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Overview

Members of the European Union signed an agreement known as the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. However, a number of European Union member states, including Greece and Italy, were able to circumvent these rules and mask their deficit and debt levels through the use of complex currency and credit derivatives structures. The structures were designed by prominent U.S. investment banks, who received substantial fees in return for their services and who took on little credit risk themselves thanks to special legal protections for derivatives counterparties. Financial reforms within the U.S. since the financial crisis have only served to reinforce special protections for derivatives—including greater access to government guarantees—while minimizing disclosure to broader financial markets.

In the first weeks of 2010, there was renewed anxiety about excessive national debt. Some politicians, notably Angela Merkel, have sought to attribute some of the blame for the crisis to hedge funds and other speculators stating that "institutions bailed out with public funds are exploiting the budget crisis in Greece and elsewhere".

Although some financial institutions clearly profited from the growing Greek government debt in the short run, there was a long lead up to the crisis. EU politicians in Brussels turned a blind eye and gave Greece a fairly clean bill of health, even as the reality of economics suggested the Euro was in danger. Investors assumed they were implicitly lending to a strong Berlin when they bought eurobonds from weaker Athens. Historic enmity to Turkey led to high defense spending, and fuelled public deficits – financed primarily by German and French banks.

On 23 April 2010, the Greek government requested that the EU/IMF bailout package (made of relatively high-interest loans) be activated. The IMF had said it was "prepared to move expeditiously on this request". The initial size of the loan package was €45 billion ($61 billion) and its first installment covered €8.5 billion of Greek bonds that became due for repayment.

On 27 April 2010, Standard & Poor's slashed Greece's sovereign debt rating to BB+ or "junk" status amid fears of default. The yield of the Greek two-year bond reached 15.3% in the secondary market. Standard & Poor's estimates that, in the event of default, investors would lose 30–50% of their money. Stock markets worldwide and the Euro currency declined in response to this announcement.

On 1 May, a series of austerity measures was proposed. The proposal helped persuade Germany, the last remaining holdout, to sign on to a larger, 110 billion euro EU/IMF loan package over three years for Greece (retaining a relatively high interest of 5% for the main part of the loans, provided by the EU). On 5 May, a national strike was held in opposition to the planned spending cuts and tax increases. Protest on that date was widespread and turned violent in Athens, killing three people.

The November 2010 revisions of 2009 deficit and debt levels made accomplishment of the 2010 targets even harder, and indications signal a recession harsher than originally feared.

Japan, Italy and Belgium's creditors are mainly domestic institutions, but Greece and Portugal have a higher percent of their debt in the hands of foreign creditors, which is seen by certain analysts as more difficult to sustain. Greece, Portugal, and Spain have a 'credibility problem', because they lack the ability to repay adequately due to their low growth rate, high deficit, less FDI, etc.

On 13 June 2011, Standard and Poor's downgraded Greece's sovereign debt rating to CCC, the lowest in the world, following the findings of a bilateral EU-IMF audit which called for further austerity measures. After the major political parties failed to reach consensus on the necessary measures to qualify for a further bailout package, and amidst riots and a general strike, Prime Minister George Papandreou proposed a re-shuffled cabinet, and asked for a vote of confidence in the parliament. The crisis sent ripples around the world, with major stock exchanges exhibiting losses.

Some experts argue the best option for Greece and the rest of the EU should be to engineer an “orderly default” on Greece’s public debt which would allow Athens to withdraw simultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate. Economists who favor this approach to solve the Greek debt crisis typically argue that a delay in organising an orderly default would wind up hurting EU lenders and neighboring European countries even more.

In the early hours of 27 October 2011, Eurozone leaders and the IMF came to an agreement with banks to accept a 50% write-off of (some part of) Greek debt, the equivalent of €100 billion. The aim of the haircut is to reduce Greece's debt to 120% of GDP by 2020.

Causes

The Greek economy was one of the fastest growing in the eurozone from 2000 to 2007; during that period, it grew at an annual rate of 4.2% as foreign capital flooded the country. A strong economy and falling bond yields allowed the government of Greece to run large structural deficits. According to an editorial published by the Greek right-wing newspaper Kathimerini, large public deficits are one of the features that have marked the Greek social model since the restoration of democracy in 1974. After the removal of the right-wing military junta, the government wanted to bring disenfranchised left-leaning portions of the population into the economic mainstream. In order to do so, successive Greek governments have, among other things, customarily run large deficits to finance public sector jobs, pensions, and other social benefits. Since 1993 the ratio of debt to GDP has remained above 100%.

