“Please ensure that your own oxygen mask is securely fastened before trying to help others”. See below for relevance to Eurocrisis …

2010 and all that — Relitigating the Greek bailout (Part 1)

It’s becoming a common theme of the more intelligent end of criticism of the Eurogroup to identify the 2010 bailout as the real error. Triangulating between Karl Whelan, Mark Blyth, Simon Wren-Lewis, Steve Waldman and Martin Sandbu, for example, we can identify the following argument (which of course doesn’t do justice to any of them — do please read the links rather than assuming I’ve summarised anything accurately!):

1. The 2010 bailout was mainly directed at stabilising European financial markets, so either
2a. The actual amount of financing available for the Greek fiscal deficit was smaller than it might otherwise have been, or
2b. Greece would have benefited more in the long term from a program with the same deficit financing but a face value debt writedown
3. So, most of Greece’s economic problems today would have been better if it had defaulted in 2010 rather than accepting the Eurogroup’s program.

There’s some truth in these points — as I say, it’s the most intelligent critique of the Eurogroup — but in my view the conclusion is wrong and the 2010 bailout was not a mistake. It’s worth relitigating in detail though, because in going through the choices made in 2010 we can learn a lot about how bailouts in general operate, and how the development of the programs since 2010 could end up generating serious errors going forward. This is going to have to be (at least) a two-part series because I want to get quite detailed — this part deals with point 1 above and the question of “Who was the 2010 bailout meant to benefit?”.

A couple of conceptual primaries. I’m going to be using a couple of key concepts quite a lot, so it’s best to spell them out ahead of time rather than introduce them at the same time as a bunch of other complicated stuff.

First, I think we need to make a distinction between two kinds of “austerity”. In my view, the real definition of austerity is a tightening of the fiscal stance *as a policy choice*. That’s what happened in Ireland. In Greece, though, in 2009–10 at least, the fiscal deficit was not, in my view, chosen as a policy. It was the outcome of a genuine, albeit politically driven, budget constraint. (Olivier Blanchard makes this important point clearly). If the people negotiating the package had unlimited money, they would have agreed a larger primary deficit in 2010, but they didn’t — the 2010 package was the largest amount of financing that was available.

Second, let’s not make mistakes based on dividing the deficit financing by the total size of the package, and getting results that “x% of the financing went to Greece, all the rest went to creditors”. This is just missing the concept of a debt rollover. It’s the nature of debt crises that they tend to happen to countries with big debts, and countries with big debts have creditors. The creditors[1] effectively agreed to roll over their outstanding debts, and to provide EURxbn of additional financing. If the debts had been smaller or larger, that wouldn’t have changed the number EURxbn.

On with the show …

Part 1: The 2010 bailout — who did it benefit?

It is terribly easy to get confused about patterns of exposure to Greece from European banks, because the statistics at the time were reported every which way, and the fact that three of the biggest banks in Greece were owned by foreign entities meant that the consolidated numbers were often heavily distorted. (For the record, at the time of the May 2010 bailout, Emporiki was owned by Credit Agricole, Geniki was owned by SocGen and EFG Eurobank was owned by the Latsis family, via a family holding company with a banking licence in Geneva). You can see that the headings on this contemporary table put together by the BIS have a scattering of footnotes indicating various data issues — however, they accord with what the banks themselves were telling investors at the time, and I think these numbers are broadly correct. For the purposes of this analysis, I will go with about EUR25bn in Germany, and about EUR27bn in France.

“Public sector “ is the line to look at here. Note the big number for France in “Non-bank private” — that shows that it includes the big subsidiaries

Data for domestic bank holdings is made a lot easier by the heroic work of Sylvia Merler and Jean Pisani-Ferry at Bruegel, who have put together a comprehensive time series for government bond ownership. As of Q1 2010, the Breugel dataset records Greek domestic banks (OMFIs, column G in the spreadsheet) as holding just under EUR40bn of government debt.

It is not clear — and probably impossible to know — to what extent this EUR40bn figure double-counts the government bonds held by Emporiki and Geniki, but for reasons to be discussed below, I don’t think that matters so much.

So we can say the following things, just from the data:

1) The majority of Greek government bonds were held by non-Greek residents — Merler & Pisani-Ferry reckon about 72%.

2) However, the Greek domestic banking system was far and away the largest single holder, almost as much as French and German banks put together

We also know:

3) French banks, in particular, had a lot of their Greek government exposure through subsidiaries, and could at least in principle have reduced their losses in the event of a Greek government default by taking advantage of limited liability.

