A Dutch wissleblower, a Greek tragedy, and the faith of the euro

It could all have been quite different if they had taken this man seriously..

The Denials That Trapped Greece


THE warning was clear: Greece was spiraling out of control.

But the alarm, sounded in mid-2009, in a draft report from the International Monetary Fund, never reached the outside world.

Greek officials saw the draft and complained to the I.M.F. So the final report, while critical, played down the risks that Athens might one day default, with disastrous consequences for all of Europe.

What is so remarkable about this episode is that it wasn’t so remarkable at all. The reversal at the I.M.F. was just one small piece of a broad pattern of denial that helped push Greece to the brink and now threatens to pull apart the euro. Politicians, policy makers, bankers — all underestimated dangers that seem clear enough in hindsight. Time and again over the last two years, many of those in charge offered solutions that, rather than fix the problems in Greece, simply let them fester.

Indeed, five months after the I.M.F. made that initial prognosis, Prime Minister George Papandreou of Greece disclosed that, under the previous government, his nation had essentially lied about the size of its deficit. The gap, it turned out, amounted to an unsustainable 12 percent of the country’s annual economic output, not 6 percent, as the government had maintained.

Almost all of the endeavors to defuse this crisis have denied the overarching conclusion of that I.M.F. draft: that Greece could no longer pay its bills and needed to drastically cut its debt.

Until October, when European leaders conceded that point, the champion of the resistance was Jean-Claude Trichet, who stepped down this month as president of the European Central Bank. It was he who insisted that no European country could ever be allowed to go bankrupt.

“There is simply no excuse for Trichet and Europe getting this so wrong,” said Willem Buiter, chief economist at Citigroup. “It is fine to make default a moral issue, but you also have to accept that outside of Western Europe, defaults have been a dime a dozen, even in the past few decades.”

If leaders had agreed earlier to ease Greece’s debt burden and moved faster to protect the likes of Italy and Spain — as United States officials had been urging since early 2010 — the worst might be behind Europe today, experts say.

The turning point came at a late-night meeting last month when Angela Merkel, the German chancellor, pushed private creditors to accept a 50 percent loss on their Greek bonds. Mr. Trichet had long opposed such a move, fearing that it could undermine European banks. Instead, at his urging, European leaders initially promoted painful austerity for Greece, prompting a public backlash that pushed Mr. Papendreou’s government to the brink of collapse and could force Athens to abandon the euro.

Many view the latest rescue plan as too little, too late.

“Because of all this denial and delay, Greece will need to write down as much as 85 percent of its debt — 50 percent is not enough,” Mr. Buiter said.

It was never going to be easy to turn things around in Greece, particularly given European politics. In countries like Germany and the Netherlands, many people oppose bailing out their southern neighbors. Policy makers and, indeed, many financiers believed that they could buy enough time for Greece to solve its problems on its own.

“It was quite obvious, by the spring of 2010, that Greek debt could not be paid off,” said Richard Portes, a European economics expert at the London Business School. “But in good faith, policy makers felt that Greece could grow out of its debt problem. They were wrong.”

BOB M. TRAA is no one’s idea of a radical. A Dutchman, he labors at the I.M.F., among the arcana of global debt statistics. He wrote the 2009 report.

Immediately after that bulletin, he produced another, more damning analysis, which concluded that if Greece were a company, it would be bankrupt. The country’s net worth, he concluded, was a negative 51 billion euros ($71 billion).

But because Greece had a high-enough credit rating at that time, it could keep borrowing money and skate by. Once again, the Greek government objected to the I.M.F. analysis, although this time, the report was not amended.

Attention has only recently been drawn to these early I.M.F. studies. The Brussels research group Bruegel, which conducted an analysis at the I.M.F.’s behest, concluded the fund should have done more to draw attention to Greece’s troubles.

By early 2010, banks and bond investors were growing reluctant to lend Greece money. The country’s finance minister, George Papaconstantinou, delivered a blistering message to his European partners.

“I know we have German elections in May,” he said, referring to a regional vote to be held that month that was being blamed in part for Germany’s reluctance to sign off on a rescue package for Greece. “But I have a 9 billion euro bond maturing on May 9,” he added, “and if we are not careful, this could blow up in our face before the election!”

Despite that warning, Mrs. Merkel, angry over being misled about Greece’s finances, stalled for time. Greek officials were acknowledging privately that the country was out of money. No one wanted to say so publicly.

“Any talk of restructuring was a total taboo,” said a senior Greek official, who spoke on condition of anonymity. “We never even brought it up. If we made this case to Europe, we would have been pariahs forever.”

