3. Surrender and accept third bailout (Outcome 2). (Game over)
4. Fight back. (The Troika’s turn to move)
In the case of 4 above, the troika has two options:
The troika’s second choice
5. Acquiesce to a viable agreement (Outcome 3). (Game over)
6. Push Greece out of the eurozone (Outcome 4). (Game over)
How will this confrontation play out? The answer depends on the two sides’ preference orderings. Figure 3 examines what will happen if the two sides are rational in the neoclassical sense of behaving in a manner that satisfies their preferences best, given logically defensible beliefs of what the other side will do, assuming its known preferences.
The following is common knowledge. The troika prefers Outcome 2 to 1 and Outcome 1 to 3 – in symbols {2,1} & {1,3}. In plain words, the troika prefers a Syriza surrender to offering Syriza a fair deal at the outset, but it also prefers offering Syriza a fair deal at the outset to doing so after a fight with Syriza. The Syriza government prefers a quick compromise on a fair deal, Outcome 1, to a fair deal after a fight – {1,3} & {3,2}.
What will determine the outcome hinges on Syriza’s ranking of Grexit (Outcome 4) in relation to surrender (Outcome 2) and the troika’s ranking of Grexit (Outcome 4) in relation to a fair deal once a fight has begun (Outcome 3).
There are four possible cases, depicted in Figure 3 below.
1. Syriza prefers surrender and a third bailout (Outcome 2) to Grexit (Outcome 4), while the troika prefers Grexit to any compromise. In that case the troika will be aggressive, predicting that Syriza will surrender, a prediction that will be confirmed. Thus, Outcome 2.
2. Syriza prefers Grexit (Outcome 4) to surrender (Outcome 2), while the troika also prefers Grexit (Outcome 4) to acquiescing after Syriza has fought (Outcome 3). In this case Grexit is guaranteed, even if both the troika and Syriza prefer a quick fair deal. Thus, Outcome 4.
3. Syriza prefers surrender and a third bailout (Outcome 2) to Grexit (Outcome 4), but the troika too is Grexit-averse, preferring Outcome 3 to Outcome 4. Thus, Outcome 1.
4. Syriza prefers Grexit (Outcome 4) to surrender (Outcome 2), but the troika is Grexit-averse, preferring Outcome 3 to Grexit (Outcome 4). In this case the troika will predict that Syriza will fight if provoked and so settle immediately – opt for Outcome 1 by choosing non-aggression. Thus, Outcome 1.
The above of course presupposes that each side knows the preferences of the other. If they do not, a Grexit-averse troika may test the Syriza government with initial aggression or, equivalently, a Grexit-averse Syriza may test the troika by fighting after the troika’s initial aggression.
Reading these lecture notes years later, after the events narrated in this book, should explain clearly why at the time I ruled out bluffing and instead concentrated all my energies on convincing my colleagues that, unless we feared Grexit less than we feared surrender, there was no point in being elected; indeed, the only way of keeping Greece within the eurozone sustainably was to fear Grexit less than we feared a third bailout.
Figure 3: Outcomes depending on the preference ordering of the troika and Syriza. NB {X,Y} denotes a preference of Outcome X over Outcome Y.
Appendix 4: Options for Greek debt liability management
The debt-restructuring proposal in my non-paper contained three sections corresponding to three different slices of Greece’s public debt and was based on earlier work I had done when still in Austin, with additional input from Lazard.
1. PERPETUAL BONDS IN EXCHANGE FOR THE ECB’S SMP BONDS
Creditors have already mentioned the possibility of lengthening the maturities and reducing the interest bill charged on Greece. This idea should be taken to its logical limit in the case of the SMP bonds that are held by the ECB and which would have been haircut massively had the ECB not purchased them. Our proposal is that this slice of Greece’s debt, which presently comes to €27 billion, should be swapped for a new perpetual bond, so as to avoid any amortization. The proposed swap of the SMP bonds for a new perpetual bond will not reduce the nominal debt, but this is a secondary issue compared to the benefits of foregoing amortization.
