Sixteen years after faking its fiscal numbers and nine years after the onset of its sovereign insolvency, Greece has finally managed to officially “exit” the bailout program. The news was greeted by a chorus of European officials singing their praises to the European crisis resolution policies (the “European solidarity helped Greece” argument) and the post-crisis reforms. The corollary of this self-congratulatory bravado is that Europe will never again experience another financial and sovereign crisis on the scale of 2008 to 2014, thanks to the structural and institutional changes, enacted by Brussels.
With that, the Plato’s Cave of European economic policymaking has gone darker and quieter than it has ever been before. Speaking on the subject of Greece’s “exit” from the bailout program, Eurogroup President Mario Centeno said that “we have all learned our lessons” from the Greek crisis. Tweeting on the day of the announcement, Donald Tusk, the president of the European council exulted: “Congratulations to Greece and its people on ending the program of financial assistance. With huge efforts and European solidarity, you seized the day.” Neither of these presidents seemed to comprehend the extent of abuse of truth they engaged in.
In reality, the Euro area leadership, as well as the leaders of the majority of the Eurozone’s member states have learned virtually nothing from the events of the last 18 years.
A dead canary in the dead mine
Greece is a good starting point to understanding this reality.
The IMF-EU-ECB Troika that was in charge of the Greek crisis management effectively presided over dragging Greece into the worst economic depression ever experienced by an advanced economy by forcing the governments to raise taxes, cut public investment, and slash unemployment insurance, pensions and welfare.
In simple terms, the Troika forced strongly pro-cyclical fiscal policies onto Greece, with a logical denouement: The crisis-hit economy was pushed into an ever-deeper contraction. Automatic macroeconomic stabilizers – fiscal tools that counter decline in the aggregate demand during the recession – were turned, by the Troika, into automatic destabilizers.
The lesson learned by the EU from this experience is the exact opposite of what normal fiscal policy rules suggest. Amidst the Greek crisis, the EU pushed through a new set of fiscal policy reforms under the heady title of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG). The basic premise of the new fiscal rules is to make fiscal policies even more pro-cyclical than under the previous arrangements. While the new system requires the states to run relatively balanced budgets during the periods of economic expansion (a good thing), the TSCG also requires the states to adhere to a very tight medium-term average deficit target. In other words, if a country is facing a crisis, the TSCG procedures will force it to start cutting deficit financing during the period of ongoing crisis or immediately after, during the period of fragile early recovery.
This is exactly what the EU prescribed in 2011 and 2012 to Greece and other “peripheral” Eurozone states, effectively making the crises worse, while also making their fiscal positions weaker.
Worse, Greece is set to remain a hostage to the Troika rules for years to come. In fact, the country is required to run primary surpluses of 3.5 percent of GDP through 2022, and 2.2 percent for the subsequent 38 years. This means that the country will have virtually no fiscal room to deal with any crisis or recession awaiting it between now and 2060. The Kafkaesque absurdity of centrally managing the Greek economy this far into the future has not dawned on anyone in Brussels or Frankfurt, but it shows precisely the core basis for the TSCG: Europe believes in functionality of purely fictional frameworks, disregarding empirical realities of economic shocks and risks.
Conveniently forgotten, post-2012 second Greek bailout, has been the core culprit of the crisis: the banking sector, and more specifically, the German, French, Irish, Dutch, Portuguese, and other euro area banks that accumulated EUR128 billion worth of Greek assets by the onset of the global financial crisis. Following Greece’s run into sovereign insolvency, these assets were rendered virtually worthless. The first Greek bailout package of EUR110 billion agreed in May 2010 underwrote these banks deleveraging out of Greek bonds. With virtually all money going to underwrite euro area banks’ sales of Greek assets, the country was back to the Troika for another bailout in 2012. The second “rescue package” for Greece, in February 2012, amounted to EUR130 billion and included a 53.5 percent debt haircut, borne out by private Greek bondholders, triggering a Cypriot banking crisis. By August 2015, Greece was in the need of a third bailout, which injected a further EUR86 billion into the failing state.
