Why Greece May Be the New Lehman

Here we go again. This time it’s Europe’s fault, and the crisis could be worse than last time, at least politically.

By BILL EMMOTT

April 22, 2015

POLITICO

Remember when in 2008 Hank Paulson’s U.S. Treasury Department decided to let Lehman Brothers go down, pour encourager les autres, and then found that it brought les autres crashing down too? Well, Germany and the other euro-zone members are now trying to repeat that brilliant trick with Greece. If you were looking for where the next big financial meltdown might begin, you need look no further. Chances are, it is about to happen in Europe.

If it does, the political consequences could be even worse than last time. Strangely enough, the political risks are easier to evaluate than the economic ones. The risk of a Greek default or exit from the euro begin in Greece: If the left-wing party that runs the new government, Syriza, is discredited, following the discrediting of the old establishment parties, this risks strengthening the fascist alternative, Golden Dawn.

Then, the political risk moves rapidly to France, which is the scariest country in Europe right now. Already, the 25 percent share of the opinion polls held by the anti-immigrant, anti-EU Front National party of Marine le Pen is scary. But imagine what a new political and economic crisis in Europe might do for Ms. le Pen: her chances of becoming France’s president in 2017 would jump from remote to conceivable.

Another risk is that Europe’s banking system remains fragile, not cleaned up and reinforced in the way America’s banking system has been since 2008. As long as the European Central Bank stands ready and able to print money in order to provide the banking system with liquidity this should remain true. But what if that were to be blocked? Which it might be, if German politics react badly and severely to a Greek default.

Then, we could be in a repeat of 1931, when the collapse of a European bank, CreditAnstalt of Vienna, brought about a sudden worsening of the depression that was taking hold in America and Europe. We are all connected now.

This isn’t the way things looked, quite recently. Back in January, when Greek voters elected Syriza on a mandate to get a better deal from its euro-zone partners and the International Monetary Fund over its vast public debts, the favored metaphor of most commentators was the game of chicken.

Greece’s photogenic prime minister, Alexis Tsipras, and especially its economics professor-turned-sex-symbol finance minister Yanis Varoufakis talked tough, and their German counterparts Angela Merkel and Wolfgang Schaueble talked tough in return. But everyone assumed that in the end there would be a compromise and not a car crash.

The euro would survive. Greece would not default, would pretend to continue to repay its public debts (now 170 percent of GDP, a colossal level), and would be stealthily given some economic life support. This would buy time for the Greek economy to start growing more rapidly, convincing the Greek public to accept reforms such as privatization.

That acceleration in growth would convince the German public that a country they previously saw as lazy good-for-nothings was willing to play by the rules. A little money would be provided to ease Greece’s transition from slothful parasite to competitive modern nation. Everyone would live happily ever after.

It was a comforting fiction. But now, three months later, reality is about to reassert itself. The car crash is looking the much likelier outcome. And the scary thing is that both sets of drivers appear as if they might even want it.

Which means that they are both assuming that the political and economic consequences of Greece either defaulting on its sovereign debts, or leaving the euro, or both, would be bearable and even worth bearing.

It would be nice if this pessimistic analysis were to be proved wrong, and that a compromise were about to be unveiled. The reason why that at present looks unlikely is not just that there is no sign of it happening: such is always the nature of bargaining, at any level. No, the reason for pessimism about a compromise is that as time has gone on, the two sides appear to have found themselves with less room for manoeuver, not more. They both look trapped.

Greece, after all, has undergone an extraordinary economic and political shock since the global financial crisis struck in 2008. Its clientelistic, extravagant political culture, which had been no secret, hit a wall: it ran out of money. The result was a slump in GDP of more than a quarter, a jump in unemployment to nearly 30 percent of the workforce (roughly, U.S. Great Depression levels), and a huge budgetary contraction. The question for the new Syriza government has been: what more could we do?

