Thursday, July 21, European leaders were to once again
meet at a summit called to resolve the Greek debt
crisis with a new Euro 115 billion bail-out plan.
This meeting had an element of urgency about it, since
failure to arrive at an agreement could result in
a crisis that goes beyond Greece and engulf Europe
as a whole. This is not just because a collapse of
talks with respect to Greece can lead to contagion
that precipitates new crises in other weak links in
the European chain such as Portugal and Ireland. It
is also because there are clear signs that the disorder
afflicting Greece is now having repercussions in Italy
and Spain, the third and fourth largest economies
in the eurozone, and in large economies outside the
zone such as the United Kingdom.
Just before the July summit, the yields on government
bonds issued by Italy and Spain rose sharply to their
highest levels since the launch of the Euro and the
share values of banks headquartered in these countries
fell significantly. These were clear signals that
fears of the crisis spreading beyond Greece had gripped
financial circles. Yet, it is not just the spread
that defines the magnitude of the problem. Rather,
it is the fact, revealed far more clearly than during
the 2008 financial crisis, that the crisis goes deeper
than recognised at first sight.
One feature of the Greek debt crisis is that the accumulation
of public debt that defines it was not largely the
result of a banking bail-out. Debt was not incurred
to rescue banks on the brink of failure, because they
had lent to households and created and invested in
toxic financial assets. Rather public debt ballooned
because it was used to finance expenditures needed
to keep the Greek economy going.
When the Euro was launched and the eurozone with a
single market and currency was formed and then expanded,
a feature that was inadequately thought through was
that the group consisted of members at differing levels
of development and with different degrees of competitiveness.
The more advanced countries were likely to cater to
the larger European market and be quite successful
in this effort. They had the advantage of higher productivity.
They were not overly disadvantaged by much higher
labour costs, since they had access to the unemployed
and underemployed labour force of the union as a whole.
And their competitiveness could not be bruised by
the devaluation of the currencies of the less developed
European nations since they had adopted the Euro as
If the less developed nations could not find themselves
a niche in which they could compete, the only way
they could keep income and employment growing is through
large public expenditures and a complementary expansion
of the non-tradables sector, especially services.
There remained the question of how these public expenditures
were to be financed. Moreover, governments also needed
to finance the welfare expenditures that were in any
case historically significant in European countries,
and were rising because of the aspirations generated
by the possibility of a common European standard.
In the circumstances, in what was clearly a partly
visible and partly concealed violation of the Maastricht
criteria, the Greek government had resorted to excess
borrowing to promote growth and finance minimal welfare
expenditures by European standards. Embedded in the
Maastricht criteria was the notion that governments
would not resort to excessive deficit-financed spending
to create jobs, expand output and sustain welfare.
In return for that discipline, the governments in
the less-developed European countries were promised
compensation through transfers in the form of structural
funds for development, and their populations the right
to migrate to other countries in Europe for a better
The problem was that being independent and democratic
nations, governments in each country needed to keep
an eye on the electorate and adopt programmes and
policies that could win them elections. Given the
circumstances created by their entry into the eurozone,
this might have required enhanced deficit spending
The resulting ''error'' was not purely that of governments.
Banks within Greece and elsewhere in Europe were obviously
willing to lend to the Greek government, presumably
on the grounds that this was sovereign debt of a ''developed''
country, on which default was unlikely, and returns
reasonable. Many factors contributed to the perception
that lending to European governments involved low
risk. The risk of income or capital loss due to default
was seemingly low, since the debt involved was public
debt with a sovereign guarantee. Even any residual
risk of sovereign default was seen as negligible,
since such default by any one country threatens the
euroís stability. The risk of loss due to a collapse
of the exchange rate also appeared minimal because
of the many governments and central banks interested
in a stable or strong euro.
In the event, banks, seeing an opportunity for lending
at low risk for reasonable return, ''over-lent'' to
governments like Greece, not merely ignoring evidence
that the Maastricht criteria were being flouted, but
that the level of debt was rising rapidly. This is
not to say that all affected countries in Europe had
followed the same route to a potential public debt
crisis. There were others, like Ireland for example,
where the problem was in the first instance not excessive
public borrowing but excess private debt encouraged
by a credit-happy banking system. When the danger
of simultaneous default by a large number of private
borrowers and consequent bank failure was revealed,
the government had to step in to bail out the banks
by taking over their non-performing credit assets.
