Updated: Feb. 13, 2012
Over the last decade, Greece went on a debt binge that came crashing to an end in late 2009, provoking an economic crisis that has decimated the country’s economy, unleashed increasing social unrest and threatened both Europe’s recovery and the future of the euro.
In late 2009, the new government of Prime Minister George A. Papandreou announced that it had discovered that its conservative predecessor had falsified budget figures, concealing a swollen debt that was growing rapidly in the wake of the global economic meltdown. Greece was quickly frozen out of the bond markets, and in May 2010 began to rely on an aid package of €110 billion, or $152.6 billion, agreed to by its richer European neighbors.
The price was a series of austerity measures meant to cut the country’s bloated deficit and restore investor confidence. Greece cut the pay of its public workers — a quarter of the work force — by 10 percent — but continued to miss deficit targets as its economy sank deeper into recession, shrinking by an estimated 5.5 percent in 2011.
Throughout 2010 and 2011, investors continued to demand ever higher interest rates for Greek borrowing as the market appeared to conclude that some sort of default was inevitable. Mass demonstrations turned violent in October 2011 as Parliament barely passed additional austerity measures Europe demanded to keep the bailout money flowing.
Also that month, European leaders won agreement from banks to reduce some of Greece’s debt by 50 percent. But the conditions coming along with the aid plunged Athens into turmoil, and in November, Mr. Papandreou decided to step down. Lucas Papademos, an economist and former vice president of the European Central Bank, was named prime minister and assembled a temporary government of national unity that pledged to quickly approve the tough terms of a second European aid package of $150 billion.
By early 2012, the sense of crisis had returned, as the leaders of France and Germany threatened to withhold the second aid package without further cuts and promises of structural economic changes. At the same time, Greece plunged into meetings with banks and hedge funds about deeper writedowns on its debt — up to as much as 70 percent.
The proposed austerity package included 20-percent cuts to base pay for workers in private companies and a loosening of public sector job protections. With elections looming as soon as April, the three parties that make up Mr. Papademos’s coalition feared that they were essentially being told to commit political suicide to save the country.
The European Union’s plan of tax increases, spending cuts and now wage cuts has pushed the country into a deep recession; the economy shrunk by almost 12 percent between 2009 and 2011 and is expected to shrink by up to 6 percent in 2012. The crisis has also stripped Greece’s political center, weak to begin with, of its last shreds of political legitimacy. With unemployment at 21 percent, businesses closing, credit scarce and the proposed new wage cuts expected to further decimate the shrinking middle class, the hard left and extreme right are rising.
Mr. Papdemos reached a deal to support the new austerity measureswith two of his coalition members, the Socialists and New Democracy, a center right party. The right-wing party, Popular Orthodox Rally, balked, but is too small to block the deal, which includes a 22 percent cut in the benchmark minimum wage and cuts of 150,000 public sector layoffs. Greek workers responded by walking off the job for the second general strike in a week.
Street demonstrations in Athens turned violent, and 80,000 people marched in protest the day before Parliament approved the package on Feb. 13.
Even with the measures, officials in Athens and Europe began considering the consequences of a Greek default and exit from the euro zone, steps once seen as unthinkable.
The deal is expected to unlock the 130 billion euros, or $172 billion, in new loans and save Greece from potentially disastrous default.
Once the deal is finalized and the measures are approved by the Greek Parliament, lenders are expected to begin releasing to Greece the aid it needs to prevent a default when its next debt payment comes due on March 20, 2012.
But as part of the deal, the European Union is expected to be establishing an escrow account that would hold new money lent to Greece, and using it first to pay creditors, before the Greek government can tap it for any other purpose. The idea, backed by Germany and the Netherlands, may make further loans to Greece more palatable to German voters, but many Greeks see it as a fundamental loss of sovereignty and feel that they are being pushed into poverty to appease banks.
Meanwhile, according to the European Union statistical agency, Greece’s debt rose to 159.1 percent of gross domestic product in the third quarter of 2011, from 138.8 percent a year earlier.
A growing number of economists have argued that the dislocation in Greece shows that austerity is precisely the wrong medicine for the struggling economy. Shrinking the G.D.P. side of the equation makes it harder to bring down Greece’s debt ratio to a more sustainable level, as the country has pledged to do, and adds pressure for further austerity.
