In October 2009, Greece elected George Papandreou, who had promised to increase public spending and clean up corruption. At an EU summit during December of that year, to regain the confidence of his EU colleagues, Mr. Papandreou delivered a short, blunt speech that stunned the 26 bloc members: ââCorruption, cronyism and a lack of transparency have undermined the state and have to be eliminated,ââ and added basically that his country was corrupt from A to Z. While it had been suspected for some time, he said that the magnitude of Greeceâs budget deficit was not the 3.7% of GDP reported in April 2009, nor the feared 6%, but nearly 13%! After numerous upward revisions, it turned out to be 15.8%! Greece understated its deficits in previous years as well. From 1995â2010, Greek deficits averaged nearly 6%, and exceeded the Maastricht limit of 3% in every year. The cumulative effect of these deficits was a government debt/GDP ratio by the end of 2010 of 143%, the highest in the Eurozone. Further, in early January 2010, a European Commission report found that the Greek government had persistently and deliberately misreported the countryâs public finances from before Greece joined EMU in 2001âa step that would never have been allowed if what is known now was known then. Entry to EMU contributed to the eventual crisis as it enabled Greece to issue huge amounts of debt at low interest rates, the implicit assumption being that the Eurozone would not allow one of its members to default. The ability to borrow at low rates enabled Greece to live well beyond its means for a decade. At the end of the decade, the bill came due.
In December 2009, the credit rating agencies began cutting Greeceâs debt rating, triggering large-scale sales by many private investors and pushing up yields (see Exhibit 3.24). Despite ambitious deficit-cutting plans, the credit rating agencies were still not convinced and continued to downgrade Greek debt and interest rates continued to rise. Opposition to the bailout in Germany meant that market confidence had all but vanished by April 27, 2010, when S&P cut its rating of Greek government bonds to BB+, just below investment grade. S&P estimated that the likely âârecovery rateââ for bondholders if Greece were to restructure its debt or to default, was only 30â50% of their principal. That prompted panic in bond markets. The yield on Greeceâs 10-year bonds leapt above 12% and the yield on two-year
bonds soared over 16% at one point on April 29, 2010. Borrowing rates for Portugal, Ireland, and Spain jumped, too.
By April 2010, a â¬110 billion ($150 billion) European bailout was announced that would save Greece for several years. One motive for this intervention was to avoid banks taking losses on loans to Greece. However, many believed it offered only a temporary respite as Greece was basically insolvent. Austerity measures imply the government needed to convert a 13% budget deficit into a surplus of 5% over the next several years to pay off interest payments as well as improve competitiveness. Analysts and the rating agencies viewed these cutbacks as unlikely in a politically charged environment coupled with poor growth and high unemployment rates. Civil servants voiced strong opposition to 12% cutbacks and took to the streets with strikes and demonstrations. Protestors also laid siege to Greeceâs parliament, and extremist provocateurs torched a bank that killed three employees. The alternative to the degree of austerity required to service Greeceâs debts is debt restructuringâa polite term for default. The marketâs expectation of default is reflected in the high yields on Greek bonds.
Despite representing only 2% of the Eurozoneâs GDP, the Greek financial crisis sent shockwaves throughout the Eurozone as investors speculated which country would be the next to suffer. Portugal, for instance, in 2010 saw its debt rating lowered two notches since its debt/GDP ratio approached 90%. The government was forced to adopt a series of increasingly harsh austerity measures to bring its public finances under control after a budget deficit of 9.6% the prior year. During the crisis, the euro fell 20%, from above $1.50 in December 2009 to below $1.20 in June 2010. During the same six-month period, the Greek stock market declined 46%, and also precipitated contagion effects in other markets, including the Spanish stock market, which fell a third, and the Portuguese market, which declined more than 25%. The Economist reported (December 4, 2010) that ââThe euro is proving costly for some . . . as one botched rescue follows another.ââ The periphery economic crisis has sorely tested the Eurozone.
By early 2012, after the public sector unions and pensioners living off the state and the multitudes enjoying lavish welfare benefits violently resisted every serious reform, Greece faced a stark choice: Take another bailout and adopt austerity or abandon the euro and accept the consequences. Despite defaulting on its privately held debt in March 2012, the ultimate end to the crisis would not come until the Greeks understood that they could not consume more than they produced and adopted pro-growth policies that would allow them to produce more.
Questions
What event initially precipitated the Greek crisis?
Why was Greece in so much trouble?
What problems in Greece highlighted wider problems in the Eurozone?
How did the Greek crisis affec tthe euro?
What pro-growth policies could the Greeks adopt that would allow them to produce more and how would adopting them help resolve their crisis?