4) When we compared the GGB exposures to total capital and reserves, we can see that the Greek domestic banking system in April 2010 had EUR39.1bn of reserves, while the French system had EUR463.9bn and the German had EUR368.4bn.

Probably better to just check out the dataset at the link rather than suffer this adventure in Microsoft Paint. Figures for Q1 2010.

In other words, a write-off of all Greek government debt would have been a deep flesh wound for the German and French banks (around 6-7% of total capital), but a complete wipe-out for the Greek banks (just under 100% of capital and reserves).

Don’t take the calculations in point 4 above too seriously. It’s always a bad idea to divide numbers from different datasets, and it’s also not really possible to aggregate capital across banking sectors this way — if all the capital is in Bank A but all the GGB exposure is in Bank B, then you can’t set one off against another. But the general order-of-magnitude is about right and accords with my understanding of the position when I was a professional bank analyst back in 2010. The French and German banks would certainly prefer not to have lost the money, but could take it (with the possible exception of Commerzbank, which had very weak capital and large exposures). The Greek banks, on the other hand, would have been bust immediately.

So I think the more incendiary rhetoric — anything claiming that the 2010 bailout was a con-trick that was only organised to prevent a state bailout of the French and German banks — can’t be stood up. Nonetheless, I do think there’s a lot of truth to the view that a strong motivation for the bailout was to preserve financial stability in Europe.

The Lehman syndrome …

… Because this is all complicated stuff. I barely understood it myself at the time, and I was working on a team of eight professionals who won every European equity research award going that year, largely for our work on the crisis. It was really not easy to dig down into the disclosures and work out which banks were OK and which weren’t.

For this reason, if you’d had a “sudden stop” in the form of a major credit loss on Greek exposure, it’s entirely possible that you would have a situation similar to September 2008, in which banks just stopped lending to one another. There actually was a mini-crisis later in 2010 and into 2011, when the US money market mutual fund industry decided to reduce its exposures to Europe. The authorities were scared of another meltdown in money markets — which would not in any way have been quarantined to Europe, any more than Lehman was kept in the USA — and a consequent second credit crunch. It can’t be denied that this was a large part of the motivation for wanting a solution to be found which delayed any day of reckoning on Greek debt until the financial system was in better shape to bear it.

So, it wasn’t really about helping Greece then? Well, I think that’s an odd way to look at it. As they tell you before takeoff in every single aeroplane flight, it is important to make sure that your own oxygen mask is correctly fitted before trying to help others. At that point in time, Greece was completely dependent on its Eurozone partners (and the IMF) to finance its budget.

A financial collapse and credit crunch in Europe would have very severely impaired their ability to dedicate either political or financial capital to that end. If you think that the support in 2010–11 to funding Greece’s primary deficit was miserly, imagine what kind of a package might have got through the Bundestag in the aftermath of a financial collapse that put Germany back into a double-dip as deep as its 2008 recession, and which would have looked very much as if it was Greece that had caused it. Not only was it not an unreasonable priority for European policymakers to want to avert a financial crisis in Europe, in my view it’s pretty clear that their doing so made it possible to help Greece more, not less, than if such a crisis had happened.

So, concluding part 1, I think it’s sensible to say that:

1. The primary motivation for the 2010 bailout was, indeed, preserving European financial stability
2. But this was not in any way inconsistent with getting the best outcome for Greece
3. A Greek government default, considered as an alternative solution, would have done much more damage to Greek banks than any other country’s
4. Specifically, theories under which the entire motivation was to protect France and/or Germany from having to bail out their domestic banks aren’t sustainable at all.

Coming soon … How possible would it have been to finance Greece’s program without the Eurogroup?

[1] It can certainly be argued that talking about “the creditors” here is a sneaky trick. A further criticism of the 2010 bailout is that it allowed private sector creditors a window of opportunity to get out of the trade, ensuring that by the time the PSI came around, and certainly by the time the reprofiling arrived, Greece largely had nothing but public sector creditors. I can see why German taxpayers and IMF shareholders might have wanted private sector entities to take a bigger lump of the pain, but in my view this was a necessary precondition to any sensible management of the Greek debt burden. Greece, in my opinion, has certainly done a lot better by having its restructuring negotiations handled by political entities which are capable of providing further financing, than having its debt in the hands of a motley crew of holdouts and vulture funds.