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A year into the crisis and after driving up the bailout costs of taxpayers horrendously, Berlin has won the bail-in of the private sector that it needed in order to calm voters. Whether this will save Greece and monetary union remains uncertain.
Why did it take so long? Last spring, as Greece’s problems began to mount, Deutsche Bank CEO, Josef Ackermann, who chairs the Institute of International Finance, offered to put together a €30 billion bridge loan on a public-private partnership basis. He and other bankers wanted to secure Greece’s external liquidity needs for a year. But the proposal was rejected by German Chancellor, Angela Merkel, other EU leaders, and the EU Commission. Ackermann’s motive behind his proposals... was to give eurozone governments enough breathing room to establish something of a European Monetary Fund to cope with Greece and other highly indebted eurozone members in the periphery.
Merkel has stuck to a short-term, politically lowcost strategy, trying to maintain or gain political power while making a minimum of political enemies. After all, she is a “power frau”, and indeed for many years her approach has been quite successful. In the effort to involve the private sector, Germany, as the financially strongest member of the eurozone, has been supported by other creditor countries such as the Netherlands, Austria, and Finland. This “northern” creditor bloc, however, has been facing increasing opposition the farther south one looks.
With the crisis reaching a breaking point, certain questions arise. What did the German effort to push for burden-sharing so far achieve? What have been the consequences for market and risk premiums, and the impact on total bailout costs for taxpayers in creditor countries?
When Berlin insiders talk of an “endgame” in the context of how Merkel, Finance Minister Wolfgang Schäuble, and co have responded to the eurozone debt, they could summarise the zigzagging journey under the heading: “How a strategy of minimal political costs since February of last year led to self-entrapment, leaving Berlin policymakers with only extremely costly options”. When asked in one of the recent traditional summer interviews about her plans for resolving the escalating crisis, Merkel answered that she “only does what is necessary”. This explains why she avoided from the beginning investing too much of her own political capital, but instead looked for opportunities to maintain and strengthen her domestic political power.
After Merkel and Schäuble failed dismally last year to “bail-in” the private sector, Schäuble didn’t get far this year at first with enticing banks and insurance companies to contribute to the second Greek rescue package by rolling over maturing Greek bonds on a “voluntary” basis. As top euro crisis fighter, Schäuble got a lot of media attention with his bond rollover proposals. For months he insisted that any new aid package for debt-stricken Greece must involve banks and other investors. He hoped, by getting banks, insurance companies, and investment funds to roll over Greek bonds with long maturities, to raise about €30 billion for a second Greek bailout, which could be in the range of €120 billion.
In announcing his plan, he met with fierce resistance from many eurozone countries, but also opposition from the European Central Bank and the Bundesbank, as well as warnings from the rating agencies. The ECB indicated that even if banks agreed to roll over maturing Greek bonds on a voluntary basis, this could lead the rating agencies to judge this a “credit event” with the consequence that the ECB would cease to provide liquidity to Greek banks. When the rating agency Fitch downgraded Greek debt to one step above default status, they listed “the lack of certainty on a second aid package for Greece” as a reason. “Schäuble is backing down”, read the headline in the July 14 issue of Handelsblatt, Germany’s economic and financial daily, as it looked like private creditors wouldn’t contribute to the new aid package for Greece—a big defeat for Germany.
Merkel and Schäuble now have only extremely costly options left. Merkel will have to tell German voters that in order to save the monetary union, she will need further billions in German guarantee pledges, credit enhancements, and euro infusions, thereby committing ever-larger portions of German tax revenues for years to come. So far, Germany’s political elite has not been able to calm the public’s worries about the stability of their money and the future cohesion of monetary union. Months of bickering between the German government and the European Central Bank over possible bond rescheduling and bond rollovers hasn’t helped, either. EU coordination and crisis management has been so bad that some consider it a systemic risk. Ultimately, Europe as a whole faces a leadership crisis.
German angst about the euro
The spectre of German taxpayers footing the bill for ever-more bailout billions for Greece and other highly indebted eurozone countries is haunting important segments of the German electorate. Even within Merkel’s governing coalition, some Bundestag members have been very critical of any new bailout schemes. Simple calculations by leading economists in the endless debates about the crisis have been sinking in. The head of the Munich IFO Institute, Hans-Werner Sinn, argues that since 2008, Greece has been financing public and private consumption that is 17 per cent greater than what it generates in goods and services, simply through more debt or money from the printing presses. German and EU leaders confront the simple choice of whether to use taxpayer money and capital to allow the Greeks to continue like this.