In February 2010, Yanis Varoufakis, a political economist with ties to Mr. Papandreou’s party, suggested publicly that Greece default. He was attacked by the Greek finance ministry for spreading what officials there viewed as treasonous notions.

FROM the beginning, Mr. Trichet of the European Central Bank privately warned Greek officials that the European Union would cut off funds to Greek banks unless the nation agreed to austerity measures.

“You are not getting any help unless you implement your cuts,” Mr. Trichet told them bluntly, according to a witness to the discussions. Rather than help matters, the stance fed a broader panic in the financial markets.

Earlier this year in Washington, in a speech to bankers and government officials, Mr. Trichet said the austerity measures were key and that there was no need to reduce Greece’s debt. His assurances did little to ease the angst in the room.

“People were raising questions,” said Charles Dallara, the head of the Institute of International Finance, which was the host for the event. “But it was such a dramatic notion — having a European country default — no one could accept it.”

That pattern, however, began much earlier. In April and May 2010, as European leaders scrambled to come together with their first rescue for Greece and to create a bailout fund for other countries using the euro. Timothy F. Geithner, the United States Treasury secretary, urged his European counterparts to “think big.” He called on them to produce a plan that might rival in size the $700 billion bank rescue that Washington devised in 2008. At one point early in the talks, the team from Washington, headed by Mr. Geithner and Ben S. Bernanke, the chairman of the Federal Reserve, was told that the initial European proposal was for a bailout fund of about 60 billion euros.

The team was stunned. The American officials told the Europeans that they were off by an order of magnitude, meaning that Europe should be talking about at least 600 billion euros.

Markets were calmed briefly by the I.M.F.-backed plan for Greece and the 440 billion euro rescue facility that was eventually agreed upon. In October 2010, Mrs. Merkel and the French president, Nicolas Sarkozy, suggested requiring some sacrifice from banks and other euro zone creditors, though their idea was that this would not happen until 2013 and would not affect Greece.

But that declaration, agreed upon at a meeting in Deauville, France, set off alarm bells in the markets. First, Ireland, then Portugal, were forced to seek bailouts of their own. By breaking the taboo over private-sector losses, but without having an immediate plan for Greece or financial firewalls for other nations, the French-German statement set back prospects for tackling the mountain of Greek debt.

Athens’ failure to make good on its economic promises, meanwhile, including a 50 billion euro privatization program, turned attention to the deteriorating political situation in Greece.

Last April, the Dutch finance minister, Jan Kees de Jager, dared to raise the subject of Greek debt restructuring again, only to receive another blast from Mr. Trichet. By May, the Germans had concluded, long after most private economists said it was inevitable, that a restructuring was needed.

Instead of bolstering Athens’ finances, the austerity program in Greece was turning a recession into a near-depression. The issue was broached at a meeting in Luxembourg, which was convened in secret but which quickly leaked to the press. This time, Wolfgang Schäuble, the German finance minister, argued that Europe must face up to its Greek losses. But by now Mr. Trichet’s objection was more than philosophical: the European Central Bank had acquired a lot of Greece’s debt as part of the effort to prevent its collapse and could suffer if it was forced to write off its Greek bonds at a huge loss. He stormed out of the dinner in a huff.

The result was more delay.

It is very difficult to stand up to the president of the E.C.B.,” said Guntram Wolff, an economist at the Bruegel Institute. “This is the person with the best information in the world and he was saying a Greek restructuring would be the end of the world.”

BY this spring, the realization in Greece that it would need another bailout was forcing Mr. Papandreou to consider all options — even the extreme step of leaving the euro, according to one banker who talked with him at the time. But the subject of reducing Greece’s debt, which was on course to swell to more than 180 percent of its annual economic output, was still taboo.

In late June, Mr. Dallara, the banking representative, met with the prime minister and his newly appointed finance minister, Evangelos Venizelos, in Athens. There would have to be a haircut on Greek debt, Mr. Dallara told them.

Paradoxically, it was a representative of the banking industry, perhaps more in tune with the realities of the marketplace, who finally insisted that Greece could not borrow and cut its way out of the crisis without having to restructure its debt.

“There was shock and surprise on their faces,” Mr. Dallara recalled. “They could not believe it.”

Again, Germany put its foot down — another delay. While a new deal reached in late October will force bondholders to accept deep losses, Europe, Greece and Mr. Dallara continue to insist that the transaction will be voluntary. As a result, there will be no need to trigger Greek credit defaults swaps, which would add to the complexity and cost. But in the eyes of many debt experts, this is simply another form of denial.

“You have to have a coercive element to make it work,” said Mitu Gulati, a sovereign debt expert at Duke University Law School. “To not accept that means you are living in Alice in Wonderland.”

Stephen Castle reported from Brussels.