Well, that isn’t quite the question Mr. Tsipras asked, during January’s election. It was, how long can we put up with this pain? And the answer was: no longer, please, but we’d like to stay in the euro, because although leaving might help us, the risks of doing so are more than we want to bear. Thanks for thinking of our welfare, but we’d rather not risk even more instability and pain than we’ve already had to bear.

So the task of the new Syriza government was essentially impossible. It was to keep Greece in the euro, but with no further painful spending cuts and wage cuts. Voters had said they wouldn’t tolerate any more. They wanted to stay in the euro, but to find some hope. Syriza offered to give them that hope.

Then they hit the wall, which was built by the euro-zone’s creditor nations, led by Germany: no concessions could be given. Why not? Because domestic public opinion would not allow it, because German voters did not trust Greek governments’ promises any longer. Give us a clear and detailed plan for growth-boosting reforms, said the creditors, and then we can talk, but otherwise you have to stick to your existing commitments.

That is where the trap was sprung. Syriza knew that for domestic electoral reasons they had to find ways to ease their voters’ pain through more public spending. Germany knew that trust in Greeks among German voters was almost non-existent, and trust in left-wing Greeks would be even lower.

In negotiations, time generally helps. It eases pressures and softens tough positions. That has not however been the case with Greece and the euro. The political uncertainty prompted by Syriza’s election in January brought to an end the mild economic recovery that might otherwise have eased Greece’s situation.

Instead, since January Greece’s already parlous situation has just got worse: deposits have been withdrawn from Greek banks, GDP growth has ceased, public debt has become even larger, and in the short term, the funds needed to make immediate repayments have virtually run out. So time is being lost, not gained. Which has hardened Greece’s position because it has deprived the Syriza government of room either to wriggle or to learn.

So here we are, drifting towards the point when Greece’s government runs out of money. One of the advantages about being a government is that a lot of resources can be seized in the short term to meet immediate payment demands, which is why it is hard to know exactly when Greece will really run out of money. But every short-term fix to grab resources makes it clearer to Messrs Tsipras and Varoufakis that they are making life for themselves harder in the future.

Thus, on the Greek side, the temptation is rising simply to default on debts and end the need for repayments. With Greek banks stripped already of their deposits, it probably looks as if the immediate dangers of a debt default or even exit from the euro look manageable, when compared with the political dangers of giving in the German demands.

On Germany’s side, a rather similar logic is gaining hold. Greece accounts for only 2 percent of the GDP of the eurozone. So its loss would not matter much. Most of Greece’s debt is now held by the European Central Bank or other public institutions, so a default would do little harm to private banks. Meanwhile, the European Central Bank’s promise to “do whatever it takes” to defend the euro means that the contagion of a Greek default or Grexit on Italian, Spanish, Portuguese or Irish government debt markets could be contained. The resources are now there to protect the European banking system.

Perhaps these views might prove correct. Greece might be able to default or leave the euro without an economic collapse. A rapid economic recovery, following a currency devaluation, might avert any extreme fascist political reaction. And perhaps the eurozone might be able to shrug off a Greek default or exit, as no doubts would rise up about the future behavior of other large debtor countries such as Portugal, Italy, Spain or even France.

The question is whether “perhaps” is a good basis for policy. Not that a euro that survives this current crisis between Greece and Germany would be in good shape. It would remain a mutant child of European integration, a monetary union that consisted only of a shared currency and shared rules (post-crisis) on fiscal deficits, but without the normal elements of monetary union, which amount to a a sense of collective responsibility for public debts.

We will see, during the next few weeks, whether the Greeks will move to a default or whether the Germans will move towards an acceptance of mutual responsibility for Greece’s debts, and for those of other big sovereign debtors, allied with clear common rules for the management of that debt.

So that’s where we are. In Europe, complacency mixed with domestic political traps is leading European governments towards an outcome which, within a matter of weeks, could bring about a huge global economic and political risk. And they think they have matters under control.

Have we learned nothing since the Lehman shock?

Read more: http://www.politico.com/magazine/story/2015/04/greece-economic-crisis-117228_Page2.html#ixzz3Y7QIlrKc