by Neil Irwin
“She is betraying the very concept of Europe,” editorialized the Frankfurter Rundschau. “In calling on the IMF, Merkel calls on none other than the United States, which dominates the IMF with its blocking minority of 17 percent. What a wretched state of affairs. What a disgrace for the European Commission and the European Central Bank.”
But Merkel had a crucial ally. As late as March 4, Trichet had said that while “the IMF’s technical assistance is very important,” he did “not believe that it would be appropriate to introduce the IMF as a supplier of help” financially. But as the political wind shifted, so did Trichet. In a typical Trichet touch, the Frenchman barely acknowledged that there’d been any change in his view at all. “I never said myself, and neither have my colleagues, that the IMF did not have very good expertise,” he said on April 8, after endorsing the agreement that brought the IMF in to help support Greece.
The agreement that Trichet and the leaders of the sixteen nations then in the eurozone hashed out in Brussels that Thursday—the announcement came at just before midnight—was a classic product of the Rube Goldberg contraption that is the European decision-making process. Hours were consumed not only by meaty issues like IMF involvement, but also by the question of whether the joint announcement would refer to a “European economic government” being created to handle any Greek rescue, or a “European economic governance.” The French very much wanted the former, while a number of countries more worried about ceding national sovereignty wanted the latter. The finished product ran to only a page and a half and was exceptionally vague, essentially amounting to a promise that the governments of Europe wouldn’t let Greece go bankrupt. “Euro area member states reaffirm their willingness to take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole,” the statement said—as if this mere assurance would be enough to keep private markets lending money to the troubled nation. Trichet promised in a press conference that “the mechanism decided today will not normally need to be activated.”
There were no numbers in the communiqué that might give a sense of the financial resources the eurozone governments were willing to deploy to help Greece. The amounts that sources were whispering to reporters were in the paltry €20 billion range, about a third of it coming from the IMF. Any such disbursements would require the assent of all sixteen of the nations then using the common currency; even a Slovenia or a Malta or a Cyprus could, in theory, block collective action.
It was the first time European leaders had acknowledged the reality that with the yoke of a single currency, they would need to stand behind each other. But it was also a lost opportunity. This was a time when Greece’s crisis was a relatively inexpensive one for Europe to solve; the nation’s economic output was only about 2 percent that of the eurozone as a whole. But instead of simply writing a check and guaranteeing Greek finances, the message sent from Brussels in the spring of 2010 was that while the nations of the eurozone would stand behind their weaker members, they would do so reluctantly, only when they had absolutely no other choice, with huge procedural obstacles, and on a scale inadequate to the size of the problem.
It didn’t take long for financial markets to reach exactly that conclusion. The cost for the Greek government to borrow money for a decade, 6.46 percent a couple of days before the summit, fell only to 6.28 percent the following day, hardly the move to be expected if markets were convinced that Europe stood behind Greece unconditionally. More worrisome, as the weather warmed up that spring, there was contagion in the air.
With the value of Greek bonds plummeting along with the nation’s credit rating, global investors were quick to ask, “Who’s next?” The answer, to many in the financial sector and the media, was an acronym: “PIIGS,” for Portugal, Ireland, Italy, Greece, and Spain. Within the ECB, officials favored a different ordering of the same places. Their preferred acronym both put the nations roughly in order from most to least financially troubled and was at least somewhat less offensive to people who were natives of the countries in question. So the ECB focused on the “GIPSI” nations: Greece, Ireland, Portugal, Spain, and Italy.
Greece’s financial problems should have been inexpensive to solve. But by moving slowly and timidly in addressing the nation’s deteriorating financial position, European leaders ensured that a different price would be paid. Over the month of April 2010, the cost for Greece to borrow money soared to nearly 10 percent. The other GIPSIs also faced increases. Irish ten-year rates rose from 4.48 percent at the start of the month to 5.12 percent at the end. Portuguese borrowing costs rose from 4.22 percent to 5.14 percent.
It was herd behavior by global investors. In fact the GIPSI nations were very different from each other. The list included one country that was running huge annual budget deficits before the crisis (Greece) and four that weren’t. It included two countries that had very large amounts of total debt relative to GDP (Greece and Italy) and three that didn’t. (At this point, Spain actually had less public debt than fiscally sound Germany.) It included one country with flexible labor markets and a pro-business environment (Ireland) and four that put many obstacles in place to firing workers, cutting pay, or otherwise allowing businesses to adjust to a changing economy. Two nations were weighed down by huge losses in their banks (Ireland and Spain), while the others weren’t. Three countries are small enough that their financial rescue would have been easily affordable by Europe as a whole (Greece, Portugal, and Ireland); two are so large that a financial rescue could strain the continent’s resources to the breaking point. Here’s a by-the-numbers summation along with Germany’s numbers for comparison:
Even though the five GIPSI countries faced very different challenges, the markets started to view them as all in the same situation. Perhaps more problematic, so did many in the stronger European governments, imagining that the crisis was simply the result of profligate Southern Europeans spending money they didn’t have—and they tailored their solution accordingly.
