMF, payable in quarterly installments over three years. The loans were at tough rates and it was clear that servicing them would create a repayment shock in 2013. But it was the best that the lending countries were willing to offer. Merkel promised an affirmative Bundestag vote for May 7. The question was whether the markets would give Europe that long.

Merkel presented the rescue package to the German Bundestag on Wednesday, May 5. It was, she declared, “alternativlos”—without alternative.⁴⁹ Merkel’s rewording of Margaret Thatcher’s famous pronouncement—there is no alternative (TINA)—was to become notorious. Meanwhile, that same day Greece was rocked by a general strike that mobilized both main wings of the Greek labor movement and shut down transport and public services. In Athens protesters fought running battles with riot police. As the parliamentarians debated the austerity program in committee, a firebomb crashed through the window of a branch of Marfin Bank, setting the building alight and killing three staff members. Karolos Papoulias, the grizzled president of the Hellenic Republic and veteran of the Greek resistance in World War II, declared: “Our country has reached the edge of the abyss.”⁵⁰ On May 6, the Greek parliament convened to vote through what was the most draconian austerity program ever proposed to a modern democracy. That morning, the ECB board was meeting in Lisbon and reporters e-mailed the news that the imperious Jean-Claude Trichet had refused even to discuss the possibility of stepping in to buy Greek bonds. Earlier in the week, on the back of the new fiscal program, the ECB had reluctantly agreed to continue repoing Greek debt, but actively buying bonds was a step too far.⁵¹ It was not what markets needed to hear.

When US trading opened—in the afternoon by European time—prices plunged. By one p.m. the market was down 4 percent. With the ECB refusing support, there was heavy trading in credit default swaps on Greek government debt. In a single day the Volatility Index (VIX), a measure of market uncertainty, surged by 31.7 percent. The euro plunged, losing 2.5 cents by early afternoon.⁵² What was going on between terminals on both sides of the Atlantic that afternoon would later become a matter of dispute in American courtrooms. But at 2:32 p.m. the market went into spasm.⁵³ Half an hour later, by 3:05 p.m., the main American stock markets had given up 6 percent of their value, erasing $1 trillion from portfolios. As panicked traders fled to quality, demand for US Treasurys surged, driving yields down from 3.6 to 3.25 percent in a matter of minutes.

Thanks to the transatlantic time difference, news of the “flash crash” hit the BlackBerrys of the ECB board as they sat down to dinner in Lisbon. Eighteen months on from the Lehman crisis, it seemed that the delay in bailing out Greece was about to precipitate a second financial catastrophe. Even the head of the Bundesbank, the tough-talking Axel Weber, realized that the ECB could not maintain the hard line that Trichet had taken that morning. The “ECB must buy government bonds,” he exclaimed across the dinner table.⁵⁴ For the conservative team at the head of the ECB, it was a dramatic moment. They understood that they needed to act. The world was watching. Athens was literally burning. Soon it might be Rome. But the ECB did not want to be the only buyer in the market. It was determined not to let Europe’s governments off the hook. It wanted austerity across the board. Furthermore, though the ECB might buy bonds to provide temporary support, what was needed, sooner rather than later, was a giant state-backed fund to provide confidence to the bond markets. Making European governments and taxpayers responsible for each other’s debts would create a nightmarish political entanglement, but it would at least reinstate the clear line between fiscal and monetary policy, on which the ECB founded its precious claim to independence.