This resulted in the large scale substitution of private
with public debt that could be easily ensured because
of the perception of low risk. In due course, this
led up to debt levels that provided the basis for
a potential default on sovereign debt.
But the Greek case is particularly telling. Inasmuch
as the current crisis has its roots in the processes
described above, it is a crisis that challenges the
very possibility of coordination of the kind required
for the sustenance of the eurozone in a world of mobile
The fact that the whole of Europe is under siege is
coming through in news from the banking sector. Greek
banks are the most exposed to Greek debt and therefore
the most fragile. They are substantially dependent
on funding from the European Central Bank (ECB) to
keep their operations going. Such funding is provided
against collateral, which consists largely of government
bonds. If the government defaults on its debt, the
value of those bonds would turn suspect, and the flow
of funds from the ECB to the Greek banking system
would under normal circumstances freeze. Thus the
bail-out for Greece is almost directly a bail-out
of the Greek banking system as well.
But the problem does not stop with the Greek banks.
As noted earlier, bank share values in countries such
as Italy, Spain and even England are falling sharply.
This is despite the fact that in the ''stress tests''
conducted recently by the European Banking Authority,
only a few banks were found to be in difficulty and
most passed the text. This was because, while focusing
on the adequacy of capital with these banks to deal
with non-performing assets, the danger of large scale
sovereign default was not factored in. But those looking
at the exposure of these banks to default-prone sovereign
assets find it to be high. In the event the market
has discounted the EBAís test and dumped banking shares.
Thus, if the Greek crisis is not resolved quickly
it is bound to spread elsewhere, beyond Ireland and
Portugal, touching some of the largest eurozone economies
and even the United Kingdom. Yet there is little confidence
that a satisfactory solution will emerge soon. The
immediate reason is the stance adopted by Finance.
When a little more than a year ago an agreement on
the first Greek bailout was arrived at, the banks
that had ''over-lent'' but had been saved from potential
failure by the prevention of default did not contribute
to the solution. The IMF put in its bit. So did squabbling
European governments and tax payers. And they did
so in return for a massive austerity package that
spelt loss of jobs and benefits for large sections
of the Greek population. But the banks went scot free
and even chose to hike the interest rates they charged
for any new credit they provided.
As a result of all this, more than a year later, the
Greek crisis remains unresolved. Recession induced
austerity is limiting the revenue generation needed
to repay debt. And the debt gets larger because of
higher interest rates. In search of another dose of
support, the Greek government has adopted a new set
of austerity measures. But a solution remained elusive
even as leaders prepared for their mid-July summit.
The basic problem is that the banks and financial
institutions are unwilling to pay a price to resolve
a problem that they created through the speculative
lending that helped inflate sovereign debt in Europe.
They have their way because they exercise immense
economic and political power, aided by the ECB that
has disagreed with any plan that smacks of a write-off
of a part of debt owed to the banks, or even a restructuring
that replaces old with new debt with extended maturities
and lower interest rates.
The rating agencies discredited during the crisis
have also contributed to the mess and served the interests
of the banks that create the credit assets they rate
for a fee. As if to re-establish their credibility,
these agencies are routinely downgrading debt across
Europe and elsewhere, pushing up interest rates in
the bargain. They have also threatened to declare
full or ''selective'' default on Greek public debt if
banks are required to accept even a small ''hair-cut''
or a restructuring that reduces the value of their
credit assets. If default is declared banks would
have to provide for the losses involved and could
find themselves cash-strapped and even insolvent.
Fear of the ripple effects that this may have restrains
governments and central banks.
This has angered the German and Dutch governments
who are upset that they are called upon to contribute
to the resolution of the regionís problem, while the
banks that were an important part of the problem take
home the benefits of resolution. These and other European
governments are also faced with the strengthening
of a new parochialism in Europe, with the citizens
of the more developed nations resenting being asked
to save the ''profligate'' citizens of countries burdened
All these elements together delay the agreement needed
to save the Euro on the one hand and prevent another
crisis of the kind experienced in 2008. Finance capital
was responsible then and is responsible now. Unless
the interests of finance are subordinated to the interests
of the real economy and that of ordinary citizens,
the future does look bleak.