2. GDP-INDEXED BONDS TO BE SWAPPED FOR THE FIRST GREEK LOAN DEBT
The outstanding first Greek programme debt (also known as the Greek loan facility) can be swapped against GDP indexed bonds and/or asset-backed securities. That way, Greece could share with its official creditors the benefits of the recovery. As pointed out in a note by the German institute DWI, the merit of GDP-indexed bonds is to introduce counter-cyclicality by linking the debt service to the country growth performance. However, given the high level of interest concessionality already granted on the debt, the indexation could rather focus on the amount of principal debt redemption. Asset-backed securities could also be swapped in exchange for the EFSF debt. In the specific case of banks shares currently held by the EFSF’s Greek branch, Greece could swap these assets for EFSF bonds, thus benefiting from the new capacity granted to the European Stability Mechanism directly to hold banking assets.
3. SPLITTING THE SECOND GREEK LOAN EFSF DEBT INTO TWO PARTS
The outstanding second Greek programme debt to the EFSF can also be swapped for GDP-indexed bonds and/or asset-backed securities. Additionally, a splitting operation could help too: Greece’s debt obligations vis-à-vis the EFSF into two instruments; half of it turning into a 5 per cent interest-bearing instrument, and the other half into a series of non-interest-bearing instruments (zero coupon bonds), repaying the other 50 per cent principal at maturity. This idea follows the comment made by Klaus Regling, European Stability Mechanism director general, in 2013 stating that the true economic burden of the debt is not correctly captured by the DSA analyses undertaken by the IMF. The debt parameters are as important to assess debt sustainability as the debt nominal level itself: EFSF loans are very long term, with very concessional interest rate reduced to EFSF funding cost. The merit of making explicit the concessionality of the debt is to allow for a wider range of options. The liability management exercise would then focus on the non-interest-bearing asset. In the simpler option the creditors could cancel the part that carries no coupon. In real economic terms they would lose little, only the market value of the non-interest-bearing bonds, and would still cash the amount of interest originally due. However, the impact of debt cancellation of half of the EFSF’s claim would have direct negative consequences on the EFSF itself and, subsequently, on member states’ fiscal accounts. One key objective of the forthcoming discussion with European creditors, and possibly the ECB, could be to structure a mechanism that would bring to Greece the benefits of debt cancellation while spreading over time, in a phased fashion, the direct financial impact on creditors’ public accounts. In another option, Greece could offer to swap the non-interest-bearing asset against other instruments such as asset-backed securities or the GDP-indexed bond previously mentioned. In a third option, the government could directly sell some of its assets to extinguish at market price the non-interest-bearing instrument held by the EFSF. The EFSF could then use these resources to purchase in the market zero-coupon instruments to match its balance sheet. The debt owed by Greece would be nominally reduced by half in such a scheme.
Notes
Chapter 1: Introduction
1. A few months after I had resigned the ministry, my good friend and academic colleague Tony Aspromourgos, upon hearing about my exchanges with Larry Summers, confirmed my suspicion when he sent me this quotation from Senator Elizabeth Warren, documented in 2014:
Late in the evening, Larry leaned back in his chair and offered me some advice … He teed it up this way: I had a choice. I could be an insider or I could be an outsider. Outsiders can say whatever they want. But people on the inside don’t listen to them. Insiders, however, get lots of access and a chance to push their ideas. People – powerful people – listen to what they have to say. But insiders also understand one unbreakable rule: they don’t criticize other insiders. I had been warned.
John Cassidy (2014), ‘Elizabeth Warren’s Moment’, New York Review of Books, Vol. 61 (no. 9), 22/5–4/6/14, pp. 4–8.
2. Quotations from catalogue entry for Danae Stratou’s 2012 exhibition It is time to open the black boxes!
Chapter 2: Bailoutistan
1. One-third of the €110 billion came from the IMF, which means from the taxpayers of the IMF’s member states, which is more or less the whole world. The remainder came from the EU’s taxpayers.