The next day, on May 7, 2010, the tone at the meeting of the European Council was apocalyptic. Commissioner Rehn and President Trichet delivered dire warnings. “It’s Europe. It’s global. It’s a situation that is deteriorating with extreme rapidity and intensity,” Trichet insisted. As the Financial Times reported, it came as a shock to the sometimes provincial European Council: “Leaders of smaller eurozone countries not fully plugged into world financial markets had, until this moment, not appreciated the gravity of the crisis. But even more experienced leaders appeared stunned.” “[Nicolas] Sarkozy was white with shock,” reported one ambassador. “I’ve never seen him so pale.”⁵⁵ But despite the sense of crisis, and despite the deal on Greece, there was no agreement on creating a general security umbrella for the eurozone as a whole. Sarkozy pointed the finger back at the ECB. How could Europe’s central bank stand by while the credit of Europe’s governments was ruined? Why was the ECB not acting like the Fed or the Bank of England? “Sarkozy was screaming: ‘Come on, come on, stop hesitating!’” recalled one EU policy maker. Sarkozy was backed by Italy’s Silvio Berlusconi and Portugal’s José Sócrates, both of whom had reason to fear a general sovereign debt crisis. But Merkel, the Dutch and the Finns all pushed back. The ECB was independent. It must be free to act as it saw fit. Friday, May 7, ended without agreement. But after events on Wall Street, it was clear that something big had to be done before trading resumed in Asia on Monday, May 10. The Europeans were going to have to move from the national bailout for Greece toward providing a more comprehensive financial backstop for their entire currency zone. They could not expect to handle their problems state by state through bilateral agreements with the IMF. Whereas a few weeks earlier they had balked at coming up with a few tens of billions of euros, now they were going to have to contemplate far larger numbers.

Under huge pressure from governments around the world, Europe’s leaders reconvened on the afternoon of Sunday, May 9.⁵⁶ Obama had worked the phones to Merkel and all the other key European leaders. Ben Bernanke called an impromptu conference call of the FOMC to approve the renewal of the swap lines to the ECB, the Bank of England, the Swiss National Bank and the Bank of Canada.⁵⁷ Likewise, the G7 convened a conference call to coincide with the meeting of the European finance ministers. Japan, Canada and the United States were on the line. At this crucial moment Schäuble was hospitalized by an allergic reaction to a medication. So Spain took the chair, and France’s finance minister, Christine Lagarde, found herself as the liaison between the two groups. With two phones on the go at once, she had the EU 27 in one ear and the G7 in the other. The scale of the bailout fund agreed was enormous: 60 billion euros came from the EU Commission funds, 440 billion from the European governments. Dominique Strauss-Kahn offered to use the IMF’s resources to back the fund at the same ratio that had been employed in Latvia the previous summer. But whereas tiny Latvia had needed only a few billion euros, now the IMF pledged 250 billion. It was by far the largest commitment the IMF had ever made to any program. The $1 trillion pledged to the IMF at the London G20 that was supposed to mark the advent of a new age of global firefighting would be deployed to rescue Europe. The figures were impressive, but the all-important question was how the rescue fund would be constituted and financed. Was this a first step toward the mutualization of sovereign debts, and thus a radical step beyond Lisbon? Berlin was not going to concede anything of the sort.⁵⁸ The entire deal hung in the balance until a Dutch participant with expertise in shadow banking suggested that the European Financial Stability Facility (EFSF) be incorporated as a private special purpose vehicle registered in the tax haven of Luxembourg. Eurozone governments would contribute capital on a country-by-country basis without assuming any overarching intergovernmental “European” commitment.

Even in this makeshift form, the EFSF would take months to put in place. What was needed when trading resumed on Monday morning was immediate support for Europe’s bond markets. That could come only from the ECB. The EFSF agreement satisfied Trichet. The governments were now serious. The question was whether he could carry the board of the ECB, and specifically whether he could win over the Bundesbank. After coming around to bond buying at the moment of panic on May 6, Axel Weber had subsequently had a change of heart. He did not want to risk breaking ranks with German public opinion and his German colleague on the ECB board, chief economist Jürgen Stark. On his way back to Frankfurt from Portugal, Weber retracted his agreement. Nevertheless, on Sunday, May 9, Trichet put the proposal to the vote and won majority approval. He then waited to make any public announcement until the early morning of May 10, when Europe’s governments were finally ready to present their ramshackle bailout fund.⁵⁹ The ECB would not move first.

