Keywords

The Greek economy; truth and flatteries; competitiveness; fakelakia; Private Sector Involvement (PSI); downsizing of public debt; did PSI help?

4.1 “My Lord,” Said Demaratus to King Xerxes, “Do You Want Me to Tell You the Truth or Flatteries?”

“My lord,” said Demaratus, the former King of Sparta (515–491 BC) exiled in the Court of Xerxes¹ to a question posed by the King of Kings, “Do you want me to tell you the truth of flatteries?” Xerxes answered: “The truth,” and assured him that he will not alter his hospitality no matter what his answer was. Demaratus’ policy of saying the truth is the one described in this and the next chapters deliberately.

“Greece has been brought up in the school of poverty,” Demaratus informed Xerxes. “Virtue was not born with it. Virtue is the result of temperance and severity of our laws – the very laws which give us the arms to fight poverty and tyranny.² Therefore, I dare say (the Greeks) will not listen to your propositions because they aim to enslave them. In regard to their number, don’t ask me how many they must be to resist your army. Even if they are only one thousand, they will fight you.”³

Demaratus concluded by saying that while the Greeks were free, they were not so in an absolute sense, because “the law is for them an absolute master and they follow its letter much more than Xerxes’ subjects follow their King. The supreme authority is the command of the law, and its command is that no matter how numerous the enemy’s army may be they have to hold their post at all cost, win or die.”

This was true of antiquity, but it is no longer true today. The laws are being interpreted in a lax way, as corrupt politicians make promises they know very well they cannot keep—and common citizens find it convenient and profitable to believe them and therefore they reelect these corrupt, do-nothing politicians. Promises engage only those listening to them, said Charles Pasqua, a French politician. It’s a concept worth repeating.

For twentieth and twenty-first century Greece, the result has been a disaster. Countries in which financial competence is better aligned with political responsibility have a lesser need for draconian⁴ measures. This is not true for Greece. After three long decades of mismanagement, the need for correction is God size. Public debt in comparison to GDP is an important (negative) barometer, and among western nations (ex-Japan), Greece excels by a margin:

Debt-to-GDP ratios—both their absolute value and their trend—are an important measure of economic health. Hiding or massaging the numbers does not improve a bad situation; it is only worsening it. Yves Mersch, governor of Luxembourg’s central bank did the wrong thing when he denounced “increasing speculation on the capacity of Greece to honor its debts.”⁵ In late April 2010, when this statement was made, for any practical purpose Greece was bankrupt.

When Standard & Poor’s downgraded Greece long-term debt to junk, the European Commission responded that it expected rating agencies like S&P to be responsible at this difficult and sensitive time.⁶ This, too, has been the wrong initiative. As Demaratus would have commented if he lived today, people and countries should never fail to listen when independent critics start saying that they are going downhill.

Debt has to be served and repaid. A great deal of tax money which might have been used for investments to provide the ground for future jobs goes into debt interest and repayment. What is more, the higher is the public debt the lower becomes a debtor’s creditworthiness—therefore the higher the interest rate he or she has to pay.

In a way, it comes as no surprise that the European debt crisis got bone and muscle in Greece. Since Euroland’s start, the weak links in euro’s chain have been Greece, Italy, Spain, and Portugal—but Greece was also hit by exceptionally bad political mismanagement. Part of it was the derivatives trick to hide a large chunk of the country’s debt, done in collaboration with Goldman Sachs and allegedly arranged by Mario Draghi, currently president of the ECB. (More on this is described in Section 4.3.)

Contagion from economic mismanagement knows no borders. When the Greek debt crisis flared up in 2009–2010, European Union leaders hoped to contain it at the Greek shore by providing a bailout of euro 110 billion (then $160 billion) over 3 years. Of this, euro 80 billion came from Euroland member countries and euro 30 billion from the IMF.

The European Commission, ECB, and IMF who loaned their money to Greece, Portugal, and Ireland set up a tri-party commission, known as troika, to supervise how the money was spent and whether agreed upon measures were taken. The troika’s mission has been to find out whether agreements associated to the bailout loan were kept, and document its finding. The IMF has a long experience in that sort of measures and in control.

Lenders want to see that the party borrowing their money works and does not use it for festivities. In Philadelphia, Benjamin Franklin was walking in the night past the shops of artisans who had taken a loan. If the borrower was busy at his shop, he would be patient even if that man was in arrears. But if he saw him drinking in a tavern, he would call in his loan.

The first bailout package for Greece proved to be insufficient. The country needed more money for a longer period of time. As an article in The Economist put it: “This sent European policymakers into frenzy. Their attempts to find a solution have sometimes seemed to spring from the pages of an overwrought thriller.”⁸

On June 23/24, 2011 Euroland’s heads of state met in Brussels to decide on the second rescue package, under condition that the Greek parliament endorses the extra austerity the country had to swallow, along with a program to privatize state assets. Overoptimistic estimates suggested that assets to be privatized could fetch between euro 50 billion and euro 80 billion. These were numbers picked out of a hat.

In their book Why Nations Fail Acemoglu and Robinson advance the thesis that nations fail because their leaders are greedy, selfish, and ignorant of history.⁹ Drifting is accelerated by accommodating and weak institutions, and when drifting starts, there is little to discourage elected officials (or for that matter dictators) from looting even the little bits and pieces that still remain of public wealth.

Rescue packages can do no miracles. Those authorizing them try to shake up sclerotic economies, but politicians able to undertake sweeping changes and liberalize conditions characterized by conflicts of interest are not on hand. Economies can benefit from bailouts if, and only if, those who govern push through harsh measures to first stabilize the debt level then start paying it off.

