James Meadway looks at the deepening crisis for the European ruling elite.
This was all supposed to be over last Thursday morning. With markets rebounding joyfully at news of a rescue deal, the euro crisis had finally been contained.
In the space of barely more than a weekend, that has unravelled entirely. The call for a referendum on the so-called rescue package by Greek Prime Minister Georgios Papandreou merely capped its rapid unravelling. The prospect that EU’s principal victims would be asked their opinion of the policies inflicted on them provoked near-hysteria in respectable quarters. EU leaders, Greek politicians, and the financial markets united to denounce this unseemly democratic intrusion.
But whatever the outcome of the political furore – and it now looks likely that Papandreou’s government will not survive – it will not be the referendum that breaks the deal. The package offered last week, skimpy as it was on details, contained the seeds of its own destruction. The EU is, once again, demonstrating itself incapable of resolving its crises.
Should the promised referendum fail to materialise, lost, as seems likely, to a snap general election, those skimpy details will need filling in. What we have so far is the outline of a fresh round of crises.
Three parts, none of them good
There are three key elements to the deal. First, banks will be asked to build their stocks of capital held in reserve, by €109bn across the Eurozone. Second, 50 per cent of Greek debt will be “voluntarily” written off by its creditors. Third, the European Financial Stability Fund, established last year to provide bailout cash, will be inflated from €440bn to €1trillion.
None of this stands up to serious scrutiny. The first two parts are counterproductive. The third threatens catastrophe.
Increasing bank reserves – recapitalisation – has become necessary because the European banking system is still very weak from the previous financial crash. Banks use their reserves as a backstop against crisis. By holding more in reserves, the theory is that they will be better able to withstand any future turmoil. At least part of the reason for bank failures in the last few years, such as Northern Rock in 2007, has been exactly the weakness of their reserves.
But to increase their reserves, banks will need to raise the funds to do so. That will mean raising capital from the financial markets, but they are (understandably) not much inclined to provide funds. The banks will, as a result, have to turn to official sources – to either their own national governments, or, where governments cannot afford to provide funding, to the EU funds. This means, in other words, a further bailout at taxpayers’ expense. The alternative is for banks to restrict their lending, but this would exaggerate stagnation inside Europe.
Even then, the sum needed may not be enough. The IMF, before the deal, was suggesting that €200bn would be need to put Europe’s banks on a more sound footing. The amount now proposed is half that.
Turning the screws on Greece
Greece’s national debt is now approaching 190 per cent of GDP, having risen over the last year. It is unpayable, and the debt write-off at least starts to admit that. By writing off a chunk of the debt, the hope is that the burden of interest payments and debt repayments on the Greek economy will be eased, allowing it to recover. But a leaked, confidential document from joint EU/IMF/ECB “Troika” last week suggested “at least” a 60 per cent debt write-off would be needed for Greece to have a hope of recovery. The IMF has independently hinted that 70 per cent may be more reasonable.
If the amount of debt written off is not sufficiently large, no recovery is possible. Greece will remain trapped in a downwards spiral of high debt and sharp recession, with debt payments dragging the economy further and further into the abyss. A 50 per cent write-off will reduce the speed of this spiral, buying the EU some time, but unless a miraculous economic recovery occurs it will not break it. The crisis will continue. Greece will be forced into a further default.
Nor is it clear that Greece’s creditors will agree to it. Official loans, made by the ECB and IMF, will be untouched. Instead, private creditors will be expected to carry the cost. There is no guarantee they will all do so “voluntarily” – from their point of view, why should they? Some of them hold a form of insurance against a default, known as “credit default swaps” (CDS). If these insurance contracts are triggered by a default, the “insurers” – those holding the other side of the CDS contract – will have to pay out large sums. Around half of these, on some estimates, are in the US. The crisis could spread rapidly.
And the 50 per cent write-off arrives at a terrible price. Greece, already crippled by austerity, is to undergo still more pain at the hands of the Troika. A three-year austerity plan is proposed, with details finalised over the next few months. Permanent foreign oversight would be established in the Greek finance ministry, effectively ending its sovereignty over taxation and spending.
