Troika inquiry: talk to the organ grinder, not the monkey


The European Parliament’s inquiry into the troika and its record in eurozone bailouts sounds like a welcome effort to hold Europe’s crisis managers to account.

Unfortunately, the inquiry’s report is likely to miss the bigger picture, because of the European Parliament’s institutional navel-gazing and narrow focus on the troika – a team of civil servants – rather than its political masters.

The troika of inspectors from the IMF, European Commission and ECB were merely assigned to work out and monitor the details of a pact between debtors such as Greece and creditors such as Germany.

The troika’s judgment on specific reforms – such as dismantling Greek workers’ bargaining power in the labor market before it had tackled anti-competitive practices in many product markets – deserves to be questioned. But the decisions that matter most were taken far above the pay grade of Poul Thomsen & co.

How much time and financing would Greece get to bring its budget under control? Should its debts be restructured? Should banks in the eurozone core take a hit? Should aid from core taxpayers include transfers? Should Ireland’s citizenry really repay all of its banks’ foolish borrowing? What macroeconomic policies should the eurozone as a whole adopt if the periphery has to swallow austerity? If the people of the periphery are paying almost the entire costs of the eurozone’s “adjustment” while the core offers only loans, then who is bailing out whom?

Those are the questions that need an inquiry. Because the one-sided answers that Europe’s dominant powers have given will haunt the eurozone’s recovery for years to come.

Not so fast, says core Europe. Greece got itself into trouble. Nobody in Germany forced it to live beyond its means for years. Why should others bear the cost of Greece’s follies? Debt forgiveness would only reduce the pressure to change.

Indeed. Just as repayment in full by foreign taxpayers of reckless international lending also reduces the pressure on Europe’s creditor economies to change. It takes two to tango, and it took both debtors and creditors to lay a web of unwise lending across the Eurozone in the years before 2010.

The troika bailouts reflect a worldview, backed by an asymmetry of power, in which moral hazard exists only for debtors, and in which the causes of the eurozone crisis are to be found exclusively at national level in the South. If you accept that narrative, then questions about the troika are limited to the details of how it implemented its mission.

But that’s a biased view of how the eurozone crisis happened. A more complete account of what went wrong raises deeper questions about the mission itself.

The first question for the European Parliament’s inquiry should be: what is the euro crisis anyway?

There’s a dominant view among disinterested experts, although there are differences of emphasis. A synthesis of the main factors at system and country level goes something like this:

The euro eliminated perceived risks of cross-border lending, encouraging massive capital flows from core to periphery. Those capital flows reflected and facilitated distortions in core and periphery economies alike.

A “push” for the flows came from core economies, especially Germany, which under the euro developed a huge surplus of national savings over investment. This reflected a falling labor share and rising profit share of German GDP as a result of wage restraint. As household incomes stalled, consumption fell behind production, and domestic investment fell behind savings. German banks lent the difference – which rose to over 7 percent of GDP – abroad, helping to flood parts of the euro periphery with cheap credit.

A “pull” for the flows came from periphery countries where the deep fall in interest rates encouraged various kinds of borrowing binge: by Greek politicians, Irish bankers, Spanish property developers, Portuguese consumers. Each country’s existing economic or political flaws determined the form of its bubble, which in turn exaggerated those flaws. The binges fed excessive growth in demand around the periphery, which pushed up prices and strangled export sectors. Growing trade deficits were plugged by yet more foreign credit.

(The one place that doesn’t quite fit this story is Italy, which avoided a credit bubble, perhaps thanks to a conservative banking culture. But what Italy shares with the rest of the periphery is that the euro’s early years were a sedative that delayed reforms and amplified prior weaknesses.)

The 2008 global financial crisis changed risk perceptions and led to a series of “sudden stops” in Europe. Capital turned and fled for home, cutting off liquidity for one periphery country after another. Self-fulfilling fear of “contagion” spread faster than blundering European authorities could respond.

Simple, really. A classic cross-border credit bonanza ending in sudden stops. All too familiar to emerging economies in Asia and Latin America. Europe has seen it before too, on the eve of the Great Depression: back then, Germany and other parts of Central Europe were the “periphery” that was first deluged with, then starved of credit.

The central question for the troika inquiry should be: what kind of an answer were these bailouts to this kind of crisis?

They were a creditor’s kind of answer.

They were all about making sure that periphery governments and banks would repay all of their debts, whether to private-sector investors or to official lenders who stepped in to replace them.

It did not matter that some – not all – of the periphery’s governments and banks were insolvent: they did not plausibly have the future income streams to repay all of their debts. Creditors weren’t prepared to admit that, but they were prepared to squeeze the standard of living in nearly half the eurozone to get back as much of their money back as possible.

The alternative path, of sharing the cost of two-sided folly by restructuring periphery debts early, was rejected out of creditors’ self interest. The two justifications that core governments put forward were moral hazard and contagion risks.

But contagion happened anyway, because markets didn’t buy the strategy. The unrealism of pretending that debtor countries and their banks could repay everything, based on wishful thinking about growth in a time of austerity, undermined investors’ confidence that Brussels and Berlin knew what they were doing.

Germany’s obsession with moral hazard for debtor countries made contagion worse by delaying the intervention of the ECB, which alone had the firepower to halt runs on countries’ bond markets.

And moral hazard cuts both ways. What incentive is there for Germany to rebalance its economy if its bad foreign lending gets bailed out by the taxpayers of economies to which German money flows?

The IMF’s non-eurozone directors saw in 2010 that Greece’s bailout was designed for the benefit of French and German banks. Greece, like Ireland later, took one for the team.

