01/03/2017 Greek debt crisis

Financial Markets and Institutions

EFN425: Assessment Item No. 1

Pierre Meziane
9895191
 Pierre Meziane, 9895191, EFN425 Financial Markets

Summary
Financial innovations to obscure true debt level. ................................................................................... 5
Financial regulation in Greece. ................................................................................................................ 6
The role of banks within Greece. ............................................................................................................ 8
Potential financial contagion within the Eurozone and the international financial system. ................ 10
Moral hazard and financial institutions that have lent money ............................................................. 12
REFERENCES : .......................................................................................................................................... 14
 Pierre Meziane, 9895191, EFN425 Financial Markets

Since its establishment, one the most threatening events to the Eurozone has been the Greek
debt crisis in 2008. Greece was finally able to join the Eurozone in 2001 after meeting necessary
requirements (such as cutting into public spending and implementation of austerity measures).

After the elections in 2009, Greeks discovered the unimaginable: the public deficit was not of 6% but
of 12.7%.1 The deficit corresponds to 115% of the GDP, which was massive: Private actors held the
debt, which meant it was even more volatile (graph)! From A, the credit rating of Greece shows a
depreciating pattern on monthly intervals.

Nobody wanted to buy Greek debt therefore its treasure bond lost value: the country was not able to
close its budget anymore and had to call for international help.

In April 2010, an agreement was found with the EU: a first rescue plan (the Troika) of 110
billion euros is set up with the European central bank, the European Commission, and the
International Monetary Fund.2 This came with a price, namely that Greece had to adopt a tough
austerity plan which involved freezing civil-service salaries, long-term pension contributions and tax
increases.

Originally, this plan was not well accepted in Greece. There was turmoil in mid-2015 when the EU
and Greece failed to come to an agreement. Athens unilaterally broke negotiations. When they faced
financial collapse of their whole system, a third agreement was signed.

First I will discuss the financial innovations that helped Greece to obscure true debt levels.
Then, I will present the financial regulation system in Greece and its changes. Furthermore I will
highlight the role of banks within Greece and potential financial contagion of the crisis within the
Eurozone and beyond. Finally, on a moral level there was a hazard on the part of financial institutions
that have lent money to Greece.

1,2
From Karamanlis to Tsipras The Greek Debt Crisis through Historical and Political Perspectives

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 Pierre Meziane, 9895191, EFN425 Financial Markets

Financial innovations to obscure true debt level.

How could Greece accumulate such a massive debt, without anyone noticing?

Source: ECB

It appears that the precedent government started using financial tricks to hide their debt in
order to enter Eurozone. 1 The fact that the Greek debt contained significant loans in various
currencies outside of the Euro was raising their debt level because of the rise of the yen and the
dollar against the Euro in 1999-2000.2

They conclude a pact with Goldman Sachs3 to initiate a swap on their debts in 2000 and
2001: the idea of this operation is to change the currency of the debt when you contract it and when
you refund it. It is not illegal but what is more controversial is that Greece and Goldman Sachs played
with the exchange rate (artificially founded on a historical one), which led to a dissimulated loan
from the country Eurostat could not spot. The rate was so advantageous that Greece was able to
borrow more for the same price. It allowed Greece to hide more than 2 billion euros of debt from
this institution responsible for monitoring EUs countries debt level. This corresponds to 2% of its
owing debt, and allowed compliance with the Maastricht treaty.

Moreover, they falsified their declarations regarding public hospital liabilities and hid an
additional 4.8 billion . Eurostat discovered issues regarding payments to pharmaceutical industries
in 2009-2010.4 This was perhaps even more criticisable than the Goldman Sachs agreement because
it was a large contributor to the undesirable effects on Greek welfare. There were active efforts
made to keep this out of the public eye and Eurostat regulatory bodies.