Ratcheting Up the Pressure
In January 2012, European leaders were stepping up the pressure on Greek bondholders to take voluntary losses to ease the region’s debt crisis.
Private sector bondholders are seeking yields of nearly 4 percent on the new bonds they would receive in a swap for their holdings, but Greece, as well as Germany and the I.M.F., argue that a yield closer to 3 percent is necessary to give the restructuring a serious hope of success.
At stake is the need to pare Greek debt to levels where the country can conclude a bailout with the European Union and the I.M.F. that would give it the cash it needs to repay loans coming due in March and, officials hope, allow Athens to finance its needs through 2013. Without such a package, Greece could be faced with a chaotic default that would further destabilize the rest of the euro zone.
Even more complicated were the talks on the demands from the “troika’’ for new cuts in government spending, wages and pensions and changes to free up Greece’s rule-bound labor market. By mid-February, the leader of Popular Orthodox Rally, one of the three parties making up the coalition government, was talking about pulling out, although Mr. Papademos would still have a majority in Parliament.
The other two members of the coalition are the Socialists and the center-right New Democracy party, which was in power while the country’s debt burden was secretly amassed.
Barely Avoiding Bankruptcy
Greece barely avoided bankruptcy in June 2011, as European leaders threatened to withhold a €12 billion installment of the bailout funds until another austerity package of cuts, tax increases and sales of public companies was adopted. Mr. Papandreou managed to force the bill through Parliament in the face of days of massive street protests.
In late July, European leaders agreed on a $157 billion second bailoutthat proposed that investors swap some of their Greek bonds for loans with longer maturities and European guarantees. The deal would represent a loss of about 20 percent for banks — far less than the 60 percent discount Greek bonds were trading at.
In September, European officials angrily stormed out of meetings in Athens, saying that Greece was failing to live up to austerity promises it had made for the first package. On Sept. 27, Greece’s Parliament voted to back a hugely unpopular new property tax, leading officials from the “troika’’ — the European Union, the European Central Bank and the I.M.F. — to clear the way in the next installment of $11 billion in international financing, staving off a looming default.
On Oct. 20, Parliament approved a new raft of austerity measures,including additional wage and pension cuts, public sector layoffs and changes to collective bargaining rules, as violent demonstrations raged outside. Tens of thousands marched through Athens on the second day of a general strike.
Meanwhile, the Greek economy continued to fall deeper into recession.
That gloomy news led European leaders to consider pushing banks to take a far bigger “haircut’’ on their Greek loans than the 20 percent that had been agreed upon in July — perhaps as much as the 60 percent discount already reflected in the market price for Greek bonds. After difficult bargaining, they succeeded in forcing the banks to accept the 50 percent loss voluntarily, thereby reducing Greece’s debt load without setting off a default that could have unforeseen consequences across the global economy.
What If Greece Drops the Euro?
Officially, the guardians of monetary union have refused to discuss in public the possibility of member states abandoning the euro. But as the truth dawns in Greece and other weak euro zone economies that the price for remaining bound to the single currency will be more hardship and sacrifice, a growing number of legal and financial experts — to say nothing of the Greeks themselves — are examining in detail what would happen if Greece abandoned the euro.
Over the last year, Greeks have withdrawn almost 40 billion euros, or nearly $53 billion, in deposits from their banking system, equal to about 17 percent of the nation’s gross domestic product. A total of 14 billion euros in deposits was withdrawn in September and October alone.
The deposit flight peaked in October and early November, at a time of intense political uncertainty in Greece and financial turmoil in Europe. According to Georgios A. Provopoulos, the head of the Greek central bank, the outflows have stabilized of late under the leadership of the new prime minister, Lucas D. Papademos. Since becoming prime minister he has said forcefully that Greece’s future lies within the euro zone, not outside it.
But that has not stopped investment banks, academics and lawyers from digging deep into what a euro exit would look like. Over the last month Nomura and UBS have come out with detailed studies on the topic. Nomura forecast a 60 percent devaluation of the new drachma. UBS went further, warning of hyperinflation, military coups and possible civil war that could afflict a departing country.
A New Prime Minister and Unity Government
The choice of Mr. Papademos, a former vice president of the European Central Bank, came after infighting that prompted fears that Greece’s political class would be unable to stop feuding — and positioning themselves for the next elections — long enough to agree on a unity government.
In the through-the-looking-glass world of Greek politics, the argument was not over who could claim the cabinet positions but who could avoid taking them, particularly the Finance Ministry.
