The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (4 page)

Mr Karagiannis is one of an army of new voters for Syriza, the radical-left coalition. There are more supporters near another stop on the Olympic torch relay. A steel factory near Piraeus port has been officially occupied by striking workers for six months. They claim they’re being asked to accept a pay cut of almost 50 per cent. The factory that a decade ago, during the boom, produced steel for Greece’s stadia and bridges, now lies idle in the time of bust. All the pressure applied by the Troika on Greece comes to a concentrated focus on workers such as these. Wage cuts are not an unfortunate by-product of Greece’s bailout. These cuts are the key ingredient of the medicine prescribed by Germany for Greece’s long-term growth. Leading German economic figures expressed something close to moral outrage at the soaring salaries of Greek workers in the boom time. During the first eight years of the euro, the real cost of employing Greeks surged by 40 per cent – without Greeks working harder or producing more. During the same period, German workers saw their productivity rise while their wages fell.

This tale of two workforces – the ‘unit labour costs’, to use the cold economic phrase – is as important to the euro debate as the deficit and debt figures. The Greeks point to the scale of the cuts in salary and government budgets. The Germans point to the staggering increases: state spending in Greece soared by a extraordinary 89 per cent over the last decade, almost five times that of Germany, much of it going into salary rises. What Greeks call sado-austerity is seen by their European masters as simply the bursting of a bubble – and a painful return to a reality from which the Germans never really departed. In theory, in order to regain its competitiveness, Greece very much needs what a eurocrat might call ‘labour cost realignment’. But actual Greek workers do not respond lightly to suggestions that they need a German-style fall in their wages. ‘It upsets me that they believe we get high wages. Our wages are very low,’ says Alexis Athanasios, a steel worker. ‘We can’t even afford to support our families.’ Haris Manolis, a 38-year-old technician, blames Germany for wanting ‘to come here and have factories with cheap labour’.

The easiest way for Alexis and Haris to regain competitiveness would be for Greece to follow Britain’s example and devalue. But that, clearly, is impossible within the Eurozone. So instead Greece has endured three years of internal devaluation. This has only served to deepen and lengthen the recession. Unemployment is at a record 27 per cent; for young people it is at an astonishing 60 per cent; for women it is over 66 per cent.

One extraordinary proposal floated by the Troika in 2012 was the introduction of a six-day week, effectively abolishing the weekend. Pressure was also placed – more fruitfully – on Greece’s minimum wage. Germany did not have a minimum wage, so how could Chancellor Merkel sell the bailout to the German people when the Greeks had a minimum wage of nearly €900 per month? Even in Spain it was only worth €750. In Greece the minimum wage had risen by 59 per cent during the first nine years of its membership of the Eurozone. ‘We had a huge fight over minimum wages,’ says a senior adviser in Berlin. ‘The minimum wage was limiting tourism growth, foreign companies weren’t expanding because it was too expensive, and there were lower salaries in Turkey, Tunisia, Croatia.’ He told me that German companies operating in Greece had to hire people on the black market. The outcome was that, to match the reality of black-market pay rates, the minimum wage in Greece was cut by one-fifth – and by one-third for under-25s. With Greece internally devalued, Berlin argued, northern Europeans could holiday there more cheaply than before, so giving the Greek tourist economy a big boost, and thus helping the country on the road to recovery. In addition, visitor numbers would be boosted by those too frightened to holiday in Tunisia or Egypt during the upheavals of the Arab Spring.

The reality turned out to be rather different. The violent protests, clouds of tear gas and burning banks that marked the Athens Spring were accompanied by a collapse in tourist numbers. By 2012, when I met Antonis Stelliatos, head of the Hellenic Yacht Owners Association, boat rentals were down 35 per cent, conference bookings down 50 per cent, and car rental was down 15 per cent. He was hosting the launch of a large new yacht near Piraeus harbour. He wore a T-shirt sporting the slogan

Greek Sea

Not in Crisis

over a picture of an azure lagoon. The riots and the tear gas were only rare occurrences in Athens, he said, before correcting himself. ‘The riots are in fact only in two squares in Athens: Syntagma and Omonia.’

Still, everything was conspiring to push Greece into the doom loop of a collapsing economy: higher unemployment, lower take-home pay, lower spending, lower tax receipts and stubbornly high deficits. On top of that, tourism
– representing one-fifth of the Greek economy, and one in five jobs – was being crushed by the images of social unrest beamed into Europe’s living rooms.