Whether we speak of Club Med (Italy, Spain, Portugal, Greece) or larger economies, a bailout strategy will never work in a vacuum. Somebody has to be in charge and, as first act of faith, correct the wrong impression created by successive governments that citizens and nations can continue living beyond their means. A leader must explain to the citizen that getting loans to pay for excesses is the worst possible policy.¹⁰ Also, that entitlements serviced by loans end up in a disaster. This is precisely the point where the plain talk by Demaratus to Xerxes provides an awakening. Europe has:

If one doubles these figures, the resulting statistics would include the United States and point to the fact that a shrinking productive capacity coupled with the demands posed by a rising nanny state is the prescription for economic and social catastrophe. This is not just a Greek problem; it’s a problem which has infiltrated every corner of the West.

Even if by a magic wand all debts were extinguished, if nothing changes in spending more than the nation earns, then the current situation will reproduce itself in a few years. In righting the balances, the most important advance of all is not austerity but the understanding by everybody that past conditions should not be allowed to repeat themselves. Even after it wanes, the crisis will come back with a vengeance if spending and spending continues, which means that the nation will never go back to stability.

4.2 The Target Should Be Competitiveness

Until the EU/ECB/IMF bailout came along, the Greek crisis has chiefly been a drifting, with euro’s helping hand wearing off and the country feeling pressure from the markets. But sovereign finances, and even more so the economy, are not defined by markets alone. Rather the limits of solvency are tested by people’s willingness to accept tax rises, spending cuts, a (hopefully) temporary lower standard of living, and what it takes to bring up competitiveness in a globalized economy. A government, any government, runs out of political capital long before it runs out of money.

Whether center-right or center-left, Greek governments did not spend what scant political capital they had in negotiating with IMF and with Euroland for a break. They did not press the basic fact that above all the economy needs to grow, but globalization has wiped out the medium-sized Greek industries. Neither did they undertake growth-promoting structural reforms, albeit a controversial issue because of internal opposition by entrenched interests (labor unions included).

To promote structural reforms, governments have to explain to the public the need for change in attitude and culture, facing down public-sector unions and enforcing changes which may be painful but are also deadly necessary. They did not even do so after the bailout was decided. George Papandreou and his successor prime ministers took the easy way out. No wonder, therefore, that by March 2013, not quite years after the first bailout:

True enough, Euroland and the IMF placed more emphasis on austerity than on structural reforms, aggravating Greece’s economic woes. But it is no less true that since Day 1 of the bailout the government did not take the measures it should have taken by instituting a new economic policy centered on competitiveness in the globalized market.

Competitiveness is a concept which has often been misinterpreted, and in many cases misused. The better way to define it is in the words of Warren Buffett who once said that: The single most important decision in evaluating a business is pricing power. If you have the power to raise prices without losing business to a competitor, if you have got a very good business. (But) if you have to have a prayer session before raising the price by 10 percent, then you have got a terrible business.¹²

Buffett’s definition is equally valid for companies and for a nation’s industrial standing. In fact, pricing power is particularly important in a low-growth environment like that of Italy, Spain, France, Portugal, and Greece. A nation’s companies and its labor force need two things to be ahead of the curve in pricing power:

Notice that innovation is deliberately not added as a third bullet because, very important, it is an ingredient demanding R&D budgets, research laboratories, and people able and willing to challenge the “obvious” and a sophisticated infrastructure. Each one of these issues enhances competitiveness but is outside the main theme of this discussion.¹⁴

The Swiss mechanical watch industry provides a good example of what I mean by attention to, and competitive advantage from, high quality. Like jewelry, the watch industry is more cyclical than other sectors, and therefore more vulnerable in a downturn. But the effect on market share is uneven, and quality makes the difference.

Roughly 1.2 billion watches are produced annually in the luxury class, but only 26 million of these are made in Switzerland. However, 95 percent of watches priced above CHF 1000 and sold worldwide are Swiss-made, and the label “Made in Switzerland” is one of distinctive quality, especially appreciated in emerging markets. High quality is not assured just by trying to do a better job:

By contrast, the Greek industry has problems in competing both cost-wise and quality-wise. Like quality, costs matter a great deal in competitiveness. A proof of a mismanaged economy is that over the years of the euro, wages grew 30 percent more than corresponding wages in Germany. It needs no explaining that under these conditions, the Greek industry lost its competitiveness in Euroland’s market and in the global market.

Governments, and even more so labor unions, have the bad habit of continuing to live in a make-believe world of their own—a world totally detached from current reality. While professing loudly that they want to see more jobs, they do whatever it takes to destroy jobs. Short of a long-term plan which accounts for competitiveness, unemployment has no other way to go but up.

The case of lack of competitiveness is vividly displayed in Italy, where Sergio Marchionne, the chief executive of both Fiat and Chrysler, has been trying to overcome powerful labor union resistance to competitiveness. In 2009, Fiat’s five biggest assembly plants in Italy produced 650,000 cars using 22,000 workers. That same year, a single Fiat plant in Tychy, Poland, produced 600,000 cars with 6100 workers each earning about a third of their Italian counterparts. In terms of deliverables:

In Greece, too, as a result of loss of competitiveness, plenty of Greek employees and workers lost their jobs. Not only Greek industries, such as textiles, went under when the “low-costs” came along, but other sectors of the economy, too, went into decline. Even agricultural products are now imported. As a recent news item has it, Greece is importing salads and other vegetables from north-western Africa (the Maghreb). This is absolutely inexcusable. Fresh vegetables should be a home-grown industry.

The positive effect of competitiveness is seen not only on jobs but also on current account figures which improve with exports. Greece’s improved current account deficit shrank mainly due to collapsing imports. Exports are up, but not much. In the first 2 years after the first bailout, exports rose 2 percent while imports plunged 15 percent. Competitiveness can only be regained the hard way:

That is why structural reforms, including “internal devaluation” (Chapter 13) are so essential not only to Greece but also to Italy, Spain, Portugal, and Cyprus. These are not incidental remarks but basic observations which help in explaining why bailouts don’t work. When assessing the practicalities of rescue plans, the reader should familiarize himself or herself with Gresham’s law. Simply put, it states, “Bad money drives out good.” As long as bad money remains in the economy protected by special interests, good money will keep away.