Initially currency devaluation helped finance the borrowing. After the introduction of the euro in Jan 2001, Greece was initially able to borrow due to the lower interest rates government bonds could command. The late-2000s financial crisis that began in 2007 had a particularly large effect on Greece. Two of the country's largest industries are tourism and shipping, and both were badly affected by the downturn with revenues falling 15% in 2009.

To keep within the monetary union guidelines, the government of Greece had misreported the country's official economic statistics. In the beginning of 2010, it was discovered that Greece had paid Goldman Sachs and other banks hundreds of millions of dollars in fees since 2001 for arranging transactions that hid the actual level of borrowing. The purpose of these deals made by several successive Greek governments was to enable them to continue spending while hiding the actual deficit from the EU.

In 2009, the government of George Papandreou revised its deficit from an estimated 6% (8% if a special tax for building irregularities were not to be applied) to 12.7%. In May 2010, the Greek government deficit was estimated to be 13.6% which is one of the highest in the world relative to GDP. Greek government debt was estimated at €216 billion in January 2010. Accumulated government debt was forecast, according to some estimates, to hit 120% of GDP in 2010. The Greek government bond market relies on foreign investors, with some estimates suggesting that up to 70% of Greek government bonds are held externally.

Estimated tax evasion costs the Greek government over $20 billion per year. Despite the crisis, Greek government bond auctions have all been over-subscribed in 2010 (as of 26 January). According to the Financial Times on 25 January 2010, "Investors placed about €20bn ($28bn, £17bn) in orders for the five-year, fixed-rate bond, four times more than the (Greek) government had reckoned on." In March, again according to the Financial Times, "Athens sold €5bn (£4.5bn) in 10-year bonds and received orders for three times that amount."

Downgrading of debt

On 27 April 2010, the Greek debt rating was decreased to the upper levels of 'junk' status by Standard & Poor's amidst hints of default by the Greek government. Yields on Greek government two-year bonds rose to 15.3% following the downgrading. Some analysts continue to question Greece's ability to refinance its debt. Standard & Poor's estimates that in the event of default investors would fail to get 30–50% of their money back. Stock markets worldwide declined in response to this announcement.

Following downgradings by Fitch and Moody's, as well as Standard & Poor's, Greek bond yields rose in 2010, both in absolute terms and relative to German government bonds. Yields have risen, particularly in the wake of successive ratings downgrading. According to The Wall Street Journal, "with only a handful of bonds changing hands, the meaning of the bond move isn't so clear."

On 3 May 2010, the European Central Bank (ECB) suspended its minimum threshold for Greek debt "until further notice", meaning the bonds will remain eligible as collateral even with junk status. The decision will guarantee Greek banks' access to cheap central bank funding, and analysts said it should also help increase Greek bonds' attractiveness to investors. Following the introduction of these measures the yield on Greek 10-year bonds fell to 8.5%, 550 basis points above German yields, down from 800 basis points earlier. As of 22 September 2011, Greek 10-year bonds were trading at an effective yield of 23.6%, more than double the amount of the year before.

Danger of default

Without a bailout agreement, there was a possibility that Greece would prefer to default on some of its debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring. Analysts gave a wide range of default probabilities, estimating a 25% to 90% chance of a default or restructuring. A default would most likely have taken the form of a restructuring where Greece would pay creditors, which include the up to €110 billion 2010 Greece bailout participants i.e. Eurozone governments and IMF, only a portion of what they were owed, perhaps 50 or 25 percent. It has been claimed that this could destabilise the Euro Interbank Offered Rate, which is backed by government securities.

Some experts have nonetheless argued that the best option at this stage for Greece is to engineer an “orderly default” on Greece’s public debt which would allow Athens to withdraw simultaneously from the eurozone and reintroduce a national currency, such as its historical drachma, at a debased rate (essentially, coining money). Economists who favor this approach to solve the Greek debt crisis typically argue that a delay in organising an orderly default would wind up hurting EU lenders and neighboring European countries even more.

At the moment, because Greece is a member of the eurozone, it cannot unilaterally stimulate its economy with monetary policy. For example, the U.S. Federal Reserve expanded its balance sheet by over $1.3 trillion USD since the global financial crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt.