Year after year, Greece was breaking the record for annual economic contraction, and in three years, one-fifth of the economy had been lost – the equivalent of losing the entire tourism sector. In cash terms, in 2012 Greek GDP had reverted to where it had been in 2005. For context, in 2008 the Greek economy was about half the size of Turkey’s. Four years later it was less than one-third the size. The Finns were such critics of what they saw as Greek profligacy, laziness and corruption that, uniquely, they demanded collateral for their rescue loans. In 2008 the Greek economy was 26 per cent larger than that of Finland. By 2012 Finland’s GDP exceeded Greece’s for the first time in history. Finland’s population is less than half that of Greece.

In Washington and in Berlin the answer was the same: if things had got worse in Greece in 2012, it was because the programme had not been implemented. As a leading government adviser in one of the Eurozone creditor nations told me, ‘The benefits from these structural reforms take two to three years to see.’

By the summer of 2011 it had already become apparent that Greece had no chance of repaying its debts in full. At this point, at the behest of the IMF, the man known as the Red Adair of sovereign debt crises flew into Athens. Lee Buchheit is an expert in helping nations renegotiate the money they owe their bankers. The theory emerging from Berlin was that the idiots who had lent Greece billions at low interest rates, presuming it was guaranteed by the German taxpayer, should lose at least part of their shirts. Why should German taxpayers bail out the private sector? The European Central Bank took a contrary view, partly because of the impact this would have on a fragile European banking system, and partly because of the risk of contagion to other vulnerable economies. For the ECB, in the form of its then president, Jean-Claude Trichet, this was about honouring the signature on a loan agreement. It also had something to do with the fact that the ECB was increasingly replacing private bankers as lender to the troubled nations. Effectively the ECB was lending to a defaulting debtor, which made a mockery of the core principles upon which the ECB was founded. As at most stages in this crisis, the squabbling Eurozone rescue squad applied the salvational balm of an unintelligible acronym – PSI. Officially, the three letters stood for ‘Private Sector Involvement’, a phrase that was meant to connote some degree of willingness on the part of creditor banks to lower Greece’s debt burden by taking what is known as a ‘haircut’. The Frankfurt-based ECB had to tag along. This is where Lee Buchheit came in.

‘Buchheit is the kind of guy who will tell me exactly how we should structure this to squeeze the creditors and get the most out of them, how to do it in the most efficient manner,’ a senior figure in the IMF told me. Most of the IMF was behind this push because it had worked elsewhere – in Ecuador, Jamaica and Uruguay. The trick was to stretch out the term of the loan, a method called ‘re-profiling’, or ‘extend and pretend’. This cut the real value of future debt repayments – a form of default – but everybody could pretend that the cash value of the debts had been honoured. Even though the IMF’s favourite weapon of devaluation could not be deployed in the case of Greece, its other favourite weapon, default – rebranded as PSI – was still very much an option.

When the agreement was reached in July 2011, Prime Minister Papandreou, together with José Manuel Barroso, president of the European Commission, and Herman Van Rompuy, president of the European Council, stood confidently in front of a weary press to announce a ‘European success’ to realise Greece’s potential. The terms of Europe’s own official bailout were considerably sweetened, with longer-term loans and cheaper interest rates. I asked why they did not simply admit that Greece had defaulted. All three disappeared off-stage rather rapidly, bringing the press conference to an abrupt end. Private creditors had voluntarily agreed to a 21 per cent reduction in the net present value of their bonds, but no haircut to the so-called ‘nominal value’, the upfront value of the bond. The deal fell apart as Greece’s economy and its debts soured, and a new deal, involving a 50 per cent nominal haircut, was agreed in October 2011. This also collapsed. After seven months of hard negotiations on terms, a deal was struck in February 2012, affecting €206 billion of Greek government bonds. The ‘bankers’ lost 53.5 per cent of the nominal value of their Greek debts. In real terms, over the lifetime of the debt, this amounted to a cut of 74 per cent. The Greek government’s debts shrunk by €107 billion, one-third of the total. Most bondholders did agree voluntarily to this offer. It was, after all, an offer that they could not really refuse. But the Greek government also invoked special clauses that forced some otherwise unwilling debtors to take a hit. This triggered credit default swaps (see
here
) – bets or insurance on a country going bust. This had been a ‘red line’ that Brussels officials vowed not to cross in the first deal. By early 2012 Greece was not just officially in default – it was the world’s biggest sovereign defaulter.

