To understand why Greece and its creditors have failed to put its debt burden on a sustainable path, look beyond the headlines about the intransigence of the left-wing government in Athens and the tested patience of officials in Berlin and Brussels.
Blame lies with the monetary union’s flawed political structure, where a highly integrated financial system coexists with fragmented and unpredictable governance. That structure means it’s dangerous to assume that bigger eurozone economies such as Spain or Italy won’t also see a revival of investor concerns about their own debt levels when the European Central Bank ends its monetary support for the region’s bond markets.
With Greece unlikely to meet €6.7 billion in bond repayments to its European Union creditors this summer, a familiar game of chicken is playing out. The Syriza government, we are told, refuses to enact more spending cutbacks, and its EU creditors refuse to provide debt relief without those commitments. As always, the risk of an unwelcome “Grexit” from the eurozone gives the battle its requisite context of high drama.
But the longer-term narrative, which transcends these sporadic episodes of brinkmanship and their changing characters, tells a more complete, and ultimately depressing, story. Over the past six years, Greece has received multiple EU-IMF bailouts worth more than €240 billion, as well as a separate private-sector debt restructuring. Yet since 2008, the country’s GDP has shrunk by 25% and its debt to GDP has swelled from 109% to almost 180%.
With the notable exception of Argentina, financially strapped countries that share no currency with other nations typically avoid such protracted struggles. They complete debt restructurings within a few months and a year or so later regain access to international capital markets. But in Europe the common currency structure has locked Greece and its lenders into a self-destructive cycle of mutual mistrust and evaporating confidence.
Since there is no international bankruptcy court, sovereign restructurings always face political challenges as the debtor and creditor countries’ taxpayers, and the shareholders of private lending institutions all duke it out to determine how to distribute the losses. But in this case, it’s further complicated by the close financial integration between eurozone member countries. It brings a heightened level of contagion risk to the table – the idea that investors in other eurozone countries’ bonds will sell them to cover losses incurred in Greece and unleash a vicious cycle of market pressure.
To forestall that risk, eurozone authorities were always reluctant to let private-sector creditors suffer big “haircuts” on their investments – which inevitably translated into a bigger burden for taxpayers. Yet there were no pan-European political institutions to pool fiscal resources and automatically apportion how to share those burdens. Without a U.S.-style centralized federal government, the 17 member states would fight over every dollar. The result was something close to paralysis.
“The technological and capital market integration was so advanced, and the world was so fragile after the 2008 crisis, that in order to really create freedom of decision-making in Greece you needed a huge amount of institutional buffers that weren’t there -- buffers against contagion,” says Georgetown law professor Anna Gelpern, a long-time scholar of sovereign debt markets.
It’s tempting to suggest that bankers and hedge funds exploited this dysfunction at taxpayers’ expense. But one fund manager who participated in the private sector involvement, or PSI, talks of 2012, and who asked not to be named because of ongoing interests in European debt, complained that even when the creditor committee was poised to sign a deal, the 16 EU finance ministers couldn’t agree on the terms among themselves. “Our discussions on the Greek side progressed a lot more easily than the discussions on the European side,” he said.
This tortured process looms over the eurozone’s future, even if Greece finally gets a successful debt restructuring. The same flawed structure means that contagion could rear its head again in Portugal – or worse, in Spain or Italy – currently low bond yields could spike again and the panic that of 2012 could return. While we are a long ways from those levels, this month’s rapid selloff in the region’s bond markets hints at how quickly things could unwind.
For now, the ECB’s massive bond-buying program functions as the de facto institutional buffer that the eurozone politicians failed to build. But its powers aren’t limitless – the ECB can only act within a narrow mandate of achieving price stability and suffers internal political divisions of its own.
Such alternative “buffer institutions are cushions to buy space to find a political solution,” said Ms. Gelpern. “If you run through those buffers without getting a political solution, then the system is going to crack. We are closer than ever to that.”