Bad Faith

Sipa via AP Images

Angela Merkel, German chancellor, and Greece Primer Minister Alexis Tsipras give a joint press conference, after the meeting, at the German chancellery on March 23, 2015, in Berlin.

Readers of the financial press may be forgiven for thinking that the negotiations between Greece and Europe have one feckless partner—the new government of Greece—and one responsible partner, a common front of major governments and creditor institutions, high-minded in their pursuit of rational policies and the common European interest.

The view from Athens is different. On June 11, I attended the hearing of a Greek parliamentary commission investigating the Greek debt. Phillipe Legrain, former adviser to the then-EU President José Manuel Barroso, testified. Legrain is a technocrat, an economist, and a very reserved individual. He spoke in measured tones.

The original crime in the Greek affair, Legrain said, was committed in May 2010, when it became clear that the country was insolvent. At that time, the IMF staff was convinced that Greek debts must be restructured, and that debt relief was not only necessary but also just, given that reckless borrowers are always matched to reckless lenders, and that lenders are compensated, in part, for the risk of loss.

Restructuring did not happen. Instead, a trio of Frenchmen—at the IMF, at the European Central Bank and at the Elysée, and backed by Angela Merkel—decided to pretend that Greece's problem was merely temporary, that there was a larger financial crisis to be warded off, and that the largest bailout in history should be directed not to save Greece, but to off-load the exposure of French and German banks onto all the European states, with Germany's taxpayers taking the largest share.

Why did the IMF get into the act, making its largest loan in history (32 times Greece's quota) over the reservations of its staff and the objections of many non-European members? Because the Managing Director at the time, Dominique Strauss-Kahn, wanted to become President of France. 

At the same time, the European Central Bank under Jean-Claude Trichet bought up some 27 billion euros in Greek bonds, thereby raising their price. Why did Trichet do this? To support the original lenders, once again in large part the French banks. 

In so doing, the European powers were able to avoid imposing losses on the large banks. And by his actions, Trichet locked the ECB into a refusal to accept losses on Greek bonds as he stretched, if not broke, the legal mandate of the European Central Bank.

As a basic principle of finance: you do not make new loans to a bankrupt. What you do, when faced with insolvency, is restructure the debt. IMF staff and board members who understood this at the time were overruled. Instead the leadership of Europe joined in an enormous lie: the pretense that the Greek debt could be sustained. In 2010, the IMF representatives of France, Germany and the Netherlands promised (on that pretense) that their banks would hold on to their Greek debts. In fact, they sold off everything that that they could.

Back in 2010, the Greek government could have restructured its own debt, under Greek law, but failed to do so. When a restructuring did occur in 2012, it was on the creditors' terms, which was why Greek pension funds lost 60 percent of their value. And that, of course, is a major reason why Greek pensions are in such terrible trouble today.

In 2010 Greece had to swallow an austerity program that would be—as Poul Thomson of the IMF promised the IMF Board— “tough, difficult, and painful.” Although the program called for an unprecedented “fiscal adjustment” of 16 percent of GDP, it also predicted that Greece would suffer a fall of GDP on the order of only 5 percent, to be followed by recovery beginning in 2013. Meanwhile the debt-to-GDP ratio would rise to 150 percent by 2013 and decline thereafter. In fact, the fall in Greek GDP was five times as large, the debt-to-GDP ratio today stands above 180 percent. And there has been no recovery at all.

Later in the hearing, Legrain was asked his view of the economists behind these predictions and the officials who voiced them. On this one point, his testimony faltered. Was it incompetence? Panic? Ideology? The witness was unsure. Perhaps, he offered, some of them, “in their stupidity,” thought it was going to work. In any event, as he testified, “nobody has suffered for their mistakes.”

No. Mr. Thomson continues to call the shots at the IMF, which—although it now argues the need for debt relief—continues to demand the same package of deflationary cuts that pass in official language as “reforms.” Among these are savage reductions in the lowest pensions Greece pays, which would cut a third from payments that are already only about 12 euros per day.

Meanwhile, according to a report in the Frankfurt Allgemeine Zeitung on June 14, the European commission was prepared to lighten up on those pension cuts in return for cuts in the Greek military budget. Who torpedoed this? According to the FAZ, it was the IMF.  If that agency believes that it will be easier to pressure the Greek government to starve its elderly poor, they truly have not been paying attention. Or, more likely, given the now-clear divisions and disarray among the creditors, the IMF has decided that it does not want any agreement—and therefore further negotiations are futile.  

And as the IMF insists that Greece meet every condition, things are quite different just a bit to the north and east. For Ukraine, according to a statement by Mme. Lagarde on June 12, as reported by Zero Hedge, the IMF "could lend to Ukraine even if Ukraine determines it cannot service its debt." So much for debt sustainability—for the bedrock principle that you do not make new loans to a bankrupt.

Sympathetic American readers have become used to seeing Germany, the Germans, their Chancellor Angela Merkel, and her finance minister Wolfgang Schäuble as the villains in this drama. They have underestimated the half-hidden role of the Rasputins of Paris. And also that of the Svengali of Frankfurt, Mario Draghi, who as I write rumbles threats to the Greek banking system. These are threats that may, in the next few days, unleash the very avalanche that Draghi once promised to do whatever it takes to prevent.

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