Over the days that followed, the markets calmed. Despite the opposition from Germany, the ECB’s promise to buy helped. There was less rush to sell if there was a purchaser of last resort. But to make this commitment manageable for the ECB, there was one further, unpublicized facet to the deal. Even if there was no immediate restructuring of Greek debt, the banks should not be permitted to offload their entire holdings of distressed debt. A concomitant of the ECB’s bond buying, insisted on with particular force by Merkel and Schäuble, was that all the eurozone finance ministries would pressure their leading banks to refrain from selling their holdings of Greek and other troubled bonds. The bargain was never complete. In Germany, Deutsche Bank led a group that agreed to hold on to the debt for three years.⁶⁰ But many smaller banks refused to take the pledge. And rumors quickly spread that of the first 25 billion euros in bonds bought by the ECB, the vast majority had come from France.

The IMF put its imprimatur on the deal at a meeting of the board on Sunday, May 9, 2010. With Strauss-Kahn on the ground in Europe, the chair in Washington was taken by John Lipsky, a Bush appointee who had alternated time at the IMF with stints at J.P. Morgan. No one around the table at the IMF’s headquarters was pleased with the situation.⁶¹ It was an enormous engagement. It was profoundly disturbing that it was being undertaken to manage a crisis in Greece, a comparatively rich European country, at the behest of the EU. The Greeks were being lent vastly more than their quota, the capital contribution that normally limited a country’s IMF borrowing rights. The Fund was required to share control over the program with the other members of the troika, and its own experts were far from persuaded that Greece’s debts were sustainable. As they put it cagily: It was undeniable that “significant uncertainties around” the program made it “difficult to state categorically” that Greece would ever be able to pay back its debts. Normally this would be a red flag. Who, after all, would benefit from Greece taking on new loans from official lenders to pay off existing private debts it could not service? The outspoken Brazilian board member insisted that the program not be referred to as “a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders, mainly European financial institutions.”⁶²

One could hardly ask for a clearer statement of the “bait and switch” substitution, by which a problem of excessive bank lending was turned into a crisis of public borrowing.⁶³ But this substitution resulted less from a skillful ideological conjuring trick than from a lowest common denominator compromise between the main players in the Greek debt drama—Germany, France, the ECB, the IMF and the Obama administration. Certainly at the IMF there was little illusion about the compromises they were entering into. On May 9 the tone in the room at the IMF board meeting was so negative that Lipsky felt it necessary to put the opposite case. Lipsky was fully committed to the White House line. He was a devotee of Geithner’s logic of maximum force.⁶⁴ Indeed, Lipsky liked to embarrass his cosmopolitan IMF colleagues by calling for the Fund to adopt not the Powell Doctrine but “shock and awe,” the title the US military gave to their devastating aerial assault on Baghdad in 2003.⁶⁵ From the chair at the crucial meeting in Washington on May 9, Lipsky recognized the concerns and criticism of his colleagues, but pronounced himself “a little disturbed by the suggestion that the Fund program should obviously have involved debt restructuring or even default.” Restructuring “would have had immediate and devastating implications for the Greek banking system, not to mention broader spillover effects.” This was what was ultimately decisive.

The IMF board approved the disproportionate and risky Greek bailout not because it made sense in its own terms, or was good for Greece, but because on the track record to date, Europe’s inability to contain the Greek crisis meant that there was “high risk of international systemic spillover effects.”⁶⁶ Instead of restructuring Greek’s unsustainable debts, what would be restructured were its entire public sector and its creaky economy. Heroic assumptions about cost cutting and efficiency gains were the ways in which the IMF squared the Greek program with its conscience. Perhaps if it were shaken thoroughly enough, “sclerotic” and “clientelistic” Greece could be jolted onto a higher growth path that would make its debts sustainable after all. Austerity and “reform” were the only items on the agenda that the otherwise divided parties to the deal could agree on. Whether this was economically effective or politically sustainable and what it would mean for the democratic politics of Europe was another matter altogether.