As interest rates rose steeply for Greece that April, it was becoming clear that the March 25 strategy of merely pledging to back the nation wasn’t working. Greece had €8.5 billion in bonds coming due in May, and it was looking increasingly impossible for the government to roll that debt over—to find buyers for newly issued bonds—at an affordable rate. On April 23, Prime Minister George Papandreou acknowledged what had become obvious to anyone who understood the perils of debt dynamics in a country that owed so much money. Standing in front of a picturesque seaside scene on the Greek island of Kastelorizo, just off the Turkish coast, Papandreou invoked his country’s ancient history: “It is a national and imperative need to officially ask our partners in the EU for the activation of the support mechanism,” said the prime minister, saying the country would need €45 billion in emergency loans. “All of us—the present government and the Greek people—have inherited a ship that is about to sink. . . . We are on a difficult course, a new Odyssey for Hellenism. But we now know the way to Ithaca and have charted our route.”
It’s worth remembering that the original Odyssey lasted a decade and included run-ins with cannibals, a witch who turned the captain’s men into swine, and a violent one-eyed giant. The voyage Greece was about to undertake wouldn’t be that much more relaxing.
• • •
Four days after Papandreou’s acknowledgment that Greece was out of options without an international bailout, the markets again turned against the nation, and hard. Standard & Poor’s cut Greece’s debt to junk status, judging the country no more creditworthy than the shakiest borrowers. The cost for the nation to borrow money for ten years rose to a new high of 9.7 percent on April 27. But that actually understates the challenge. It wasn’t just a higher interest rate that Greece was facing, but a shutdown in the function of its markets; there was, in effect, no longer a workable market in which the nation could borrow money. European leaders and the IMF returned to their negotiations to transform th
eir vague concept of a Greek rescue into something more tangible.
All involved hoped that the deal announced on May 2 would be the end of the affair. It called for €110 billion to be provided to Greece over three years—the latest in an ever-escalating amount of cash being deployed to the country. Some €80 billion would come from the nations of the eurozone, the rest from the IMF—and they came with strings attached. Signed by Papaconstantinou and Provopoulos, the eighty-one-page memorandum of understanding with the IMF laid out what the Greek government would do to slash its spending and step up tax collection. It pledged a “frontloaded multiyear adjustment effort” reducing the annual budget deficit from more than 15 percent of GDP in 2009 to less than 3 percent by 2014. To make that happen, the Greek government agreed to raise taxes on cigarettes and alcohol, to put in place “presumptive taxation of professionals” so that doctors and other high earners couldn’t evade their taxes so easily, and to cut pay for public employees.
The ECB was neck deep in the negotiations; if the other eurozone governments were to come up with cash to bail out Greece, they wanted their central bank to be on board as well. “We were also asked by the Heads of State and Government, to make an independent judgment on whether or not it was appropriate for them to activate the bilateral loans that they envisaged,” Trichet said a few days later. “Their own decision would be taken only on the basis of our independent judgment.” To show its dedication to the cause, the ECB once again extended its willingness to help Greece by taking its downgraded debt as collateral from banks around Europe. This time, the central bank pledged to accept the nation’s debt indefinitely, no matter what might happen to its credit rating.
All this came at a price, however. If Trichet were to offer such extraordinary help to Greece and put its own balance sheet at risk, he would require that his staff have firsthand information about how Greece was faring in its austerity measures and reforms. Under the Greek memorandum of understanding, four times each year, a team of staffers from the IMF, the European Commission, and the ECB would travel to Athens to check on Greece’s progress in fulfilling its end of the agreement—with a passing grade needed to receive the next disbursement of bailout funds. Greek officials started calling this group the “troika.”
Suddenly, three organizations run by unelected officials—one of them the central bank—would effectively gain power over the taxing and spending policies of a democracy of eleven million people. The ECB was supposed to be insulated from politicians who might influence its decisions. But now the ECB would be doing quite a bit more than influencing the decisions of Greek politicians—it would, along with the IMF and the European Commission, be dictating them.
In the financial markets, there was a sense of relief. The Monday after the announcement, borrowing costs for the GIPSI nations fell and stock markets rallied. But, in an emerging pattern, the relief would be startlingly short-lived. As the week progressed, two things became clear: While Europe and the IMF might have come to Greece’s rescue, they had no broader plan to deploy financial force in other nations that might get into trouble. And within Greece, there were signs that the agreement the government had struck would have a hard time sticking. The streets of Athens erupted in protests, as tens of thousands of people assembled in Syntagma Square in front of parliament, many carrying bats or hammers, throwing rocks, or heckling the ceremonial guards at the Tomb of the Unknown Soldier. On May 5, the demonstrations turned deadly when suspected anarchists threw a firebomb into Marfin Egnatia Bank. Three people inside perished.
On financial markets, developments were also ominous. Greek ten-year borrowing costs, 8.5 percent at the start of the week in the warm afterglow of the IMF deal, soared to nearly 11.3 percent by Thursday and 12.4 percent Friday. And the contagion was spreading rapidly to the other GIPSIs. Ireland, for example, saw its rate rise from 5.1 percent to 5.9 percent. These blips on traders’ screens could cost the affected governments billions of euros a year in extra interest payments, making their already dire fiscal situations all the worse. If the trend were to continue, five countries with more than 130 million residents could very soon become insolvent. At that point, their only financial option might be to withdraw from the supposedly eternal eurozone and reintroduce their own currencies, which they could promptly devalue to lower their debt burdens. The result would surely be economic chaos across Europe and beyond.
