It all sounded great except for one little problem: the three numbers (S,G and T) were calculated backwards, starting from what was needed in 2022 to repay Greece’s debt (in terms of cumulative surplus S) and ending up with the growth rate G that should come into play at the beginning – from 2015. But the announcement that the government would be taxing business and families to the tune of T (the extraordinary sum necessary to generate S) was enough to stop business investing and families consuming in 2015. Put simply, the T and S numbers necessary to make the programme work, to make the ‘numbers add up’ (as IMF officials always say), were not just inconsistent but fundamentally at odds with the growth rate G that was necessary to bring them about.
Despite its spectacular predictive blunder Greece proved a nice little earner for the IMF. By the time I resigned, the bankrupt state had paid over €3.5 billion in interest and fees to the IMF, averaging 37 per cent of IMF total net income, and covering 79 per cent of its total internal expenses. Ever since Greece entered debtors’ prison, the IMF has had an average operating profit of 63 per cent, much larger than that of Goldman Sachs or J.P. Morgan. And where have the IMF’s profits come from? Europe’s taxpayers, of course. In a sense, Brussels- and Berlin-based officials who look discomfited every time the IMF calls upon them to grant Athens debt relief do have a point: the International Monetary Fund wants Greece’s European creditors, who have provided the IMF with immense profits, to haircut the country’s debt to them but not to itself. And thus Greece is caught between the IMF, which correctly proposes debt relief despite having profited from Greece’s being denied it, and the EU, which has used the IMF to deny Greece debt relief.
Appendix 3: Why I had ruled out bluffing
One of the courses I taught during 2012–14 at the Lyndon B. Johnson School of Public Affairs of the University of Texas was on Europe’s financial and economic crisis. As part of the course, I devised a game to demonstrate to students how simple game-theory analysis can elucidate a complex strategic interaction. The following is copied from my notes to students.
The day after a Syriza government wins office on a mandate to challenge the logic of the bailout agreement keeping Greece in a permanent state of disrepair, the official creditors of the EU and the IMF (let’s call them the troika) will face a choice:
The troika’s first choice
1. Be accommodating to the new government, leading to a viable agreement (Outcome 1). (Game over)
2. Adopt an aggressive stance towards the new government, including fomenting a bank run, preparing bank closures and threatening Greece with Grexit if Syriza do not sign up to their fresh bailout. (Syriza’s turn to move)
In the case of 2 above, Syriza has two options:
Syriza’s choice
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:
