Greek debt crisis reveals more than it resolves

A panel of experts concurred that Greece must reduce corruption, regulation, and inefficiency to in order to open up its market to entrepreneurial forces and achieve economic growth.

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UCLA International Institute, November 20, 2015 — The Greek debt crisis has largely been portrayed as a face-off between Greece and Germany, with the future of the euro in the balance. The thumbnail view depicts Greece as struggling to repay Euro-denominated debt acquired by its previous government while undergoing severe austerity measures that have significantly contracted its gross domestic product (GDP). Germany on the other hand, the largest and richest economy of the Eurozone, is seen as insisting that Greece repay its debt without debt relief.

This simplified version of the crisis misses crucial details that contributed to its creation and continue to hinder its resolution, such as systemic domestic corruption that enabled members of the Greek elite to borrow from state banks, deposit euro loans abroad and leave the state on the hook for their debt. Not to mention the country’s complicated market regulations, which both inhibit market entry and contribute to inefficiency. Perhaps most important, the stand-off has masked the central problem of the euro: a shared currency without a unified (and enforceable) fiscal policy behind it.

A recent panel discussion of the crisis cosponsored by the Center for European and Russian Studies, the Burkle Center for International Relations and the Konrad Adenauer Foundation presented a clear, jargon-free view of the crisis and its implications. “Germany, the Euro and the Greek Crisis: Where to Go from Here?” featured Matthias Rainer Zimmer, scholar and member of the German federal parliament; Edward Leamer, Chauncey J. Medberry Professor of Management, professor of economics and statistics, and current director, UCLA Anderson Forecast, UCLA Anderson School of Management; and Aaron Tornell, a UCLA professor of economics.

Greece undergoing the equivalent of the Great Depression

According to Edward Leamer, “The global bond market forgot about sovereign default risk.” Once Greece joined the euro, interest rates on its government bonds fell to the same level as that on German government bonds. Lending rates to Greece were based on currency risk, he said, not the risk that the government would default on its loans (sovereign default risk). As interest rates declined, the Greek government issued more and more bonds, with international banks holding most of the debt. (Tornell later clarified that these were chiefly German, French and some U.S. banks, as well as American pension funds.)

“The ideal thing would have been for the Greeks to borrow as they did, but to invest for the future. But what they did is spend most of the borrowing,” he said. Yet throughout most of that period, the Greek economy continued to experience a positive GDP growth rate — “about as good as anywhere in Europe,” he said. Only when the bond markets learned that Greece was carrying a debt-to-GDP ratio of 14 percent, and not 4 percent, did the bottom drop out, said Leamer. Greece soon found itself unable to either borrow more or to repay the debt it had already accrued. “The problem was created by both the lenders and the borrowers,” he concluded.

Leamer claimed that the austerity measures undertaken by Greece as a condition for the EU stabilization loans have resulted in a 28 percent drop in its real gross domestic product (GDP), comparable to the 25 percent drop experienced by the United States during the Great Depression. Unemployment in Greece today, he added, exceeds even that of the United States during the depth of Depression, especially among youth (50–60 percent). “This is the future of Greece beings squandered here,” said Leamer. “We need to think of Greece in two decades – to invest in the assets that will make Greece look great in two decades.”

Current repayment conditions, he insisted, are destroying Greece’s ability to rebuild its economy. He judged fixed-income payments a terrible idea for a borrower in general, claiming they left little room for adjustments for contingencies. “The obvious solution is to have the interest payment contingent on GDP growth,” he argued. “So if there is there no GDP growth, no payments are made.” In that scenario, said Leamer, “Germany would be keenly interested in getting GDP growth in Greece as high as possible in order to get extremely high interest payments.”

Greek elite needs to be induced to play by the rules

“Greece today cannot repay its debt. It’s just too large,” said Aaron Tornell. He attributed the debt crisis to two principal reasons: the assumption of a systemic bailout warranty and “the tragedy of the commons.” Banks were willing to lend to Greece because they assumed that Eurozone members (or the International Monetary Fund, the European Central Bank, the European Commission) would step in and pay them off in the event that Greece defaulted. “It makes no different to lenders [who repays them],” he observed.

In the same way that no one takes care of communal properties, the system of central banks in the EU also did not take care of the euro, he implied. Every national central bank that is part of the Eurozone system has the right to lend money to banks, provided that the banks in their jurisdictions are solvent, said Tornell. But in Europe, it is the national authorities who decide which banks are solvent.

Hard times first hit Greece in 2009–10, he said, and Greek firms began to be unable to repay their debts. The Greek banks then went to the Central Bank of Greece for loans to remain solvent. “But who pays for this?” asked Tornell. “And this is the ‘tragedy of the commons.’ Europe pays because [the central bank] prints euros.” But a double tragedy of the commons happened within Greece itself, he continued. A certain stratum of the Greek ruling elite — particularly those who owned banks and firms — gamed the system by borrowing huge sums in euros, most of which they moved out of the country. In fact, he claimed that the gross private assets of Greeks abroad went up by roughly the same amount as the country’s sovereign debt.

Forgiving Greece’s debt, or even reducing it, would not address this fundamental problem: the corruption that enables members of the Greek elite to extract resources from the country with no consequences. “This is a domestic problem,” emphasized Tornell, “it can’t be solved by Germany and Europe.” Greece, he argued, must be pressured to enact reforms that destroy the power of these elites to “take what doesn’t belong to them.” Crucially, he noted that the country lacks strong property rights, which leads to widespread bribery. “Real reforms almost always come during a time of deep crisis,” he concluded.

A question of moral hazard

Matthias Reiner Zimmer viewed the Greek debt crisis as a question of moral hazard. “The [EU] monetary union has suffered from a congenital defect. It is an economic union and has a common currency, but it also needs a certain convergence in the area of public finance,” he said. The Maastricht public finance criteria were not, he said, applied to new EU entrants, particularly Greece. “Greece was allowed to adopt the euro for political reasons,” explained Zimmer. Not only was there widespread reluctance to be too strict with the “cradle of democracy,” the financial figures submitted to the EU by the Greek government had been doctored “with the connivance of Goldman Sachs,” he remarked.

Zimmer explained that Germans had not uniformly supported joining the euro. Today, he explained, they feel that both promises made by (the recently deceased) former German Chancellor Helmut Schmidt have been broken: that the European Central Bank would be as powerful as the Bundesbank and that EU members would not be liable for one another’s debts.

Whereas the first $90 billion euros in stabilization aid extended to Greece were guaranteed solely by Germany, the most recent $35 billion euro package (for the period 2014–20) was made available through an EU stability mechanism. Neither package is considered development aid. “They are intended to stabilize the financial system and enable Greece to issue its own sovereign bonds once it is in the financial markets again.” Zimmer also specified that the most recent package included a number of social components designed to limit social upheaval in Greece. “Solidarity [within the EU], in other words, is not simply about handing out money but rather, about helping Greece to help itself,” he remarked.

Zimmer rejected the idea that Greece’s debts should simply be canceled. First, the idea of a “haircut,” or debt reduction, is problematic for European creditors because it would transgress European treaties and the common legal space created by them. Second, he said, “The time scale of debt servicing has been extended to a degree that it is almost tantamount to a partial debt remission. All reasonable latitude has been exhausted in this respect.”

Having refused an offer to leave the euro for five years, Greece has opted for the long hard road to repaying its debt, said Zimmer. He claimed that there was neither an easy nor a quick solution to the crisis, commenting, “At the moment, we are truly proceeding on a wing and a prayer . . . in the hopes that the mists of uncertainty will lift at some stage.”