The Ticking Euro Bomb How the Euro Zone Ignored Its Own Rules
Part 2: The Greek Deception Is Discovered
Greece's new conservative government, elected in 2004, disclosed that its socialist predecessors had been reporting manipulated figures to Eurostat since 2000, including the numbers used to join the euro zone.
But instead of criticizing Greece, European Commission President José Manuel Barroso, a Portuguese citizen, praised the new government for its openness and congratulated it for taking such "courageous steps" to make up for the mistakes of the past. Now it was Greece's job to put its house in order by 2006, Barroso added.
But the new administration in Athens soon proved to be just as creative with its accounting as its predecessor. Defense expenditures were posted retroactively to the time of order, not payment, cleverly removing them from the current balance sheet. The bureaucracy refused to make projections about budget trends and used a purely fictitious deficit of less than 3 percent in its budget planning.
Sardelis, the director of the "debt agency," was replaced. His successor, like Sardelis before him, took advantage of the low rates on his country's government bonds. In 2005, Greek bonds were yielding rates only 0.16 percentage points higher than German bonds. The market was buying and the Greeks were selling. Government debt increased by 14.7 percent in 2006.
A blame game began in Brussels, where officials argued over who exactly had given incorrect or insufficient information to whom. The EU currency commissioner pointed his finger at the director general of Eurostat, who shifted the blame to the EU commissioners, who in turn criticized the European Central Bank. National governments and finance ministers joined the fray and, instead of the spirit of optimism that had prevailed around the turn of the millennium, dark skies were suddenly on the horizon for this new Europe.
To make matters worse, hopes of strong economic growth in the euro zone were dashed. Germany, in particular, was ailing, growth was minimal in Europe and unemployment figures were disconcerting. Europe became a constant topic of discussion at the International Monetary Fund (IMF) in Washington.
The IMF Warns Europe
Europe was under observation at IMF headquarters. The euro countries, after having built themselves brave new economic worlds since the late 1990s, mostly on borrowed money, were already in a deepening debt hole, which was still almost unnoticed and certainly vastly underestimated. They were like a mouse that is overjoyed to have spotted a piece of cheese in a trap, without noticing that by eating the cheese it will set off the trap.
At the time, then-IMF chief economist Rogoff's answer to the question of whether the euro zone could break apart again was simple: "Of course." Rogoff said that, in 10 years' time, some countries might not even be using the euro anymore. When he said these things, his colleagues, particularly the Europeans, always looked at him "as if I had a screw loose," he recalls.
The IMF noted a "paralysis in Europe," says Rogoff. The political union that had been promised for years as a real framework for the technical monetary union did not materialize. But the European party continued -- and as long as the music was playing, everyone wanted to dance. Everyone except the Germans, that is, who were busy introducing painful and unpopular reforms -- known as Agenda 2010 and Hartz IV -- to their labor market and welfare systems.
"What the Germans accomplished at the time is very impressive," says Rogoff. "They recognized a debt problem and the systemic weaknesses, and then they rationally went about eliminating those weaknesses." But instead of developing economic productivity, reforming their social systems and controlling costs, countries like Greece, Portugal and Italy borrowed more and more money, dragging out the maturities as long as possible so as to postpone the necessary decisions into the future.
But the critics targeted Germany instead of these countries. The Germans, they said, were pushing their European partners up against a wall. German exports to countries in the euro zone were growing by an average of 7 percent a year, while 73 percent of Germany's trade surplus came from these countries.
The Agenda 2010 reforms applied pressure on wages and helped reduce unit labor costs, so that Germany acquired even greater competitive advantages over countries like Italy and Greece. While unit labor costs were declining in Germany, they were going up in most euro-zone countries, especially Greece.
Greece's Structural Problems
The Greeks were consuming on credit, using cheap loans. They bought German machinery and cars, which helped increase Germany's gross national product, while neglecting to introduce reforms at home. No elected official was willing to trim the country's enormous bureaucracy, hardly anyone was interested in debt repayment, trade deficits or unit labor costs, and very few fought against corruption, subsidy fraud or unearned privileges. The consequences of these failings are still in full view in northern Greece today, in the region bordering Bulgaria.
Almost all of the many factories and warehouses in the industrial zone of Komotini are now shut down, and yet they look as if they were brand-new. Komotini is a prime example of why the Greek economy doesn't grow, why it is uncompetitive and why there is no progress in the country.
Most of the companies there never even opened their doors for business. In fact, the abandoned buildings are the ruins of subsidy fraud. Their developers obtained funds and low-interest loans from the government in Athens and from the EU to build the factories and warehouses, but they never intended to do any business there.