The threat of Germany sliding further into a “transfer union” has undermined confidence, especially in the conservative and liberal parties that form the ruling coalition government under Merkel. The recent hearing of the complainants against the bailouts before the German Constitutional Court in Karlsruhe demonstrated how much the Berlin government is acting within considerable constraints. The Merkel government is under close observation by the constitutional judges.
Berlin on a collision course with ECB
And then there has been the nerve-wrecking public war between Merkel and Schäuble on one side and Jean-Claude Trichet, the outgoing president of the European Central Bank, on the other. The conflict started after Merkel and French President Nicolas Sarkozy took their historic walk in October of last year and decided to set up what became the ESM in order to force the private sector to share some of the rescue burdens in sovereign eurozone insolvencies by taking haircuts, extending maturities, or lowering interest rates.
Ever since the EU summit in May 2010, where he presented European leaders with a horror scenario of ever-greater speculative waves against highly indebted and fiscally weaker eurozone countries, Trichet remained stubbornly against rescheduling and haircuts on sovereign eurozone debt instruments. No wonder that Trichet’s designated successor, the Bank of Italy’s Mario Draghi, sided with Trichet and supported the ECB position against letting Greek bonds be subject to rollovers and thus risking a selective default verdict by the rating agencies. Jens Weidmann, the long-time chief economic advisor to Chancellor Merkel who took over the presidency of the Bundesbank recently from Axel Weber, came out strongly in support of Trichet and the ECB Council against debt rescheduling for eurozone members. Weidmann has also rejected the issuance of eurobonds. Such a move would have far-reaching consequences, since German taxpayers would then be liable for the whole of Greek debt.
The ECB resisted even accepting as collateral Greek bank bonds, in case such bonds were subject to “voluntary roll-overs” by the banks in the context of private-sector burden-sharing. For months, however, against strong resistance, particularly from the rating agencies, Schäuble continued to insist that any new aid package for debt-stricken Greece must involve banks and other private investors. When this chapter is written for the history books, perhaps titled, “How the European Monetary Union Broke Up”, the record will show that Trichet did not shy away from risking open conflict with Sarkozy and Merkel in defence of the independence of the ECB. And this open conflict might be seen as a defining moment for the monetary stability of the eurozone.
Eurozone crisis management: A source of systemic risk
No wonder that EU policymakers—in particular the so-called “Eurogroup” of eurozone finance ministers (where German Finance Minister Schäuble plays a key role)—have come under attack from many sides for the lack of leadership in Europe. Recently they got what The Economist called “a stern wigging” from George Papandreou, the Greek prime minister. Drawing attention to the fact that his country had done its part by pushing through extremely painful economic reforms, he condemned the “indecisiveness and errors” of the European response to the crisis, noting that “a cacophony of voices and views” had prevailed, “creating more panic than security”.
The IMF, a key aid provider in the eurozone rescue operations, was highly critical of EU leaders who couldn’t get their act together. Almost totally ignored by the European media and political class, the IMF staff’s “Concluding Statement of the IMF Mission on Euro-Area Policies” under the 2011 Article IV consultation discussions (posted June 20, 2011) bluntly addressed the dismal failures in eurozone crisis management, hitting hard at the major culprits—the Germans with Merkel and Schäuble, who played hardball when it came to providing ever-more bailout billions for highly indebted euro member countries suffering under ever-higher risk premiums pushing up interest rate costs and strangling economic growth and employment.
By pushing through her long-standing demand for the finance industry to share some of the Greek rescue burden and by giving up Germany’s strong objections to widening the lending activities of the EFSF, Merkel has at last faced market realities. After nearly wrecking monetary union by sitting things out, she now can claim a sort of victory at home and on the European stage, even though the introduction of the private sector into the Greek rescue means the first default of a eurozone member country.
Berlin’s agreement to widen the range of instruments of the European bailout fund might yet set the EFSF on the road to evolving into a sort of European Monetary Fund with conditional lending and bank rescue capabilities. Facing an electorate that fears that Germany in its role as Europe’s paymaster is overextending itself by rescuing Greece and the eurozone periphery, Merkel will argue that in Brussels she at least avoided a full-fledged plan for issuing eurobonds to save monetary union.