Greece represents only 2.5% of the eurozone economy. Despite its size, the danger is that a default by Greece will cause investors to lose faith in other eurozone countries. This concern is focused on Portugal and Ireland, both of whom have high debt and deficit issues. Italy also has a high debt, but its budget position is better than the European average, and it is not considered among the countries most at risk. Recent rumours raised by speculators about a Spanish bail-out were dismissed by Spanish Prime Minister José Luis Rodríguez Zapatero as "complete insanity" and "intolerable". Spain has a comparatively low debt among advanced economies, at only 53% of GDP in 2010, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece, and it does not face a risk of default. Spain and Italy are far larger and more central economies than Greece; both countries have most of their debt controlled internally, and are in a better fiscal situation than Greece and Portugal, making a default unlikely unless the situation gets far more severe.

Austerity packages

Greece adopted a number of austerity packages since 2010.

First austerity package

The first round came with the signing of the memorandums with the IMF and the ECB concerning a loan of 80 billion euro. The package was implemented on 9 February 2010 and included a freeze in the salaries of all government employees, a 10% cut in bonuses, as well as cuts in overtime workers, public employees and work-related travels.

Economy Protection Bill

On 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to save €4.8 billion through a number of measures including public sector wage reductions. On 23 April 2010, the Greek government requested that the EU/International Monetary Fund (IMF) bailout package be activated. The IMF had said it was "prepared to move expeditiously on this request". Greece needed money before 19 May, or it would face a debt roll over of $11.3bn.

The European Commission, the IMF and ECB set up a tripartite committee (the Troika) to prepare an appropriate programme of economic policies underlying a massive loan. The Troika was led by Servaas Deroose, from the European Commission, and included also Poul Thomsen (IMF) and Klaus Masuch (ECB) as junior partners. On 2 May 2010, a loan agreement was reached between Greece, the other eurozone countries, and the International Monetary Fund. The deal consisted of an immediate €45 billion in loans to be provided in 2010, with more funds available later. A total of €110 billion has been agreed. The interest for the eurozone loans is 5%, considered to be a rather high level for any bailout loan. According to EU officials, France and Germany demanded that their military dealings with Greece be a condition of their participation in the financial rescue. The government of Greece agreed to impose a fourth and final round of austerity measures. These include:

• Public sector limit of €1,000 introduced to bi-annual bonus, abolished entirely for those earning over €3,000 a month.
• An 8% cut on public sector allowances and a 3% pay cut for DEKO (public sector utilities) employees.
• Limit of €800 per month to 13th and 14th month pension installments; abolished for pensioners receiving over €2,500 a month.
• Return of a special tax on high pensions.
• Changes were planned to the laws governing lay-offs and overtime pay.
• Extraordinary taxes imposed on company profits.
• Increases in VAT to 23% (from 19%), 11% (from 9%) and 5.5% (from 4%).
• 10% rise in luxury taxes and taxes on alcohol, cigarettes, and fuel.
• Equalization of men's and women's pension age limits.
• General pension age has not changed, but a mechanism has been introduced to scale them to life expectancy changes.
• A financial stability fund has been created.
• Average retirement age for public sector workers has increased from 61 to 65.
• Public-owned companies to be reduced from 6,000 to 2,000.

On 5 May 2010, a nationwide general strike was held in Athens to protest to the planned spending cuts and tax increases. Three people were killed, dozens injured, and 107 arrested.

According to research published on 5 May 2010, by Citibank, the European Monetary Union (EMU) loans will be pari passu and not senior like those of the IMF. In fact the seniority of the IMF loans themselves has no legal basis but is respected nonetheless. The loans should cover Greece's funding needs for the next three years (estimated at €30 billion for the rest of 2010 and €40 billion each for 2011 and 2012). Citibank finds the fiscal tightening "unexpectedly tough". It will amount to a total of €30 billion (i.e. 12.5% of 2009 Greek GDP) and consist of 5% of GDP tightening in 2010 and a further 4% tightening in 2011. Following fears of bankruptcy, further measures were implemented on 3 March 2010. These included (in addition to the above): 30% cuts in Christmas, Easter and leave of absence bonuses, a further 12% cut in public bonuses, a 7% cut in the salaries of public and private employees, a rise of VAT from 4.5% to 5%, from 9% to 10% and from 19% to 21%, a rise of tax on petrol to 15%, a rise in the (already existing) taxes on imported cars of up to 10%–30%, among others. There were further protests on 5 and 11 March.