Transparency International considers Greece to be the most corrupt country in the EU. Permits and certificates can only be had in return for cash. Not everyone in Greece sees this as a problem. Some see corruption as part of Greek culture, and they also believe that taxes are unnecessary. As a result, the government has a double revenue problem. On the one hand, the bureaucracy prevents some businesses from growing and becoming profitable. On the other hand, the businesses that do grow and realize profits find ways to pay almost no taxes at all. Every year, the Greek state misses out on an estimated 20 billion in unpaid taxes. A third of Greece's economic activity is untaxed.
Poor Ratings for Greece
In September 2008, when the Lehman bankruptcy wreaked havoc on financial markets, the Greek government believed it had been spared. Greek banks held very few of the supposedly innovative securities that Wall Street's financial wizards had devised. Nevertheless, in 2008, government debt rose to 110 percent of economic output. Greece's debt-to-GDP ratio had surpassed Italy's, and the proportion of its debt that was held by foreign investors was also significantly higher. The country of beautiful islands was in much bigger trouble than it was willing to believe.
The rating agencies, which had declared massive numbers of worthless securities to be safe investments, came under special scrutiny after the Lehman crash. After all, they were also rating entire countries and government bonds. What were their ratings worth? Had they misjudged the quality of national economies just as they had got it wrong with private companies?
For years, the world's three major rating agencies had unanimously given AAA or AA ratings to the bonds of euro-zone members. On Jan. 14, 2009, one agency, Standard & Poor's, decided to downgrade Greek government bonds to A-. It was the lowest rating among all the euro zone's then 16 members. From today's perspective, it marked the beginning of the crash.
The downgrade set in motion a downward spiral that would show European leaders how fragile their euro is and how contagious conditions in a small country like Greece could be.
Marko Mrnik, a "sovereign credit analyst" responsible for Greek government bonds at Standard & Poor's, was behind the downgrade. The native Slovenian doesn't talk to journalists, but his reports provide an indication of how he assesses the markets.
His office is in Canary Wharf in London's Docklands district, a business center with shimmering façades and coffee bars built on the ruins of the old industrial society. Lehman Brothers also had its offices there, until the end.
The purely economic criteria are readily available in the tables produced by central banks, Eurostat and the IMF. But another aspect, the politics of a country, is not something that can be figured out with a calculator. It has to do with issues such as how well an administration functions, corruption, strong unions, how rebellious a country's young people are and how strong its leader is. These are the soft -- but nonetheless important -- criteria.
Explaining the decision to downgrade the country's debt rating, Mrnik wrote that the ongoing financial and economic crisis had amplified a fundamental loss of competitiveness in the Greek economy. After this assessment was issued, prices plunged on the Athens stock exchange and interest rates rose. The buyers of Greek government bonds, wanting to be compensating for taking on more risk, demanded a higher premium. From then on, if Greece wanted to borrow 1 billion, that is, sell bonds worth 1 billion, it had to promise to pay 2.8 million more in interest than Germany was paying. The debt burden continued to grow and grow.
Alarmed by the downgrade, the European Commission initiated another excessive deficit procedure against Greece. But it was a helpless gesture. Once again, the sanction procedure remained ineffective -- not unexpectedly, one might be tempted to say. To this day, not a single euro country has even been penalized, despite the many cases of rule violations. The euro zone's sanction mechanism is an empty threat. Besides, it was poorly conceived from the start. What good does it do to slap fines on a country that is in financial difficulties?
In October 2009, the new government of Socialist Georgios Papandreou replaced the conservative administration in Athens. After Papandreou's election win, Mrnik wrote, in a confidential letter to Standard & Poor's customers, that in light of the repeated budgetary lapses of the various Greek governments, it remained to be seen whether the new administration had the will to implement a credible budget strategy. This sounded diplomatic, but it was pure sarcasm. Investors got the message, namely that the decline of Greek bonds from secure investments to casino chips was accelerating.
The Greek tragedy had begun.
Read Part 3 here.
REPORTED BY FERRY BATZOGLOU, MANFRED ERTEL, ULLRICH FICHTNER, HAUKE GOOS, RALF HOPPE, THOMAS HÜETLIN, GUIDO MINGELS, CHRISTIAN REIERMANN, CORDT SCHNIBBEN, CHRISTOPH SCHULT, THOMAS SCHULZ AND ALEXANDER SMOLTCZYK
Translated from the German by Christopher Sultan.
- Part 1: How the Euro Zone Ignored Its Own Rules
- Part 2: The Greek Deception Is Discovered