Finally, the last trick used involved moving the debt from the government to public
corporations (17 were concerned) hiding an additional 18.2 billion .5

As a result of these tricks, Greek living standards were maintained, further widening their debt.
Which brings to question the nature of financial regulation working in Greece.

1
Greeces Debt Crisis: Overview, Policy, Responses, and Implications
2
https://www.ecb.europa.eu
3
http://www.goldmansachs.com/media-relations/in-the-news/archive/greece.html
4,5
Truth committee on public debt

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 Pierre Meziane, 9895191, EFN425 Financial Markets

Financial regulation in Greece.

Banks are the cornerstones of an economy: they influence entrepreneurship, economic

growth, labour market conditions and poverty. Lack of regulation is one of the fundamental causes to
2008s crisis.

First of all, Maastricht treaty was not properly enforced: Greece was allowed to join the Eurozone
even though it did not have the competitive edge or the internal structure to withstand the euro: it
experienced -9.1% account deficit between 2003 and 2007!1

The nave goal of regulation is to prevent a bank from having too much debt compared to
their capital: this was what Basel I agreement of 1988 was about. Its main purpose was to protect
international financial stability.2 However, a distinction was made between OECDs debts and non-
OECD in weighing risks, which was too great. To fix this, the Basel II agreement was created. But the
EU Capital Requirement on Directives changed the way they were written by keeping the risk-free
status of EU sovereign exposures.2 This encouraged banks to invest in risky countries for which they
did not have to hold capital. The fact that these credits risks were under evaluation provided a cheap
way of funding for Greece and this is certainly what allowed her to build this massive amount of
debt.

The EFSF was created in 2010 (with a lending capacity of 440 billion) to deal with the crisis.3
Nonetheless, one can argue that this further complicated the economic situation in Europe by
creating additional debt instead of solving the problem. The Greek Financial Stability Fund was
created in the same year4.

1
Lessons from the malfunctioning of Eurozones financial system
2
The European sovereign-debt crisis: a failure of regulation?
3
The Greek debt restructuring: an autopsy
4
"Greek fiscal crisis and measures to safeguard financial stability ",

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 Pierre Meziane, 9895191, EFN425 Financial Markets

However it appears that these last regulations were not about preventing crisis but rather
containing its effects. The problem was about the financial regulation which failed: Basel III
agreements goal was to avoid a situation like this in the future by increasing the required level of
capital and its quality, reducing systemic risk and giving enough time for transition.1

Which leads to an issue of foreseeability regarding the Greek situation by the banking sector.

1
Is Basel III a Panacea? Lessons from the Greek Sovereign Fiscal Crisis

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 Pierre Meziane, 9895191, EFN425 Financial Markets

The role of banks within Greece.

Banks in Greece offer the same liquidity transformations as everywhere in the world by
taking deposits and providing long-term loans. Nevertheless they have had an important role in the
Greek debt crisis.

With the Greek approval to be a part of Eurozone in 2001, the cost of living for many people
increased. Greek banks pushed people to contract loans to finance growth, which in turn were
borrowed from overseas lending authorities (FDI are long term investment and Non-FDI are short
term investment).1

GREECE 1998 2000 2001 2008 2010

Home loans 7,007 11,164 15,516 77,386 80,155
Personal 3,035 5,511 7,852 36,412 35,061
loans
Business 32,731 42,999 50,908 132,457 123,243
loans
TOTAL 42,773 59,674 74,276 246,255 238,459
In million. Source: Bank of Greece

The number of loans to households increased a lot whereas the deposits remained at the same level.

GREECE 1998 2000 2001 2008 2010

Household 71,843 88,644 103,388 185,424 173,510
deposits
Corporate 13,315 20,611 25,574 42,196 36,094
reserves
TOTAL 85,158 109,255 125,962 227,620 209,604
In million. Source: Bank of Greece

1
Myths and self-deceptions about the Greek Debt Crisis

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 Pierre Meziane, 9895191, EFN425 Financial Markets

This comparison shows that Greek banks relied on international loans to meet their
engagements. When the crisis of 2008 appeared along with confidence issues, the interest rates
exploded and it became harder and more expensive to contract loans for Greek banks.