“We have got to a point where we’re at a complete standstill,” said Constantine Michalos, president of the Athens Chamber of Commerce.¹⁵ The chamber’s study revealed that from January 1, 2011 till mid-June 2012 some 68,000 Greek businesses closed and the expectation has been that a further 36,000 were at the edge and could shut down with disastrous effects on the economy.

Even tourism, one of the last remaining going industries in the Greek economy, suffered greatly as strikes drive away tourists, and street demonstrations lead holidaymakers to cancel bookings.¹⁶ Strikers, whose behavior ranged from the irrational to disgraceful, were practically cutting the branch on which they were sitting.

Tourism is a service industry and those who suffered stranded in a port because the sailors went into a wild strike, curse the hour they went there and they never come back. Nothing should have been done putting at risk the tourist industry. There are conditions under which strikes turn into folly as they kill the jobs for whose sake (theoretically) workers and employees are striking.

The scarcity of bank loans has been another big negative. It was therefore good news that on September 13, 2012 the European Investment Bank (EIB) agreed on the immediate disbursement of euro 750 million ($986 million) in loans to SMEs as well as for transport, energy, and education projects. The SMEs are scheduled to absorb about 60 percent of the loans.

This deal, whose execution was somehow delayed, was scheduled to bring real money into the economy at a time when the lack of liquidity is causing problems suffocating the market. The problem is a low timetable. Yannis Stournaras, the finance minister, said that the lender would disburse the loans to Greek SMEs by the end of 2015 through the country’s banks. But will this money be used to promote competitiveness or only to pay past debts?

Another commendable effort aimed to create jobs has been that of special economic zones which can attract foreign direct investment. China, a country with experience with special zones, suggested a special economic area should be set up near Athens and the port of Piraeus where Cosco (the state-owned Chinese shipping company) operates a container terminal. China pledged participation by other Chinese companies.

Special economic zones offering tax breaks to attract investors and reinvigorate its economy are in no way set up for the asking. They require accelerating EU-backed infrastructure projects as well as the political decision to reduce bureaucracy and red tape. The irony with the EU is that as far as special zones are concerned, Greece still had to overcome objections by some other member countries on grounds of unfair competition because the creation of such zones would give a comparative advantage. That’s the EU.

4.3 Fakelakia and the Wages of Corruption Buy Yachts

According to history books, emperor Zhu Yuanzhang, founder of China’s Ming dynasty, skinned corrupt officials, stuffed them with straw and put them on display to discourage others from unethical behavior. In the aftermath, wrongdoers and transgressors took a leave, but when Zhu died corruption returned and contributed to the Ming dynasty’s downfall.

Big corruption is not the only game in town. Widespread little corruptions exemplified by the fakelakia (envelopes with money) left on the desk of, or passed under the table to, a civil servant, doctor, or any other professional can be just as devastating. Fakelakia have become a culture in Greece, and this bad habit is more difficult to eradicate than big time corruption because it has woven itself into the fabric of society.

I have an aunt who in her 80 years needs a cataract operation for both eyes. She has the right to go to a military hospital and that’s what she did. The eye doctor knew her; unwisely in previous visits she had left behind his fakelaki. The doctor confirmed a date for the operation, but given the severe cut in pension for retired senior servants, this time she could not afford his fakelaki.

The eye doctor asked for it; she excused herself for not being able to provide it (which she should not have done). Upon hearing that this time his hand is not greased, the doctor returned to his desk took his appoints book and stroke out her date. No fakelaki, no cataract operation. This is just one example, but rumors have it that the steady flow of fakelakia make many people rich, and professionals who get plenty of fakelakia display their wealth by buying yachts.

The way a feature article in the Financial Times had it, the main political parties in Greece are seen as “pillars of a parasitic system, fuelled by political patronage and cronyism.”¹⁷ This is a double whammy from which the country has suffered for decades; hence, it comes as no surprise that the popularity of politicians and political parties is at an all-time low. The overwhelming feeling is one of disenchantment with two main parties whose:

Mid-April 2012 Greek prosecutors revealed money laundering that funded a former defense minister’s, Akis Tsochatzopoulos, life of luxury. A 103-page prosecutors’ report provided shocking evidence of an extensive money-laundering network. Allegedly, since 1997, the 73-year-old ex-minister pocketed millions of euros in under-the-table payments, with the frequency of illicit transactions peaking between 1999 and 2002.

Illegal activities were concealed with the help of close associates who ran offshore companies to hide the money, some of which was used to buy the ex-minister’s array of assets the prosecutors stated. Millions of euros’ have been linked to the procurement of Tor M1 missiles. In a related development, it was revealed that George Papandreou Jr., the then prime minister¹⁸ and Tsochatzopoulos’ boss, had hired 300 consultants (read: highly paid political appointments, typically loafers) while local authorities hired 60,000 people at the same time.

The irony behind this “60,000” is that, due to bailout provisions, the government fired about the same number of public employees.¹⁹ They went out of the door for the troika to see, and then they came back from the window.

An even greater and more damaging disgrace has been the one engineered by Goldman Sachs, in which allegedly Draghi had a role to play.²⁰ The derivatives product by the investment bank allowed Greece to gain membership to the euro by circumventing Euroland’s rules. Mortgaging assets and using creative accounting debt was hidden. The tool has been cross-currency swaps, a sophisticated derivatives instrument. Government debt issued in dollars and yen was swapped for euros, then later exchanged back to original currencies. This is said to have been the top Ponzi game of 2002.