Reforming into the status quo ante
This experience with sequentially worsening bailouts triggered by mismanagement of the banking assets resolution process in the Greek crisis case is contrasted by the EU’s complete failure to reform its financial and crisis management institutions.
Throughout the last ten years of post-crisis management, the EU generated tens of thousands of pages of banking sector reforms, all promising to end the financial crises for ever.
Yet, the Eurozone has been a laggard on designing and implementing real, tangible reforms that can effectively reduce the risks of future banking crises. Take the European Capital Markets Union (CMU) reforms package that has been growing exponentially since the first iteration published in November 2015, supplemented by the European Banking Union proposals (EBU).
One core basis for both the CMU and EBU from the start has been to reduce the extent of the Eurozone economies’ dependency on bank debt as the source of funding for investment. So far, the EU has failed comprehensively in achieving this objective. Based on the latest data, bank assets (aka, bank debt) account for the larger share of total investment funding in the EU today than in 2006. Worse, the share of equity in supporting EU27 investment activity has gone from around 45 percent of GDP in 2006 to 32 percent in 2017. Faced with the reforms, the European financial sector and capital markets are now more dependent on debt than before the global financial crisis.
Another core policy objective in the CMU has been to create more seamless flow of cross-border investment. This failed as well. Last year’s research from Bruegel, a Brussels-based economic think tank, shows that: “financial intermediation … remains mostly national. For example, the proportion of equity that is of domestic origin often exceeds 50 percent, a strong home bias that effectively prevents risk-sharing across borders. Also, bank lending is mostly national and cross-border asset holdings, let alone cross-border bank mergers, have not even recovered to pre-crisis levels.”
The EBU has been an equally miserable failure. Euro area banks continue to nurse vast pools of non-performing loans on their balance sheets. A number of large and mid-sized banks have issues with capital buffers – either in terms of quantity of capital held, or its quality, or both. Lack of cross-border lending allowed the EU to delay any serious reforms in how banks account for and cover risks from their holdings of foreign assets. There is no consolidated system of deposits insurance. While the EU did put together a template and even created a range of bureaucracies for dealing with a Single Resolution Mechanism (SRM) to deal with insolvent banks, the system failed its first test last year in Italy when it ran across the need for orderly work-out of non-performing assets in two lenders.
All of the above institutional reforms initiatives, the CMU, the EBU and the TSCG, as well as other proposals, such as the Genuine Economic and Monetary Union (GEMU) framework, require some form of fiscal policy coordination, most importantly a mechanism for fiscal transfers between the member states. To this end, the EU has proposed to transform the European Stability Mechanism (ESM) fund used to bail out Greece and other member states, into a European Monetary Fund (EMF). Like its international cousin, the IMF, the EMF will act as a lender of last resort to the crises-hit economies. Like the IMF, the EMF will have strict conditionalities attached to its loans. In a typically European approach, the EMF will have a right of veto over the borrowing countries budgets. That would make the EMF an enforcement arm of the TSCG, a resolution support for the EBU, and the liquidity providing arm of the CMU.
Yet, reliant on the creditor states, namely Germany, for both funding and conditionality approvals, the EMF will lack the relative independence of the supra-national institutions of the Bretton Woods era, turning the European SRM into a hostage of national politics of the creditor states. In a way, the EMF will simply play the role of the ESM in the Greek rescue debacle in future crises. The likely outrun of this scenario will be further bifurcation of the EU into “core” (surplus countries) and “periphery” (vassal states), with continued growth in political discontent and populism in the latter.
Turning Europe into Greece
The systemic failures of the EU in learning from the Greek crisis and developing functional reforms ensure that the next crisis will once again span across the financial and economic contagion networks, dragging into the distress everyone: from depositors to borrowers, from households to sovereigns, from taxpayers to employers. The lessons of the Greek disaster have not been learned. The risks of another Greek bailout have not receded. The threats of the next existential Euro crisis have not receded. Ten years after the onset of the global financial crisis, both Greece and Europe are still exactly where they have been for the last ten years.