The second austerity package failed to improve Greece's economic position, and on 23 April 2010 Prime Minister George Papandreou appealed to the European support mechanism for help, which asked for the implementation of more austerity measures. The new measures, announced on 2 May 2010, included: replacement of the 13th and 14th salaries of public employees with an allowance of 500 Euro for those with salaries of less than 3,000 euro and complete eradication of the 13th and 14th salary for those with salaries of over 3,000 Euro, replacement of the 13th and 14th pension with an allowance of 800 euro for those with a pension of less than 2,500 Euro, further cuts in salaries (in addition to the two previous austerity packages) by 8% for public employees, rise of the VAT from 21% to 23% and from 10% to 11%, rise in the special tax for the consumption of tobacco, alcohol and petrol by 10%, rise in the value of property (and thus higher taxes), rise of an additional 10% for all imported cars, and others.

Mid-term plan

2011 saw the introduction of further austerity. In the midst of public discontent, massive protests and a 24-hour-strike throughout Greece, the parliament debated on whether or not to pass a new austerity bill, known in Greece as the "mesoprothesmo" (the mid-term ). The government's intent to pass further austerity measures was met with discontent from within the government and parliament as well, but was eventually passed with 155 votes in favor (a marginal 5-seat majority). The new measures included: raise 50 billion euros by denationalizing companies and selling national property, an increase in taxes for anyone with a yearly income of over 8,000 euro, extra tax for anyone with a yearly income of over 12,000 euro, an increase in VAT in the housing industry, an extra tax of 2% for combating unemployment, an increase in taxes for pensioners by means of lower pensions ranging from 6% to 14% from the previous 4% to 10%, the creation of a specialized government body with the sole responsibility of exploiting national property, and others.

On 19 August 2011 the Greek Minister of Finance, Evangelos Venizelos, said that new austerity measures "should not be necessary". On 20 August 2011 it was revealed that the government's economic measures were still out of track; government revenue went down by 1.9 billion euro while spending went up by 2.7 billion.

On a meeting with representatives of the country's economic sectors on 30 August 2011, the Prime Minister and the Minister of Finance acknowledged that some of the austerity measures were irrational, such as the high VAT, and that they were forced to take them with a gun to the head.

New property tax

On 11 August 2011 the government introduced more taxes, this time targeted at people owning immovable property. The new tax, which is to be paid through the owner's electricity bill, will affect 7.5 million Public Power Corporation accounts and ranges from 3 to 20 euro per square meter. The tax will apply for 2011–2012 and is expected to raise 4 billion Euro in revenue.

Objections to proposed policies

The crisis is seen as a justification for imposing fiscal austerity on Greece in exchange for European funding which would lower borrowing costs for the Greek government. The negative impact of tighter fiscal policy could offset the positive impact of lower borrowing costs and social disruption could have a significantly negative impact on investment and growth in the longer term. Joseph Stiglitz has also criticised the EU for being too slow to help Greece, insufficiently supportive of the new government, lacking the will power to set up sufficient "solidarity and stabilisation framework" to support countries experiencing economic difficulty, and too deferential to bond rating agencies.

As an alternative to the bailout agreement, Greece could have left the eurozone. Wilhelm Hankel, professor emeritus of economics at the Goethe University Frankfurt suggested in an article published in the Financial Times that the preferred solution to the Greek bond 'crisis' is a Greek exit from the euro followed by a devaluation of the currency. Fiscal austerity or a euro exit is the alternative to accepting differentiated government bond yields within the Euro Area. If Greece remains in the euro while accepting higher bond yields, reflecting its high government deficit, then high interest rates would dampen demand, raise savings and slow the economy. An improved trade performance and less reliance on foreign capital would be the result.

In the documentary Debtocracy made by a group of Greek journalists, it is argued that Greece should create an audit commission, and force bondholders to suffer from losses, like Ecuador did.

On a poll published on 18 May 2011, 62% of the people questioned felt that the IMF memorandum that Greece signed in 2010 was a bad decision that hurt the country, while 80% had no faith in the Minister of Finance, Giorgos Papakonstantinou, to handle the crisis. Evangelos Venizelos replaced Mr. Papakonstantinou on 17 June. 75% of those polled gave a negative image of the IMF, and 65% feel it is hurting Greece's economy. 64% felt that the possibility of bankruptcy is likely, and when asked about their fears for the near future, polls showed a fear of: unemployment (97%), poverty (93%) and the closure of businesses (92%).

The social effects of the Greek austerity measures have been severe, including poor and needy foreign immigrants, but even some Greek citizens, turning to NGOs for healthcare treatment. On 17 October 2011 Minister of Finance Evangelos Venizelos announced that the government would establish a new fund, aimed at helping those who were hit the hardest from the government's austerity measures. The money for this agency will come from the profits made by tackling tax evasion.

See also

European sovereign debt crisis

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