In the words of Stephen Lendman: “Debt entrapment followed. Greece was held hostage to repay it. The country’s been raped and pillaged. Paying bankers comes first. Doing it left Greeks impoverished, high and dry. Goldman profited enormously by scamming an entire country and millions in it… Standing armies pale by comparison. Michael Hudson calls finance warfare by other means. Generalissimo bankers run everything… It’s up to public rage to change things.”²¹

Nevertheless, while Greek voters may be sick of the corruption and clientelism that has flourished under the two traditional parties, Panhellenic Socialist Movement (PASOK) and conservative New Democracy, they still vote for them. The two have alternated in power for about three decades. Both have been discredited. Ironically, in his first EU summit 2009, George Papandreou described his own country as “corrupt to the bone,”²² but forgot to say that he was part of it.

Greece is by no means an exception. Other examples of corruption and nepotism can be found all over the political constellation from Italy and Slovakia in Euroland to the Philippines in the Pacific Rim. On October 4, 2012 Gloria Arroyo, the former Philippine president, was arrested while undergoing treatment at a military hospital on charges of misusing $8.8 million of state lottery funds during her last year in office.²³

In Slovakia, Robert Fico, leader of the Social-Democratic party won the election in March 2012 in spite the fact that his first stint in office, from 2006 to 2010, was marked by cronyism. Instrumental in his electoral victory was an intelligence report nick-named “Gorilla” which suggested that center-right politicians in a previous government may have been pocketing commissions from privatization and public procurement deals.²⁴

In the Balkans, Bulgaria and Romania, northern neighbors of Greece and Italy in the west have a long tradition in corruption. In Rome, 20 years after the bribesville (tangentopoli) scandal that swept away Italy’s post-WWII political establishment Paola Severino, the justice minister, says that corruption is as extensive now as it was then. If Severino is right, and probably she is, this is a damning verdict.

The generation of politicians, who came to prominence after tangentopoli with promises of change, abused power as much as their predecessors (see also in Chapter 8 the scandals connected to the country’s parliamentarians). According to observers of Italian nepotism and other social ills, the torrent of scandals flooding over the country in recent years are in inverse relation to the economic incompetence of professional politicians. Mario Monti is right in:

In Greece, too, corruption is alive and well among the lawmakers. On February 25, 2012 the Greek government threatened to name and shame members of parliament accused of funneling huge sums of money abroad in spite of a call to ordinary Greeks to return their savings to the country’s cash-strapped banks. Afraid that Greece leaves the euro, Greek citizens have allegedly withdrawn over euro 75 billion in bank savings since the onset of the debt crisis in 2009, hiding it at home or keeping it in safety boxes. Allegedly, some of that money left the country.

Corruption leads to major doubts about the credibility of reform efforts particularly when a country is in the middle of a severe and protracted debt crisis. It also strengthens the critics’ argument that parliaments don’t really care to pass anticorruption bills unless these are all but stripped of real content.

Neither is corruption limited to the political vertex. It is also widespread among those who benefit from the goodies distributed by the government within the realm of the ever-growing State Supermarket, and its entitlements. In January 2012, the Greek authorities caught a scheme involving 63,600 false pensions. Typically, the money went to nonexisting or no longer living persons, or was calculated according to wrong information at the cost to the taxpayer of about euro 450 million a year.²⁵

At end of February 2012, Swiss authorities reportedly froze three bank accounts of the former head of Proton, a private Greek bank. Lavrentis Lavrentiadis has been under investigation by Greek prosecutors for alleged fraud, embezzlement, and corruption involving up to euro 700 million. An audit by the Bank of Greece found that in 2010 more than 40 percent of Proton’s commercial loans were made to companies allegedly connected to Lavrentiadis—a flagrant misuse of basic banking principles.

While accusations related to corruption and mismanagement mount, in September 2012, the government of Antonis Samaras called for “zero tolerance” of corruption after reports surfaced of politicians being investigated on suspicion of taking kickbacks and evading taxes while in office. In an interview marking his first 100 days at the head of a coalition, Samaras referred to the publication of a list of 30 names of former and present politicians under investigation by SDOE, the financial police.

The leaked list of politicians under investigation included the leader of a small political party, a former mayor of Athens, a former lawmaker who was responsible while in office for promoting transparency, and a former finance minister. All denied any wrongdoing.²⁶ On information available until these lines are written the cleanhands campaign’s only victim has been Evangelos Meimatakis, speaker of parliament, who stood down after he and two of his former cabinet colleagues were accused in a newspaper article of involvement in a euro 10 billion ($13 billion) money-laundering operation in collusion with two Athens real-estate brokers. They, too, denied the accusations.

Greece has also been criticized by the EU and IMF for not cracking down on tax evasion, including the use of offshore companies and transfers of capital by wealthy individuals to international financial centers. Moreover, SDOE reported that its officers inspected thousands of businesses and found 55.7 percent of them to be in breach of taxation laws for a variety of violations led by failure to issue receipts.²⁷

Failure to issue receipts is a globally widespread practice and little can be done about it. In the late 1970s, the Italian government used the financial police and the carabinieri to inspect if customers leaving a restaurant and other shops had a receipt. This led to a new profession: accompagnatori fiscali. These were typically unemployed people who followed a restaurant’s clients till they were out of range of the carabinieri, politely asking to be given the receipts which they swiftly sold to the restaurant’s owner so that he or she did not need to report the income which he or she made.

4.4 Coming Up from Under Is a Tough Job

The firebrigade’s work known as “bailout” is based on the premise that time is being bought and recovery is given a chance to show up. An economy, however, is not returning to good shape of being asked to do so. It takes time, effort, willingness to come up from under, and luck.

This is true of both Euroland’s economy and of the European banking system. To save itself from collapse, and the economy from a second dip, the European banking system needs time to build up its reserves and improve its capital ratio which was severely damaged by the 2007–2011 deep economic and financial crisis.