The characteristic of Greek banks was that they didnt have lot of equity.1 They survived only due to
liquidities given by the European Central Bank after the international rescue call was made. Greece
could not have maintained its banking sector without external aid.

Many international banks got exposed lending money to Greece. There was a further issue with the
contagion of the crisis to Eurozone, which led speculations around its potential impossibility.

1
Financial crisis and financial market regulation: the long record of an emerger

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 Pierre Meziane, 9895191, EFN425 Financial Markets

Potential financial contagion within the Eurozone and the

international financial system.

The creation of Eurozone led to speculative action from private banks. It became more
interesting to invest in countries of the periphery such as Greece, instead of central countries
including Germany or France. There were good foundations for investment due to the Euros stability
and low likelihood of devaluation in the eventuality of unexpected crisis.

The ranking (bb+) by Standard and Poors led to an explosion of interest rates and fluctuations about
the price of Greek bonds. To fight the volatility, the standard course of action would involve making
the debt public, which was achieved by the first regulation. This was the goal of Troika achieved by
IMF, ECB, EC and European countries.1,2 The goal was to offer a safe exit for the private bondholders.

This might be the exposure that led to massive help and collectivisation of the debt by the EU. Which
was caused by anticipation of a further bank crisis that would be associated with a liquidity crisis.3

The crisis could have spread to other countries because of the assimilation effect: If Greece
is not able to withstand its debt anymore, why would Portugal be able to do so?. This was
demonstrated in 2011 when Moody reviewed Portugal, which set about a collateral effect on Spanish
and Italian bonds and due to shareholder panic increased their sale.4

1
http://www.pdma.gr/index.php/en/debt-instruments-greek-government-bonds/allocation-2005-2010
2
The Greek debt restructuring: an autopsy
3
Contagion during the Greek sovereign debt crisis
4
Contagion et crise de la dette Europenne

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 Pierre Meziane, 9895191, EFN425 Financial Markets

The main actor that avoided the spread of crisis was undoubtedly the ECB. The ECB injected
liquidities into markets to assist states in withstanding their obligations, whilst using the security
market programme to buy titles on fragile segment of the debt to prevent propagation of risks.

However it is obvious that the ECB could not solve the crisis once and for all. The creation of the FESF
insured that contagion ceased, fulfilling the role of financial institutions, such that cooperation with
central banks of European countries was possible.3

Institutional ethical compliance is a factor that may have reduced the severity of the crisis.

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 Pierre Meziane, 9895191, EFN425 Financial Markets

Moral hazard and financial institutions that have lent money

Many people and institutions used the Greek crisis to accumulate wealth at the expense of
Greece.

Goldman Sachs did not act ethically. The bank was supposed to give advice to its client. Even
though it realised the currency swap and received 600 million for it, they also bought credit
derivative swaps against the country, showing that they knew the country would not be able to pay
back its debt!1

The country got attacked by hedge funds2 , these succeeded financially due to speculations against
Greece. They have been trading CDS and naked CDS, which aggravated the situation of the country.3
To avoid these speculative attacks, naked CDS were forbidden by EU in 2012.4

Far from these private actors, the behaviour of BCE, IMF and EC is also criticisable. It appears
that the Troika and its measures of austerity violated human rights such as the right to work, to
health, to education, to social security, to housing, to self-determination and to justice.5

As an escalation of ethical misconduct these institutions started making profit on the back of the
Greece. The Eurogroup started reducing the interest rates and were eventually forced to repay any
benefits that they had reaped from such conduct.6

What is more important; Greeks rights or debt refunds? We can argue that the debt should be
declared illegal in these conditions, however, this brings up an issue of repayment.