Investors began to wonder just what the ECB might do to stop the panic from spiraling out of control. The core of the problem was that private buyers were selling off bonds. Could the ECB use its bottomless supply of euros to buy those bonds, thus pushing their interest rates down to more manageable levels? It would violate the spirit of the Maastricht Treaty, which specifies no money printing to fund governments. But by buying bonds on the open market instead of directly from governments, the ECB could get around that technicality. As analysts from the Royal Bank of Scotland wrote in a May 5 research note advocating such an action, “Better breaking the rule-book than breaking up the euro area!”
On May 6, the ECB’s Governing Council held its regularly scheduled meeting to decide on whether to raise or lower interest rates. Twice a year, the bank holds the meeting not at its headquarters in Frankfurt, but in one of the capitals of the eurozone. This was one such occasion—the council had gathered in Lisbon. Trichet led a session that Thursday morning that was utterly routine, with officials from across Europe all offering their five minutes’ assessment of the state of the economy. By Trichet’s design, they left unmentioned the burgeoning debt crisis, instead looking at data on inflation and concluding that interest rates should remain unchanged. The first question asked of Trichet at his press conference that afternoon was the obvious one: “Is the purchase of government bonds an option to fight the consequences of Greece’s fiscal crisis on financial markets? Did you discuss this option today?”
“On your first question, we did not discuss this option,” Trichet said, leaving the matter at that. When another reporter followed up a few minutes later, he replied, “I will simply repeat that we did not discuss the matter, and I have nothing further to say.”
Stock markets worldwide sold off on the sense that Trichet had no bond-buying plans up his sleeve. It wasn’t so different from the runs the likes of Northern Rock and Lehman Brothers had experienced two years earlier. Except now the entities losing their access to cash were the nations of Europe.
At 2:32 p.m. New York time—the ECB officials in Lisbon had already gathered for dinner, though their work for the day was hardly done—a large mutual fund company placed an order to sell $4.1 billion worth of contracts tied to the overall value of the Standard & Poor’s 500. Trading had already been choppy, with more dramatic ups and downs than usual as investors reacted to the latest news and speculation out of Europe. The market was already down about 3 percent for the day. Through a strange sequence of events still not fully understood, the $4.1 billion sell order—which, given the $10 trillion value of the S&P 500 index, shouldn’t have moved markets much—interacted with ultra-high-speed electronic trading systems to create a massive collapse in the market.
By 2:47 p.m., the Dow Jones Industrial Average had fallen 1,010 points, a loss of 9 percent of U.S. stocks’ total value. Prices for a share of some major companies, like consulting firm Accenture and Samuel Adams brewer Boston Beer Co., fell from double digits to a single penny in a matter of moments. By shortly after 3 p.m., the market was climbing back to its normal level, and it closed the day down 3.2 percent, not far from where it had been before what would soon be known around the world as the Flash Crash.
The episode had more to do with frailties in the U.S. stock market in a world in which trillions of dollars gush around through automated trades than anything that the ECB had done. But it wasn’t wholly unrelated to the crisis in Europe. The market had been falling all week as investors fretted about the Greek debt crisis. The Flash Crash was merely one particularly jarring piece of e
vidence of just how on-edge global investors had become over whether Trichet and his colleagues would intervene to keep Europe together. And given the uncertainty in those early hours (and days) about why it had happened, among the ECB officials themselves, it prompted a particular unhappy reaction: Did we do that?
• • •
U.S. treasury secretary Timothy Geithner practiced a particularly energetic variety of economic diplomacy. His was a packed schedule, and between meetings he constantly worked the phones to gather information, compare notes, and try to persuade his interlocutors of what they ought to do or say or write. On that Thursday in May, he arrived at his office at 1500 Pennsylvania Avenue NW at 7:30 a.m., and in the fifteen hours that followed would testify at a hearing of the Financial Crisis Inquiry Commission across town; walk next door to the White House three times, once for the senior staff meeting and twice to meet with President Obama; and make at least twenty-six phone calls to a variety of U.S. politicians and White House aides, to journalists from the Washington Post, the New York Times, and the Wall Street Journal, and to his old friends from the world of central banking. There was one call to Ben Bernanke, one to Mervyn King—and two to Jean-Claude Trichet. The last call listed on Geithner’s official schedule, with Senate Banking Committee chair Chris Dodd, ended at 10:25 p.m. (Recall that this was during the crucial final days of negotiations over what would become the Dodd-Frank financial reform act.)
Geithner’s message to Trichet and other European officials that day and in the days that followed—and, for that matter, in the years that followed—was that the time for half-measures was over. The Flash Crash had only heightened the sense of urgency among the Americans, adding to pressure from around the world—it also came from the British and from Dominique Strauss-Kahn at the IMF—for the Europeans to move more boldly than they had to that point.