Time is also needed to try to stem a negative psychology in the market, which significantly worsens when investors, economists, and analysts cannot see a light at the end of the tunnel. Instead, the risk in a bailout is that the psychology may worsen—as it did with the failure of the effort which started in April 2010 aimed to salvage the Greek economy through ill-studied program of throwing money at the problem. Critics say that the same will happen with Spain and Italy which are bigger economies than those of Greece, and when it does it will:

This is a pessimistic assessment, but it is not totally unwarranted. Much depends on the efforts the country’s citizens put to restructure their economy as the cases of Iceland and Latvia so well document (Chapter 13). Ireland’s efforts, too.

In Ireland, the euro 68 billion ($88.4 billion) bailouts by European Commission, ECB, and IMF protected Dublin from free fall in the hands of debt markets and less than 2 years on, things look much better. The Irish banking sector, which at its peak had assets 5 times Ireland’s annual GDP is downsized and reasonably recapitalized. Budget improvements, too, are realized.

This did not prevent that unemployment zoomed and thousands of young Irish men and women migrated abroad. There is no recovery from debt, particularly deep debt, without pain. The troika returns periodically to Dublin to make sure things are on track, providing fresh cash only if it is satisfied with its findings:

This is not the case with Greece, because of a number of reasons—with paying scant attention to competitiveness, and associated industrial development, while contesting rather than working is at top of the list. A banking industry at disarray further hit by the so-called Private Sector Involvement (PSI) (Sections 4.5 and 4.6), as well as governments changing like shirts—with limited vision and leadership both because they are ephemeral and run by second-raters.

It does not take the brains of Albert Einstein to understand that interminable strikes, protests down the street, Molotov cocktails, and social strife aggravate the economic problems and make recovery so much more difficult. They also end by aggravating the debt problem. Within a year after the April 2010 first bailout, public debt grew:

The most likely is that this 10 percent to 13 percent increase in national debt was used to cover the continuing public deficit. Unavoidably, part of it has gone to security. Molotov cocktails and interminable strikes are as powerful as high debt in killing employment opportunities in Greece, and not only in Greece.

Strikes should be a weapon of last resort, not a daily business. The European industry as well as the workers themselves are hurt by the labor unions’ policy of too frequent strikes. In this regard, Spain, Italy, and Greece have the worst record. In terms of average number of days lost per year per 100 workers during the first nine years of this century:

Over the same period Germany had less than 0.5 days lost and Switzerland almost half that. What the labor unions don’t understand that such statistics have a great impact when companies decide where to invest, not only foreign companies but also the country’s own. Strikes are the killers of employment. A good example is Fiat.

According to Fiat, almost one in three Italian car workers is involved in stoppages every day.²⁹ It comes therefore as no surprise that in a last-ditch attempt to fix Fiat’s loss-making Italian manufacturing base, Sergio Marchionne, its CEO, promised to invest in the company’s Italian factories if, and only if, Italian workers (who are among the world’s most “protected”) and their labor unions adopt US-style flexible contracts. Globalization is a tough critic:

Marchionne’s challenge to unions also lifts the curtain on a wider debate on how competitiveness can be restored in Western industry, as companies and governments seek to recover from the downturn which followed the 2007–2011 deep economic crisis. Like socialist parties, labor unions still live in nineteenth century style confrontation involving not only social but also political conflicts.

Marchionne’s ultimatum to unions to accept the deal or Fiat Auto will downsize and eventually close-out its Italian factories left no ambiguity at the side of the politicking labor unions that the cost of conflict would have been a big block of jobs. Albeit at a smaller scale, this is the challenge confronting a lot of Greek jobs, as well as Spanish, Portuguese, French, you name them.

There has been no divine punishment to explain why the economic and financial situation in Greece continues to deteriorate. This is in part the result of successive strikes by labor unions which paralyze the country, while social strife in the wake of austerity measures applied by the government kills tourism. The most worrying aftereffect is the economy’s inability to grow.

In turn, a shrinking economy misses its targets, opening the door to eurozone demands for yet more austerity. No wonder therefore that on May 9, 2011—a year and a month after the first rescue package—S&P downgraded again Greek debt. The market felt that there is no way out, as the April 2010 bailout was poorly studied in its premises for longer term impact. It was the result of pressure to arrange a deal rather than that of clear thinking on how to turn around a situation which kept on deteriorating.

(When the first Greek bailout was still in discussion, a French economist had commented that the choice confronting Nicolas Sarkozy, then president of France, was between lending to Greece through the troika and never seeing his money again, and recapitalizing French banks exposed to Greece and never getting back his money. In the end, the chosen course was a double loser (Sections 4.5–4.7).)

Not only foreign banks exposed to Greece but also Greek banks, and Cypriot banks who unwisely helped with loans to the Greek government, were devastated. “Looming election results make savings banks a swansong,” said Lucas Papademos, a former prime minister and central bank governor.³⁰ Wrongly, indeed most wrongly, time and again prior to the rescue, the Greek government raised short-term funds from local banks. That was instrumental in decapitating the banking system.

The government did so again in the week of August 7, 2012 following the bailouts—to the tune of euro 6 billion—after Euroland rejected a request for a bridge loan to repay a bond held by the ECB that matured in that same month. As for the ECB, it rejected a Greek proposal to delay the repayment by a month, highlighting the approach being taken by international lenders as Athens struggled to bring its bailout program back on track. Greek banks were hit by a triple whammy:

Three months prior to the euro 6 billion loan, on May 14 Karolos Papoulias, the president of the republic said that, as he had been warned by the central bank, depositors had just withdrawn euro 700 million ($890 million). Bankers whispered that over euro 1.2 billion flowed out on that very day and the days immediately after. “Most of the hard money has already left,” said one of them. “Now we are seeing a flare-up [of withdrawals] from small depositors who don’t know what to make of what is said on the evening news.”³¹

The self-reinforcing interaction between public debt and economic downturn adds its weight on debt sustainability, as it has been particularly evident in Greece. It also raises doubts about the effectiveness of troika’s role which in Greece has been less successful than in Ireland. The first rescue proved to be insufficient, leading to a second bailout. In retrospect, part of the first package’s failure was largely due to:

Both bailouts confronted an iceberg and no one seems to have questioned how much of the iceberg was under water (usually it is the 7/8). Privatization revenues were estimated at over euro 50 billion. The EU, ECB, and IMF unwisely accepted this impossible number even though the IMF’s experience suggested it was far too high. There were as well other problems which worked against the bailout.