Greece’s national debt had been heading for a completely unsustainable 160 per cent of its GDP at the end of the decade. After PSI and default that total had come down to a still lofty target for 2020 of 120 per cent. Frankfurt also tried to grapple with the idea that the write-off of Greek debt might prove rather tempting to other countries facing tough programmes
– notably Ireland and Portugal. President Trichet commented after the original July 2011 deal that ‘Greece is in an absolutely exceptional situation. For that reason it requires exceptional and unique solutions. All other Eurozone countries reaffirm solemnly their inflexible determination to honour fully their own individual sovereign signature.’ But the sovereign signatures of other, much larger countries were beginning to be doubted in the global markets. Their ratings were downgraded, the interest rates demanded on their debts shot up. Greece in and of itself should have been an irrelevance. Greece could have been completely bailed out with minimal impact on the rest of Europe. But Greece was a testing ground. And it had the power to infect market perception of other countries, such as Italy and Spain, which really
did
matter.

Lee Buchheit was present at all these negotiations, advising the Greek government. At first he thought that the pre-PSI 2010 Eurozone approach to Greece reflected a view that the crisis was temporary, that it would eventually ‘evaporate’, and therefore northern Europe’s taxpayers could be put at risk lending money to repay their creditors on time and in full. ‘Initially Greece [and Portugal and Ireland] all got gross bailouts,’ he says. ‘They were given the money to pay their creditors in full and on time. If Greece had been restructured in spring 2010 with a haircut, you might have destabilised some fragile northern European financial institutions, forcing a very embarrassing need to recapitalise them directly.’ Buchheit suggests that it was ‘perhaps more politically palatable’ to give Greece the money to repay a French or German bank rather than recapitalising them directly.

In other words, the first bailout of Greece was a backdoor bailout of northern Europe’s banks. When the bailout deal had been finalised in Brussels in the early hours of 10 May 2010, German and French banks had promised ‘solidarity’ with Greece. At the end of 2010 German banks were the largest holders of Greek government debt. But then, at the beginning of 2011, the German banks quietly dumped €10 billion of Greek debts, mostly government debt, leaving the French banks trailing in their wake. German banks were much better prepared for the Greek debt default, pushed for by their own government. President Sarkozy of France was left fumbling around, failing in his argument for limited PSI. French banks were hit by contagion, by funding concerns, and at one point by a complete stop to essential dollar-liquidity funding from Wall Street. ‘Greece – exceptional and unique’ remained the Eurozone mantra. Buchheit detected at this point the origins of the perception in the Troika that it faced a binary choice when faced with other Eurozone countries that were in danger of defaulting: either repay all debts, or give the bankers a violent haircut. A third option, ‘re-profiling’ or ‘extend-and-pretend’, had been dabbled with in Greece and had been used in the previous contagious regional financial crisis, the debt crisis in Latin America that began in the 1980s. But now this third option was being ignored. The financial advantage of ‘re-profiling’ is that it enables affected institutions to cushion themselves. The political advantage is that it can appease those in creditor nations who oppose any kind of bailout.

But what of Greece itself? Not only had the Eurozone supplied the funds Greece could not get from international markets, it had also strong-armed the international banking system into writing off a third of Greece’s national debt. The shackles of the nation’s debt bondage were loosened – a little. But the bankers and politicians negotiating the deal in the Grande Bretagne Hotel in Syntagma Square had a ringside view of the rage and the riots. Protestors actually used marble from the steps of the hotel to hurl at the police.

Nothing to match the anger of the Greek protestors in the squares of Athens was expressed in northern Europe. But the political class – especially in Germany, the Netherlands, Austria and Finland – felt there
was
widespread discontent, and they felt that they had to neutralise it. The process of placating the objectors reached a surreal climax in October 2011, when, after Greece’s first bailout had failed, bailout number two was negotiated at a series of crisis summits. The funds would come from a generalised bailout vehicle called the European Financial Stability Facility, rather than the bespoke programme arranged for the original Greek bailout. If the northern countries were to lend yet more ‘rescue’ funds to Greece through the EFSF, their political leaders needed something to show for it. Some tabloid-friendly German politicians suggested the Greeks put up some of their islands as collateral for the loans, or even the Parthenon itself. The proposal agreed in October 2011 was far more absurd: the surety was to be Greece’s sun.