1
http://www.goldmansachs.com/media-relations/in-the-news/archive/greece.html
2
Funds that are willing to take risks to make as much profit as possible. They do not always act in an ethical
way.
3
Credit default swaps : risk hedge or financial weapon of mass destruction ?
4
Regulation on short selling and credit default swaps Frequently asked questions
5
Truth committee on public debt
6
Eurogroup statement on Greece, 27 November 2012

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 Pierre Meziane, 9895191, EFN425 Financial Markets

Many actors had a role in the emergence of the Greek debt crisis, from private to public
ones: private banks (Goldman Sachs), central ones, ECB and European countries. Even though it is
certainly a consequence of the 2008 crisis, it showed that a new financial regulatory system was
needed and that improvements are still possible today.

Many ethical problems were raised: institutions such as hedge funds, Goldman Sachs and other
speculators made a lot of money during the crisis, even obliging the EU to forbid naked CDS. The
Troika infringed human rights in Greece and earned billions of euros in interest to the creditors.

In the meantime, Greeks struggled to live an everyday life, choked by the weight of their loans and
having troubles to buy food. They paid for the few politicians that played with their countrys debt.

The Greek debt crisis still have consequences today: if the crisis is not as critical as it was in
2015 when Greece almost defaulted, it is not entirely solved and is still a threat to the Eurozone. An
unlikely Grexit remains possible and this highlights the challenges Eurozone has to take on.

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 Pierre Meziane, 9895191, EFN425 Financial Markets

REFERENCES :

- BISTIS George, From Karamanlis to Tsipras: The Greek Debt Crisis through Historical and
Political Perspectives, Mediterranean Quaterly, 2016.
- NELSON Rebecca, BELKIN Paul, MIX Derek, Greeces Debt Crisis: Overview, Policy,
Responses, and Implications, Congressional Research Service, 2010
- Committee and the European Parliament, Truth committee on public debt, 2015
- ZETTELMEYER Jeromin, TREBESCH Christoph, GULATI Mitu, The Greek debt restructuring: an
autopsy, 2013
- SKAPERDAS Stergios, Myths and self-deceptions about the Greek Debt Crisis, 2015
- REPOUSIS Spyridon , " Greek fiscal crisis and measures to safeguard financial stability ", 2015
Journal of Financial Regulation and Compliance, Vol. 23 Iss 4 pp. 415 430
- LAZARETOU Sophia, Financial crisis and financial market regulation: the long record of an
emerger, 2011
- MINK Mark, DE HAAN Jakob, Contagion during the Greek sovereign debt crisis, 2012
- CONSTANCIO Vitor, Contagion et crise de la dette europenne, 2012
- VOUSINAS Georgios, Supervision of financial institutions, the transition from Basel I to Basel
III. A critical appraisal of the newly established regulatory framework, 2015, Journal of
Financial Regulation and Compliance, Vol. 23 Iss 4 pp. 383 402
- SHARMA Shalendra, Credit default swaps: risk hedge or financial weapon of mass
destruction?, 2013
- MEMO/11/713, Regulation on short selling and credit default swaps Frequently asked
questions, 2011
- EUROGROUP Statement on Greece, 27 November 2012, 2012
- JABLECKI Juliusz, The European sovereign-debt crisis: a failure of regulation?, 2012, Critical
Review, 24:1, 1-35, DOI: 10.1080/08913811.2012.684469
- DOBRA Alexandra, Lessons from the malfunctioning of Eurozones financial system, 2014
- VASSILIADIS Spyros, BABOUKARDOS Diogenis, KOTSOVOLOS Panagiotis, Is Basel III a
Panacea? Lessons from the Greek Sovereign Fiscal crisis, 2012
- https://www.ecb.europa.eu
- http://www.goldmansachs.com/media-relations/in-the-news/archive/greece.html
- http://www.pdma.gr/index.php/en/debt-instruments-greek-government-bonds/allocation-
2005-2010
- http://www.bankofgreece.gr/Pages/en/default.aspx

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