The agreed upon first Greek bailout of April 2010 included front-loaded cuts and tax hikes worth euro 30 billion, or 13 percent of GDP. These were both deeper and faster implemented than elsewhere, contributing to an ongoing drop in Greek output with GDP in free fall. The failure of the first Greek effort hit the EC/ECB and IMF coffers hard, since the second package ran to euro 130 billion, and also led to the idea that the private sector, too, should feel part of the pain—officially, voluntarily.

4.5 Private Sector Involvement in Downsizing the Greek Debt

The debt crisis of the euro rests on two legs: overleveraged sovereigns and undercapitalized banking industry. Because of the links existing between these two legs, the euro crisis is deeper and more widespread than almost anyone feared at its start. The joke about it has been that both in Europe and in America government bonds have turned from offering a risk-free return to exhibiting a return-free risk.

Since the 2007 subprimes crisis revealed the amount of leveraging by governments in the United States and Europe, the credit of western sovereigns has no more been safe. Debt-to-GDP ratios suggested that it is actually risky. For Greece, Portugal, Spain, and Italy this led to interest rate spikes to compensate for that risk. The effective 73.5 percent write-off of bond values held by private-sector holders of Greek government debt sent ripples through the financial system.

Back in early 2010, the negotiations on the first bailout package of euro 110 billion (then $154 billion) went on for several months while in the meantime the debt position of Greece deteriorated. Part of the delay was due to the fact that not all Euroland members were in accord with the bailout of Greece. Slovakia said that its GDP per head was half that of Greece. Hence, why should they loan money to Greece? Finland asked for collateral for its loan, and other countries had their reservations. But the wish of Germany, France, and the IMF prevailed.

This first package gave to banks, which had lent big money to the Greek government, the false assurance that their loans and interest derived from them were safe. This proved to be a mistake in judgment. In the wake of the failure of the first bailout, and to bring down at a more affordable level the debt-to-GDP ratio of Greece, EC/ECB/IMF promoted the so-called PSI agreed by EU political leaders in their October 2011 summit (more on this later).

Was this “voluntary” downsizing of loans justified? Was it intense government pressure, or the scare of a credit event, such as a Greek bankruptcy, which made the banks compliant? Which events are instrumental in launching a CDS has been a prominent question since early 2010 when Greece found itself at edge of bankruptcy. The fear of a credit event brought up PSI, and the irony is that, in the end, the CDS event was not avoided.

Because so many factors came into play, the answer to the questions posed by the preceding paragraphs is in no way linear. Prominent among them is the vicious cycle of debt-and-recapitalization between the banks and the state. The former’s overexposure to international loans, particularly to governments, has become unsustainable. On the other hand, the habit governments acquired to treat some banks as “too big to fail” makes no sense either.

The band aid of more loans, offered by the European Union and the IMF, eased somewhat that stress but it did not really improve the ability of Greece to service the loans and repay the capital. By late 2010 with the reforms agreed upon in April 2010 with the first bailout still to be enacted and Greek foreign indebtedness rising from euro 300 billion (then $420 billion) to 350 billion ($490 billion), it became evident that the Greek loans could not be repaid.

A recently coined technical term for such haircut is bail-in, which contrasts to a bailout. Bail-ins have been undertaken in response to costly government support of banking companies during the recent crisis: certain creditors are forced to take loses before banks benefit from taxpayers’ money.³²

A bail-in requires the statutory power of a resolution authority, which involves the recapitalization of an institution by converting and/or writing down primarily unsecured debt, while preserving other creditors. This procedure can apply both on a going concern and on a gone-concern basis (liquidation; orderly wind down) when institutions enter into resolution.³³

In the course of the early 2011 negotiations, only part of the loans taken by Greece could be the subject of a haircut, particularly those originating in private institutions and investors. Loans by the IMF, EU, and ECB were untouchable. This way, up to euro 217 billion ($282 billion) out of euro 350 billion could be subject to the PSI. Table 4.1 presents a bird’s eye view of the debt distribution.

By mid-2011, as negotiations dragged on, the haircut had risen to 50 percent, and from there it climbed to 60 percent to reach 73.5 percent by February 2012. (These percentages count both the direct haircut and aftereffect of favorable conditions attached to new bond issues to replace the old ones issued to private sector investors by Greece.)

Though reducing debt by nearly three quarters is a large sum, it became evident that the goal of swamping the sovereign debt of Greece from 160 percent or so of GDP to 120 percent—as Angela Merkel, the German chancellor had wanted—could not be attained only through the PSI. According to Bloomberg News, George Papandreou, then Greek prime minister in 2010 when the PSI discussion started, said that the 50 percent haircut in the bank debt of Greece “buys us time.” That statement has shown what was wrong with the Greek side of the debt reduction initiative.

The challenge confronting the government, therefore the Greek society as a whole, was and is not just to “buy time” but rather to turn the economy around. This requires much more than a haircut on loans. It calls for a full scale rise in hard work and in competitiveness (Section 4.2). Even a high share in forgiveness in the accumulated huge public debt would not make a great deal of difference. Instead, the priorities should have been to:

These should have been the Greek government’s top priorities, instead of “buying up time” and keeping on with mismanagement, nepotism, and corruption, European policymakers pushed on with restructuring of Greek debt due to their fear that left in its own devices Greece would confront bankruptcy sparking wider contagion. PSI was one of the measures.