Mr. Papandreou, who resigned when the new government was formed, was repeatedly rebuffed when he offered positions in the new government, reports said, because nobody wanted to be associated with the unpopular measures Greece will be forced to impose to qualify for new loans from Europe.
In particular, Antonis Samaras, the leader of the conservative opposition, did not see any reason for his party to participate. But other smaller parties also refused.
Mr. Papademos was said to have insisted on several measures he believed were crucial to his success, including a minimum of at least six months at the helm. Earlier, Greece’s major political parties had agreed to new elections in just 100 days.
News reports also said that he insisted that members of Mr. Samaras’s New Democratic party play a significant role in the unity government, which will have to pass the new austerity measures almost immediately.
The debt deal required that the Greek Parliament pass a new round of deeply austerity measures, including layoffs of government workers, in a climate of growing social unrest. It also calls for permanent foreign monitoring in Greece to ensure that it makes good on its pledges of structural changes to revitalize its economy, a requirement that many Greeks see as an affront to national sovereignty.
An Economy Likened to a Sinking Ship
Mr. Papandreou shocked investors and politicians across Europe when he announced in December 2009 that his predecessor had disguised the size of the country’s ballooning deficit. After rounds of deep budget cuts and months of vague pledges of support from the rest of Europe failed to stop the steady rise of the interest rates, Mr. Papandreou in April 2010 formally requested a promised $60 billion aid package, calling his country’s economy “a sinking ship.’’
But global investors, who had seen Greece’s bonds downgraded to junk status, were not reassured, forcing the I.M.F. and Greece’s European partners to hastily prepare a far larger package, worth €110 billion — about $140 billion at the time, and half of Greece’s gross domestic product. Mr. Papandreou, the scion of a Socialist dynasty whose father helped erect the sprawling Greek welfare state when he was prime minister in the 1980s, in return pushed through cost-cutting measures, which included freezing public-sector salaries, raising taxes and slashing pensions.
But almost a year after the bailout, the Greek economy continued to sag under €340 billion in debt, as the austerity package sent the economy far deeper into recession. Greece’s economy shrank 6.6 percent in 2010, compared with a 1.9 percent decline in 2009.
And though the cuts were meant to ease the fiscal crisis, the economic slowdown raised Greece’s deficit to 10.5 percent of gross domestic product in 2010, exceeding the 9.6 percent target set by the government, while public debt swelled to 142.8 percent of G.D.P.
As speculation rose about a possible restructuring of Greece’s debt, European officials in late May 2011 prepared another bailout package,which would offer billions of euros in new loans in return for accelerated privatization and tougher tax collection measures. The agreement for as much as €60 billion ($86 billion) would in theory address Greece’s need for cash in 2011 and put off for the time being a restructuring, hard or soft, of Greece’s huge debt burden.
Greece and Germany pushed a proposal for “reprofiling,” which would have investors exchange their shorter-term Greek debt for longer-term paper, which was strongly resisted by the European Central Bank.
Origins of the Debt Crisis
The roots of the crisis go back to the strong euro and rock-bottom interest rates that prevailed for much of the past decade. Greece took advantage of this easy money to drive up borrowing by the country’s consumers and its government, which built up $400 billion in debt. When the global economy crumpled, those chickens came home to roost.
The crisis was set off in late 2009 when the Greek government admitted that its deficit would be 12.7 percent of its gross domestic product, not the 3.7 percent the previous government had forecast earlier. Investors were stunned. In early 2010, fears over a potential default grew into a full-fledged financial panic, as investors questioned whether Greece’s Socialist government could push through the tough measures it had promised to reduce its budget deficit. As the fear spread to Portugal and Spain, leaders of Europe’s more affluent countries like Germany and France, worried about lasting damage to the euro, stepped in with a pledge to defend the currency but stopped short of an outright bailout for Greece.
As part of an austerity plan, the Greek government in early March 2010 approved a round of tax increases and pay cuts for public employees. The steps were met with a series of angry but peaceful protests by civil servants and others that seemed to suggest a limit to the extent to which the country could cut its way out of the crisis.
