Greece Acknowledges Austerity Failing, Dumping Country Into Depression

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Greece Acknowledges Austerity Failing, Dumping Country Into Depression


The Greek Finance Ministry released its estimated economic statistics this morning, and they were brutal. But the AP report can’t understand why.

On Sunday, Greece’s finance ministry said the deficit this year will likely be 8.5 percent of its gross domestic product, higher than the 7.8 percent previously anticipated, and blamed a deeper-than-expected recession for the failure. The Greek economy is projected to shrink 5.5 percent this year.

The revelation that Greece is finding it increasingly difficult to reduce its borrowings in spite of all its austerity measures has raised fears that international creditors will effectively pull the plug.

Let me fix this AP story. It’s not that Greece’s budget deficit is growing despite austerity measures, it’s because of them, exactly as prominent economists understood and predicted.

Greece is in a depression. Unemployment is at over 15%. Among young people aged 15-24 it’s 25%. The estimate of a 2.5% contraction in GDP for 2012 (after a 5.5% reduction in 2011) is laughable. It will be much higher. To meet creditors’ demands, the Greeks plan to cut 30,000 public sector jobs. That’s on a population of 11 million; it’s the equivalent of 900,000 job cutbacks in the US.

About 30% of the GDP that remains in Greece is in the underground economy, and even in the real economy, tax avoidance has become an art form. To alleviate these symptoms, Greece does not promise better tax collection or hiring of more collectors. Instead it proposes more taxes that won’t be collected!

This is fated for total disaster. The Greek economy is dead and the Eurozone along with the IMF and Eurpean Central Bank have a solution of shooting the dead patient rather than re-animating it. To make sure the banks that lent money to Greece are made whole (because Lord knows they shouldn’t feel any pain for their bad lending decisions), they’re going to turn the Euro bailout fund into a leveraged CDO. This elicited a fitting metaphor from Wolfgang Munchau:

We are now in the stage of the crisis where people get truly desperate. The latest crazy idea, which is being pursued by officials, is to turn the eurozone’s rescue fund into an insurance company, or worse, a collateralised debt obligation, the financial instrument of choice during the credit bubble. This is the equivalent of putting explosives into a can, before kicking it down the road.

So why use such a toxic instrument to construct a product to save the eurozone? The current lending size of the European financial stability facility (EFSF) is €440bn, which is equal to the guarantees given by the 17 eurozone member states. If you want to leverage the CDO without increasing the liabilities of governments, then this €440bn would become the equity tranche of the new CDO. The equity holders in the CDO are supposed to be the ultimate risk-bearers. You can leverage the structure by creating more senior tranches of bonds that would be open to outside investors. You could expand the structure further through a mezzanine layer – which carries less risk than that of the equity tranche but more than that of the senior bonds. You could look at those senior tranches as eurozone bonds.

The big difference between a eurozone CDO and a subprime CDO is the the nature of the backstop. When the eurozone CDO fails, there are no governments that can bail it out because the governments themselves are already the equity holders of the system. This leaves the European Central Bank as the last man standing.

This is a dangerous solution to a political problem, the fact that the Eurozone nations won’t commit more money for the bailout fund.

But then, the Eurozone response to the crisis has been a cascading series of dangerous and wrongheaded solutions, so why break precedent?

UPDATE: Good thoughts on this from John Lanchester. I like this especially:

What’s roiling the markets is the fact that the governments of the richer European nations, especially that of Chancellor Angela Merkel, in Germany, have been putting the domestic unpopularity of bailouts ahead of their evident economic necessity. This might be only a piece of theatre, taking the crisis right to the brink before the need for action becomes so apparent that its political cost is lowered. (Merkel is facing reëlection in 2013.) German politicians seem to have a block about making clear to their electorate just how much the country has benefitted, and continues to benefit, from the euro, mainly through its enormously helpful effect on Germany’s strong export economy. That could turn out to be a historic failure of leadership.