The most vocal opponent of PSI has been the ECB. On June 14, 2011 Mario Draghi, the ECB’s president-in-waiting, warned that any attempt to impose costs on Greek debt bondholders could lead to its own “chain of contagion.”³⁴ It did not, but neither did the PSI help the Greek economy; the government’s main preoccupation continues being kicking the can down the street.

From the Greek economy’s viewpoint internal devaluation Latvia-style (Chapter 13) was the best solution. The next best to it, back in late 2009 or early 2010, was plain bankruptcy, provided that from then on budget deficits were outlawed and entitlements re-dimensioned to a level affordable by the not-so-prosperous Greek economy. The unavoidable companion is, quite evidently, austerity. The problem with austerity measures is that they affect in an uneven way different segments of the population.

There exist similitude between Greek austerity measures during 2010–2013 and the plight of German pensioners and savers during the 1922–1924 hyperinflation. As an ancient Greek proverb advises, avoiding what fortune has decreed is impossible. The drift of the Greek economy should not have reached the point of no return. When this happens, the way back to “normal” is not made of roses. The curious thing is that none of the politicians and other actors of the disaster ever got punished for their malfeasance.

As for the banks which lost with the haircut 73.5 percent of the capital they had loaned to the Greek sovereign, directly or by buying its bonds, it is only evident that they accepted that deal under pressure by their governments. Some foreign banks, particularly the French, lost a small fortune, and their hope has been that this was a one-tantum not to be repeated. Particularly devastated were the Greek and Cypriot banks. Given the amount necessary for their recapitalization, one doubts that PSI made much sense.

Still, many politicians and credit experts criticized the position taken by Draghi who declared himself against imposing costs on Greek debt bondholders, because of a chain of contagion. The critics stated that only normal lenders should be sharing the pain on the Greek debt. Otherwise, the Greek rescue will be a gift to the banks who will lose capital on their bonds but could lose everything if Greece defaulted.

Normally, banks would have looked at the loss of a big chunk of their loan capital as involuntary, but with practically the whole Euroland in a debt crisis credit institutions, hedge funds and other lenders seemed willing to lose money now in order to avoid a tandem of defaults by the euro’s peripheral countries later. They did put, however, certain conditions.

The foremost of these conditions has been that even if Greece was allowed a soft default, this will not be repeated with Portugal, Spain, Italy, and may be other sovereigns thinking of leaving behind their obligations. In other terms, integral part of the negotiations conducted by Washington-based Institute of International Finance (IIF) on behalf of the banks was that Greece will be a unique soft default situation.

This was more wishful thinking than a realistic condition. Experience demonstrates that once a small window is opened, it rapidly turns into a big door with lots of traffic passing through it. The “unique one-in-a lifetime” small window theory is just smoke and mirrors. International Institute for Finance (IIF) Section 4.6, the banks, IMF, ECB, and EU who did not expect the Greek case to be repeated were willingly deluding themselves.

The second major condition in the negotiation with the lenders centered on the terms of restructured sovereign loans. Practically, every party seemed to agree on 30-year bonds, but at which interest rate? The banks wanted 5 percent or more, the Greek government offered less than 4 percent. This “1-percent plus” made a lot of a difference for both parties given the amount of rescheduled debt and the fact that inflation was expected to raise its head if—after long years of a lousy monetary policy—and when the economy picks up.

4.6 The PSI’s 73.5 Percent Writedown Did Not Really Help Greece

One of the opinions often heard as Euroland’s debt crisis deepens has been that lawsuits stemming from this crisis may be the silver lining for lawyers, their Ferraris, wives’ mink coats, and kids’ university educations. The restructuring of Greek sovereign debt in early 2012 has been one of Euroland’s biggest tests, but it did not lead to a legal fight. Lawyers are, however, patient; they wait. The PSI talks centered among a limited number of:

The private bondholders organized themselves into a steering committee, which is a rare event. This had failed to materialize during Argentina’s debt restructuring. The strategy was advised by Allen & Overy and White & Case, though the negotiator on behalf of private bondholders was the IIF.

One of the issues that might have led to court is that the majority of previous Greek debt was held in bonds governed by domestic law. This meant the government could insert collective action clauses into the securities, forcing all bondholders to accept a haircut if a majority agreed to a deal’s implied conditions.

By March 2012, a deal emerged with around 95 percent of private bondholders agreeing to swap their Greek-law bonds and accepting losses of 73.5 percent. Key part of the negotiation was that new bonds will be governed by English law; therefore, they will not be subject to future collective action clauses by the Greek government.³⁵

The jurisdictional issue taught a lesson. Bondholders demanded and obtained that all new Euroland sovereign debt issued after January 2012 will have collective action clauses inserted. Quite likely, this was the most important direct legal consequence of Greek debt restructuring.

On paper, taking off some 62 percent of outstanding public debt, all that related to private bondholders (including banks), provided no minor advantage to the Greek Treasury. It lifted a heavy load off the government’s shoulders. There were however four problems still left to deal with:

1. The heavy haircut applied to only part of the Greek debt; precisely this 62 percent.
The euro 158.76 billion ($206.4 billion) which drained out of the credit institutions’ treasury and individual private investors’ pockets were a large sum, but at the same time, this debt reduction only affected part of the outstanding public liabilities.

2. The other 38 percent of Greek public debt was held by institutions which would legally accept no slimming down of their assets.
Already by late 2011 financial experts had said that according to their calculations, to put itself back on a sustainable trend, Greece needed a 70 percent reduction in its euro 350 billion total debt.³⁶ The achieved euro 158,76 billion reduction represented “only” 45.4 percent of total Greek public debt.
Many experts question whether the balance of Euroland’s EFSF and ESM will be able to bear the lion’s share of the next big write-off. The IMF is a preferential creditor and will not accept any losses. However, the ECB, too, cast upon itself the status of untouchable, and (prior to OMT) stated that it will concentrate on the need to recapitalize member states’ banks. Neither were Euroland’s governments ready to accept a haircut.³⁷

3. Several of the banks which bled with the 73.5 percent haircut were Greek and Cypriot. They were weakly capitalized and recapitalizing them took care of a good part of public debt reduction.³⁸
The Greek and Cyprus banks, which were by no means global institutions, have been devastated by the PSI. With good reason, critics said that it was bad judgment to lend to an overleveraged government in the first place. The only excuse for recapitalizing them with public money³⁹ was that the government had obliged them to buy its bonds—which was plain mismanagement.