After months of fractious debate, in late March the countries that use the euro agreed on a financial safety net for Greece, combining bilateral loans from those European nations with cash from the I.M.F. But the vague assurances were not enough by themselves to reassure the bond markets, where investors steadily raised the interest rate on money they were willing to lend Greece. On April 11, European leaders announced that they would make $30 billion available to Athens, along with up to $15 billion from the I.M.F., in the form of loans with an interest rate of 5 percent — lower than the 7.5 percent Greece had been paying, but high enough that German officials could insist that it did not constitute a subsidy or bailout.
But the markets remained skeptical, and investors pushed interest rates on Greek bonds above those of emerging countries like India and the Philippines, leading to talk of a potential default.
Tensions in the Euro Zone
For Greece — and for Spain, Italy, Ireland and Portugal — the financial crisis has highlighted the constraints of euro membership. Unable to devalue their currencies to regain competitiveness, and forced by E.U. fiscal agreements to control spending, they are facing austerity measures just when their economies need extra spending. Other economies like Germany, the Netherlands and Austria have kept deficits down while retaining an edge in global markets by restraining domestic wage increases. France lies somewhere between the two camps.
The chief difficulty in working out a package to support Greece was the popular sentiment in Germany — deeply concerned about becoming the answer to the debt problems of all of Europe’s endangered economies — that Greece should pay a penalty for its former profligacy.
Since the euro’s inception in 1999, no member had sought support from the I.M.F., which typically comes to the rescue of emerging-market economies rather than developed countries. Beside unsettling the markets, Greece’s troubles have undermined the common currency it and 15 and other European nations share.
Meanwhile, questions were widely raised about the role played by banks, including Goldman Sachs, in constructing elaborate financial deals that helped the previous government hide the extent of its deficit.
Faced with the prospect of economic contagion spreading to the wobbly economies of Spain and Portugal — and the potentially devastating effect of a Greek default on French and German banks, which hold billions in Greek debt — the I.M.F. and the euro zone countries quickly worked out the larger aid package. In return for assistance in meeting debt deadlines over the next three years, Greece agreed to austerity measures that are likely to cut its budget deficit sharply — and may well produce a new round of recession.
The finance minister, George Papaconstantinou, said Greece had agreed to raise its value-added tax to 23 percent from 21 percent, to freeze civil servants’ wages and to eliminate public sector annual bonuses amounting to two months’ pay. In addition, members of parliament would no longer receive bonuses. He said special rules allowing for early retirement of civil servants would be tightened and the government intended to increase taxes on fuel, tobacco and alcohol by about 10 percent.
New Bailout and Protests
At the heart of the second bailout in 2011 is an informal understanding that the private sector holders of Greek government bonds might be persuaded to roll over their debts, or extend new loans when their older obligations come due.
By taking on more dubious Greek risk — backed by new money from Europe and the I.M.F. — exposed banks would not just step back from the precipice of a “haircut,” or a forced loss on their bonds, they might also hope that in another two years Greece will be in a better position to repay its debts in full.
The European Union first and then the I.M.F. would approve the additional financing, thus clearing the way for €12.5 billion to be disbursed to Athens at the end of the month.
The new loans, however, will be forthcoming only if more austerity measures are introduced. Along with faster progress on privatization, Europe and the fund have been demanding that Greece finally begin cutting public sector jobs and closing down unprofitable entities.
They also have been pressing Greek politicians to unite behind the new austerity package to help ensure it sticks, and are discussing a decrease in the value-added tax as a concession to win support from the right-of-center opposition, which wants more tax relief to help the moribund economy.
Adding to the urgency has been the persistent flow of deposits out of the banking sector. Since the crisis began, €60 billion in deposits have been withdrawn from Greek banks, about a quarter of the country’s output. Bankers in Athens said that outflows were particularly severe after comments — later described as rhetorical — by a Greek politician about the possibility that Greece could stop using the euro.
With great reluctance, European governments came to the conclusion that an additional €60 billion, while politically unappealing, would be less costly than the unquantifiable public money that would be needed if a restructuring of Greece’s debt produced a contagion that spread not just to Portugal and Ireland but possibly Spain and the financial system as a whole.
Another crucial point is the extent to which “reform fatigue” in Greece might prevent the ambitious deficit-cutting targets from being reached.
In fact, the dynamic of protesters changed drastically in May 2011. No longer was it just union leaders condemning the government’s policies, but a broader collection of people, mostly young, who have been inspired by a protest movement in Spain.
In October, tens of thousands of protesters massed outside Parliament when a new round of austerity measures squeaked through.