A painful adjustment was unavoidable for Greece. But its overdose of austerity and deflation was a function of the limit that Germany put on the financing package. The IMF knew in 2010 that Greece would need more time and money to shrink such a massive budget deficit. Germany said no. The financing limit dictated the troika’s timetable for closing the deficit, which in turn dictated the troika’s unrealistic assumptions about Greece’s economic recovery.

When those assumptions fell apart in 2011, German Finance Minister Wolfgang Schäuble was quick to see that the struggle over the division of costs was no longer between creditors and Greece, but between public and private creditors. Faced with a growing risk for German taxpayers, he passed on some costs to European banks. By that stage, bond restructuring didn’t do Greece much of a favor: the PSI deal reduced its debt-to-GDP ratio temporarily while mauling its banks.

The bailouts, even the belated Greek debt restructuring, weren’t about the debtor countries. They weren’t about an efficient or fair allocation of losses between debtors and creditors, or about promoting the right incentives on both sides of Europe’s debt divide.

They were an exercise in realpolitik.

The troika was invented so that creditor governments wouldn’t be seen as directly dictating terms. The creditors needed an go-between and a scapegoat. (The reason for a troika, rather than an EU dvoika of Commission flanked by ECB, is simply that Berlin doesn’t trust Brussels, viewing it as neither tough nor competent enough.) The troika’s discretion is strictly limited, as the IMF discovers every time it tries to talk to Germany about forgiving some of Greece’s debt.

The European Parliament doesn’t want to pick a fight with core countries on behalf of the periphery. The MEPs involved have made that clear. Instead, their interest is in defending the EU “community method” – especially the role of the European Parliament – against European leaders’ resort to intergovernmental diplomacy to manage the crisis.

For the MEPs, the problem with the troika is that it’s an ad hoc creation outside the EU treaties that give the European Parliament a say.

But for Europeans who still support the idea of uniting the continent, the problem is that the troika stands for Europe’s division and the tyranny of the creditors.

6 Comment(s)

  • Posted by: Tsigantes

    Brilliant article Nick.

    Now Greece is in worse danger.

    - Despite having made the biggest financial adjustment in history,
    - Despite having achieved a primary surplus 5 times bigger than Troika's projection (1.4-1.5 bn against 300m),
    - Despite Greek banks having laid aside 9% reserves (instead of the EU 8%) and being 90% state-owned and without problem,

    Troika plays games with the clean Blackrock report, delaying acceptance from December 2013 to January to February to ?? to forever postpone Greece's return to markets via the sale of bank shares; thus contributing to an 18 bn funding hole until 2016.

    On this fabricated basis Greece will therefore not be eligible to exit the program in April 2014, despite having met its conditions, and Troika stays.

    "The troika was invented so that [tyrannous] creditor governments wouldn’t be seen as directly dictating terms."

    Now - lo and behold! - Germany offers to loan Greece 18 bn, with new German-only conditions. Germany's plans for policy interventions in Greece are being debated in detail now in the German parliament - as if (1) the loan is a 'done deal' and (2) as if it is suddenly normal or legal for one EU country to interfere / determine national policies in another EU country. Ergo, it is clear that Germany views Greece not as an EU sovereign country but a private colony of its German economic lebensraum.

    Germany no longer bothering to hide behind Troika anymore, except for using it as administrative arm.

    And Greece....?

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    • Posted by: H.Trickler

      Mr. Tsigantes is well known for allusions without clear answers. Make a clear educated guess what Greece should do??

  • Posted by: Eleni Tsigante

    Excellent Nick.

    @ H. Trickler:
    And WHY did Greece refuse a debt haircut when it had chosen to place itself in the IMF program and this is the 1st step ? No doubt the reason will emerge later.

    Here's an educated guess:

    Either Greece
    (1) came under the same shotgun pressure as Papandreaou's referendum proposal
    (2) since Germany / France were insisted on PSI only (despite IMF rules of public & private debt cuts), Greece played for time in an effort to save its banks and in the hope that saner justice would prevail.

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  • Posted by: Alec Mally, IPEDIS

    It would be nice to know who the author is, the writer is hurling stones at just about everybody while trying to forgive Greece some of the worst possible governance and budgetary excesses of the last 30 years in any so-called democracy. Why not name yourself? And stop with the never-ending pleas for Greek debt forgiveness already by blaming the Troika's firemen for trying to assist....its just not going to happen.

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    • Posted by: Tsigantes

      "hurling stones at just about everybody" ?

      It is clear that you neither read this article in any depth nor comprehended its point ie that the Eurocrisis is a European problem, not a periphery problem. You may choose to disagree with that, but then you need to provide an argument.

      The article contains no plea for forgiveness for past Greek political mismanagement. It fully acknowledges it.

      And in case you have missed this, since 2010 the Greek people, at enourmous cost to themselves, have achieved an unprecedented single largest fiscal adjustment in history, and a primary surplus in 2014 five times the value of what Troika projected. This incredible feat has been acknowledged by the IMF, EU, ECB, OECD, the US government and Fed, the markets and economists everywhere.

      The moralistic blame game is now clearly redundant. It has no application, and no place in the present.

  • Posted by: H.Trickler

    While the link at wsj is objective this article from unknown author imho is too biased. It forgets to mention that in 2010 Greece refused a debt restructuring.

    The link to shows various diverging opinions which after all do not justify the title of "tyranny of the creditors".

    Anybody interested in the opinion of the old style and experienced German banker Ludwig Poullain in 2012 can read

    He correctly predicted the current outcome and suggested that Greece should have gone default.

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