4. While the troika insisted and obtained significant reductions in Greek state expenses, as well as tax increases, the government’s receipts still did not cover expenditures.

• Because of mismanagement, and

• Under pressure from the street.

4.7 Credit Events and Bonanzas for Speculators

Literally speaking, it mattered little if the PSI was “voluntary” or “involuntary.” This, however, was no academic issue because it’s the prevailing ambiguity that weighted heavily on the fate of CDSs.

In a first time, on March 1, 2012, New York-based International Securities Dealers Association (ISDA) ruled that the PSI is not a credit event even if it applied 73.5 percent haircut on lenders. This was a unanimous decision, and it evidently raised eyebrows. In one stroke, it:

The fear that CDS protection proves worthless led to unintended consequences in the real world. At one major Wall Street company, the chief risk officer said his firm concluded that the contracts are too risky, and it is either tearing them up or trying to trade out of them. This institution was also shorting sovereign bond issues, which drove down their value and contributed to Euroland jitters.

In addition, because bonds protected through CDS are used as collateral in the interbank market, the ruling that CDS is not triggered in the “voluntary” restructuring engineered by PSI made that collateral less valuable (for a broader discussion, see Chapter 5). The aftermath of a noncredit event ISDA opinion led to:

Critics said that the “noncredit event” decision by ISDA has been a nice present to those American banks which had provided, in aggregate, guarantees of more than $500 billion on all sorts of debts in Euroland’s peripheral countries: Greece, Portugal, Spain, Italy, and Ireland. There were also big losers from that curious decision and, evidently, they did not remain idle.

No surprise therefore that on March 8, 2012, a week after its first decision, the ISDA reversed itself. It issued a statement saying that the debt swap engineered by PSI indeed constituted a credit event. As such, it had two consequences:

All told, few people came out of the PSI negotiations and associated debate looking good. At early stage, it seemed that banks would be getting away with it lightly. Reportedly, hedge funds even bought Greek bonds in the hope of freeriding their way to full repayment. Depending on their price of entry to the market, many of those who did so got burned.

Germany and France had pushed ahead with PSI despite warnings from the ECB about the contagion it could unleash. At the end, the ECB protected itself from the heavy haircut and the EIB did the same in spite of the request by the boss of IMF, Christine Lagarde, who asked that to solve the Greek crisis all lenders should take losses.

Opponents of the “voluntary” private initiative argued that it came to be seen as a central cause of contagion in Euroland. For many investors, the precedent set by PSI has spooked the markets leading to widespread fear that the structure could be replicated in countries such as Italy and Spain, with a list of legal hurdles. “There has been an increasing realization in many quarters that this is a core evil,” said a bondholder, “It has been a transmission device of contagion into other sovereigns.”⁴⁰

The acceptance rate of the PSI, too, caused concerns because it has been a crucial condition imposed on both parties to the legalities underpinning this transaction. First, a statement was made about targeting a 90 percent or better acceptance. Then, when it became clear that the market showed no particular enthusiasm for this deal, the targeted rate of acceptance was reduced to between 70 and 75 percent—while Greece had to impose losses on private bondholders by passing a new law affecting all bonds:

That law was voted by the Greek parliament on February 27, 2012, but its wisdom is debatable at best. Strictly speaking, a retroactive law is not illegal; however, the fact that retroactivity is anathema to the markets sees to it that it can take long years for a country adopting such measure to tap again international capital. In addition, the structure of its public debt has been such that Greek entities were the first in line to be wounded by the PSI as given in Table 4.1 (Section 4.5).

Those who bought restructured Greek debt at very low price had reasons to celebrate. One of the hedge funds was Third Point headed by Dan Loeb. He tendered the majority of $1 billion (euro 770 million) position in Greek government bonds, built up a few months earlier at 17 cents to the euro. Third Point doubled its capital as it sold at 34 cents to the euro.

This windfall of profits came on December 18, 2012; it was a legally correct trade. Loeb took a big risk and reaped king-size reward. He bet on the likelihood that, with OMT on the air, the ECB would make a fool of itself if it left Greek bonds value drop to zero. Indeed, the market turned around, though not necessarily for long.

CDSs and market bets should not be confused. Notionally speaking, they overlap only a little, while they contrast to each other at broader range. CDC buyers seek protection. The buyers of widely downgraded debt seek exposure. Audacious bets on heavily discounted bonds are made only by a handful of risk takers who either get huge amounts or get broken. Ironically, in 2012 such successful bets have been a rare exception to the hedge funds industry record, as many players got burned.

Third Point manages assets of $10 billion and made its investors a 20 percent return in 2012 compared with an unimpressive 4.9 percent for the average hedge fund. Down to basics, the bet behind the $500 million (euro 385 million) profit Third Point made was that Greece would not be forced to leave Euroland. This was contrarian to the prevailing trend, and 2012 was in a difficult year for guessing what comes next.

George Soros, who bet against the British pound and, so to speak, “broke the Bank of England” in 1992 had a hard time to find a profits engine in 2012, after 2 years of lackluster returns. Even worse, John Paulson, the hedge fund manager who called the 2007 US housing crash which landed his fund $2.5 billion, was among those wrong-footed in 2012. He saw both his bets on a US economic recovery and a deterioration in the health of German bonds unravel.

End Notes