This is a form of blackmail. Greece is being offered an officially-sanctioned reduction in its national debt, in return for tearing up whatever remains of public spending and trashing its democracy.
One trillion nonexistent euros
The European Financial Stability Facility (EFSF) was established in May 2010 to provide bailout assistance to eurozone countries. It consists of promises to provide up to €440bn of bailout assistance, with the money coming from euro member states. The current plan proposes to balloon this sum to €1trillion, expanding the EFSF’s remit to cover also banking crises and offer insurance on loans to high-risk countries.
It is a fatally flawed scheme. The EFSF, as constituted, has next to no cash at hand. It relies on promises to pay from its members, not actual contributions of money. The proposals to balloon the Facility in size depend on taking those promises to pay, and using them to bring in – leverage - still more promises to pay.
The details on how this will be done have not yet been finalised, but a plan of sorts is emerging. The EFSF is an off balance-sheet “special purpose vehicle” (SPV) with a capacity to write its own, cheap, loans. It can do this on the basis of securing a very good credit rating, dependent in turn on the promises to pay of its creditors – France and Germany especially. These creditors use their own strong credit ratings to give the appearance of stability to the EFSF. The Facility has – importantly – no funding of its own.
This may sound horribly familiar. It is almost precisely what the banks did with sub-prime mortgages in the run-up to the 2007-8 crash: taking bad, high-risk loans and disguising them in special purpose vehicles, known as collateralised debt obligations (CDOs). When the high-risk sub-prime mortgages began to default, these intricate financial structures imploded, bringing the system down with them.
The EFSF carries with it the same dangers. The hope is that by making the Facility appear so overwhelmingly huge, it will deter future speculation against (for instance) an Italian default. But it is smoke-and-mirrors. It relies on financiers and speculators believing in the trick. Simply put, promises to pay are not as good as actual payment. You can promise anything you like. You don’t have to deliver. If the EFSF is ever called upon in any significant manner, those promises can evaporate, leaving a few countries – particularly Germany - exposed to massive costs. And even the German economy cannot afford €1trillion. The potential for catastrophe is substantial.
Even before that point, a ratings downgrade of the EFSF’s principal backers would scupper the whole scheme. France is currently under threat of just such a downgrade.
Democracy and finance
As I write, reports from Athens suggest Georgios Papandreou will shortly resign in favour of a government of national unity, lead by a former head of the Greek central bank. This will, in turn, ratify the nonsense EU deal and – it is claimed – move towards early elections.
That means no referendum, and a government of “national salvation” committed to its exact opposite through slavish adherence to the Troika’s writ. Papandreou, should he remain in office until Friday, is not expected to make it through the confidence vote. New elections could be called soon.
The last card the Greek ruling class have to play is plain blackmail against its own people: to force through an election on the issue of euro membership, and demand a choice – drachma, or euro? While a majority of Greeks would rightly reject the austerity measures, a majority are still in favour of staying inside the single currency.
But it is up to those on left, across Europe, to attempt to offer some clarity in all this. For Greek workers and their allies, the EU’s bluff should be called. Default on the debt, exit the euro, and work for economic reconstruction. The economy cannot rebuilt while the debt burden remains, and it cannot be rebuilt while the straitjacket of the euro is in place. An industrial strategy, subject to democratic controls and oversight, is a necessity.
For those outside of Greece, austerity, now driving an entire continent into stagnation, must end immediately. Economic decision-making, currently the preserve of elitist EU institutions and financial markets, must be prised open for democracy. The occupy movement has rather brilliantly begun to bring this question out: the control of resources and planning over their use, for too long subject to the supposedly neutral diktat of the market, has to be placed in the hands of the people. An assault on the power of finance, imposing capital controls and taxing its activities, is urgently required. A movement against austerity and the rule of capital, right across Europe, must now be built.
Radical economist James Meadway has been an important critic of austerity economics and at the forefront of efforts to promulgate an alternative. James is co-author of Crisis in the Eurozone (2012) and Marx for Today (2014).