2. ‘Programme’ is shorthand for the troika’s enforced measures of fiscal consolidation and reform – the so-called conditionalities of the bailout loan – whose purpose was the recovery of Greece’s economy and its government’s capacity to borrow from private investors. In reality, it meant cutting wages and benefits savagely, raising taxes and selling off the family silver on behalf of the creditors. Note also Lagarde’s use of ‘they’ instead of ‘we’. This reflects the fact that the IMF has consistently disagreed with important aspects of the conditions placed upon Greece by the European members of the troika. Still, these disagreements never triggered the IMF’s veto. In the final analysis, after IMF officials expressed their reservations, even their apologies to Greece, the IMF consistently backed the European powers’ absurd decisions.
3. Greek government bonds were trading at 19 per cent of their face value, meaning that German banks wanting to offload Greek debt by selling it to investors would have to take an 81 per cent loss.
5. These numbers reflect the fact that Germany represented around 27 per cent of the eurozone’s total income, France’s around 20 per cent, and so on.
6. The IMF was in a slightly different position, in that Christine Lagarde felt immense pressure from non-European members of the fund to retrieve every penny loaned to Athens. These members, such as Brazil, were immensely annoyed with the European leadership of the IMF for having embroiled them in a melee that was none of their business, through bending the IMF’s sacred rule and jeopardizing their money.
7. This is a statement that Mrs Thatcher made often and in a variety of ways. For example, in an interview for Thames TV (This Week, 5 February 1976) she said ‘… and socialist governments traditionally do make a financial mess. They [socialists] always run out of other people’s money. It’s quite a characteristic of them.’
8. As if that were not enough, for every dollar, pound or euro that Europe’s banks had access to, they had lent, or wagered, a cool forty. Given this so-called leverage ratio of 40:1, a back-of-an-envelope calculation reveals that if a mere 10 per cent of these bets or loans were to go bad, someone would have to pump $2.25 trillion into the banks, or else the ATMs would dry up and the banks’ shutters would come down permanently.
9. One of them in fact was Yannis Dragasakis, who would become deputy prime minister in the Syriza government in which I served as finance minister.
10. To illustrate the point, in 2015 the British Treasury repaid a bond issued during the South Sea Bubble crisis of the 1720s.
11. As late as early 2008 its income mountain was rising at a healthy rate of 5.8 per cent while its debt hole was increasing by a mere 4.4 per cent.
12. The state would frequently borrow from foreign banks and pass the money on to developers to build motorways and the like.
13. From its 5.8 per cent growth a year before it subsided by 4.5 per cent. Meanwhile, the debt hole deepened at a rate of 5.7 per cent, up from 4.4 per cent year on year.
14. It is fun to look at what a fully fledged austerity drive would have done to Britain’s economy. Around 2010 the UK’s public debt came to almost 80 per cent, or four-fifths, of national income. At the same time the UK government’s total expenditure was about half of national income. Now, suppose Chancellor Osborne had given his pro-austerity instincts free rein and gone into a frenzy, slashing government spending by half, a cutback equal to a quarter of national income. Cutting this much government spending would reduce national income by at least a fifth. Suddenly public debt would go from four-fifths to four-quarters, or 100 per cent, of national income, without even counting all the public money that ‘had’ to be given to the City’s bankers. This is why austerity, in times of private-sector consolidation, fails by its own criteria – the consolidation of public debt.
15. Indeed the numbers are telling. During his first two years in the Treasury (2010–12) Osborne actually increased government expenditure by 6.9 per cent. In this sense no actual austerity was practised by the Cameron–Osborne government at all. Austerity was utilized by them as a cover for a substantial redistribution of spending and tax cuts that favoured the rich and disadvantaged the poor. In simple terms, the top 20 per cent benefited greatly while the bottom 20 per cent suffered even more.
