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The cost of failure

THE TROUBLED state of the public finances in Greece is a real challenge for policymakers in Athens, and indeed Europe as a whole. One might argue that the fathers of the eurozone made a mistake when creating the rules for the common European currency area by not leaving a back door open for potential leavers. Maybe stricter rules should have been applied compared to those of Maastricht, set during the initial phase of the European Monetary Union entry procedures, and even more importantly, during the years following entry. The course of action under current circumstances appears to be very costly, as the Greek drama is continuing unabated.

THE TROUBLED state of the public finances in Greece is a real challenge for policymakers in Athens, and indeed Europe as a whole. One might argue that the fathers of the eurozone made a mistake when creating the rules for the common European currency area by not leaving a back door open for potential leavers. Maybe stricter rules should have been applied compared to those of Maastricht, set during the initial phase of the European Monetary Union entry procedures, and even more importantly, during the years following entry. The course of action under current circumstances appears to be very costly, as the Greek drama is continuing unabated.

Beginning with the public deficit revision following Greek parliamentary elections in late 2009, fears about the ability of the Greek government to meet its debt obligations, due to a significant increase in government debt levels, became apparent on the financial markets. Consequently, a crisis of confidence resulted in the skyrocketing of government bond yields and a steep rise in the cost of risk insurance via credit default swaps. Greek sovereign bonds yields soon became the highest among the eurozone member states. After credit rating agencies downgraded Greek government debt to junk status in April 2010 financial markets were thrown into disarray.

Talks among political leaders in the eurozone about bailing out Greece involved the International Monetary Fund (IMF) as well. An emergency loan for Greece of €110 billion from the eurozone member states and the IMF was approved in May of 2010, conditioned by harsh austerity measures. The foundation of the common risk-sharing system and the most fundamental principle of the monetary union was ruined, as the no-bailout clause was effectively broken.

As the deepening economic crisis unfolded in 2008 and 2009, governments worldwide kept on bailing out insolvent banks. However, using taxpayers’ money to bail out banks added to the already high level of public deficit and government debt.

Bailed out but undercapitalised banks then kept on financing indebted governments and the vicious circle continued. The government debt load in Greece jumped to 159.1 percent of GDP in September of 2011 from a level of 105.4 percent of GDP in 2007. In Ireland the level of government debt jumped from 65.6 percent of GDP in 2009 to 96.2 percent of GDP within a single year, as troubled banks contributed to an increase in public deficit of 32.4 percent of GDP in 2010. Ireland accepted an international bailout in November of 2010 and later Portugal became the next to receive financial aid from the European Union and the IMF. Lending programmes from international creditors totalled €85 billion for Ireland and €78 billion for Portugal.

A continuous set of emergency talks among the top political leaders of the eurozone, and later European crisis summits, followed. Key decisions from October 2011 and February 2012 brought the offer of a second bailout loan for Greece totalling €130 billion. Once again, this was conditioned not only on implementation of another harsh austerity package, but also on an agreement by creditors to Greek debt restructuring, including private sector involvement in a write-down of large parts of the debt. The ultimate objective of the debt restructuring is to reduce the debt burden to 120 percent of GDP by 2020.

Out of the nominal €352-billion value of Greek government debt, some 26 percent is held by creditors like the IMF and eurozone member states that have provided Greece with an emergency loan totalling €92 billion. Government debt in bonds and other fixed-income securities represents some €260 billion, and it is that sum that is going to be restructured.

Agreement upon a write-down on bonds means that creditors such as investment, pension and hedge funds, Greek and other eurozone-settled banks, as well as the Greek social security fund, are having to take a 53.5-percent voluntary loss in the nominal face value of their bond holdings.

The voluntary exchange period has already started and its results are expected on March 9. As part of the voluntary exchange deal, Greece is to offer creditors long-term bonds of the European Financial Stability Facility (EFSF), an investment vehicle set up by eurozone member states in order to span the gap between the no-bailout clause and an urgent need for money in some member states.

There is no doubt that the currency union designed by politicians more than a decade ago is going to be maintained. Germany's Chancellor Merkel, in tandem with France's President Sarkozy, are the vital duo behind the process of the everbroken unbreakable rule of the no-bailout clause.

For now it is Germany, the European economic powerhouse, that is keeping the wheels of the monetary union turning day by day. But a political time bomb is ticking. The likelihood of Sarkozy being re-elected in April’s French presidential election is diminishing. The anger and wrath of German taxpayers and future voters over their leaders' inability to make a final decision on the debt crisis is also growing, while parliamentary support for Merkel is declining – even within her own political party.

What was not allowed yesterday is suddenly seen as probable today. The motives behind the actions of politicians seem false and fraudulent. If Greece technically defaults in the middle of March, and if radical overrules rational in the elections in Greece, or elsewhere for that matter, then the poor nations of Europe will have to watch what’s served up next from out of this mess.

The author is WBPOnline Chief Analyst

Topic: Finances and Advisory


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