1. From the US subprime mortgage crisis to European sovereign debt 1

2. Greece: The epicenter of the Eurocrisis 2

3. © 2016 George K. Zestos  1821: Greek revolution against the Ottoman Empire.  1830: Establishment of the modern Greek state: “The kingdom of Greece.” ◦ Ruled by the young Prince Otto of Bavaria, as decided by the great powers of Europe at that time (the UK, Russia, and France). Prince Otto came to Greece accompanied by his own police and army.  1840: The Greeks revolted against King Otto, and demanded a constitution and the expulsion of the Bavarian army. Most of the demonstrations against King Otto took place in front of today’s Greek Parliament building, which was then the king’s palace. 3

4. © 2016 George K. Zestos  1960: Greece became an associate member of the European Economic Community (EEC).  1981: Greece joined the EEC as a full member.  2002: Greece became a member of the EMU.  2004: The Greek government, under the New Democracy Party, accused the previous government (PASOK) of fabricating the fiscal data in order to meet the Maastricht fiscal criteria needed for Greece to qualify for EMU membership. 4

5. © 2016 George K. Zestos  On November 5, 2009, the Prime Minister of the newly elected Greek government reported to the EU Commission that the previous government, under the New Democracy Party, had understated the Greek public deficit to the EU Commission.  Such news opened up a Pandora’s box and triggered the European sovereign debt crisis.  Since 2010 Greece has received three bailouts; nevertheless, each has been insufficient to restore financial stability. 5

6. © 2016 George K. Zestos  After Greek Prime Minister George Papandreou revealed the misreported public deficit, Greek interest rates skyrocketed. As a result, the country was unable to refinance its public debt.  Greece had accumulated a large public debt over many years. Greece entered the EMU with a public debt that was more than 100% of its GDP, which violated the 60% maximum allowed by the Maastricht treaty. 6

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8.  Although the Greek parliamentary opposition denied accusations of public deficit violations, the EU Commission insisted the Greek public deficit statistics were misreported and had to be revised.  Nobody knows what motivated the Greek Prime Minister George Papandreou to expose his country. However it is possible that if he had not made these accusations the Eurocrisis may have never erupted. 8

9. © 2016 George K. Zestos  In pursuit of profit, both investors (speculators) and credit rating agencies (CRAs) triggered the financial disaster in Greece.  They rapidly drove the quality of the Greek government bonds to junk status, and the interest rates on Greek bonds to double digits.  This is how the European sovereign debt crisis began. 9

10. © 2016 George K. Zestos  From 1995 until 2005, both nominal GDP and public debt grew at almost the same rate.  In 2005, the public debt surpassed GDP and continued to rise until it reached its maximum of €355 billion in 2011.  Nominal GDP reached its maximum of €232 billion in 2008. Since 2011, Greek public debt has stopped increasing, and leveled off to around €318 billion in 2013. 10

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12. © 2016 George K. Zestos  The Greek public debt remained high despite three bailouts and a Private Sector Involvement (PSI) program, i.e., a haircut, amounting to 52.5% of the nominal Greek public debt.  Since the bailouts were initially offered on unfavorable terms, this constitutes a reason for the increase of Greek public debt after 2010.  The three bailouts hardly provided any resources to the Greek economy, as almost all funding went to repay foreign creditors or to the recapitalization of Greek banks. 12

13. © 2016 George K. Zestos  For example the first Greek bailout was intended to save banks, insurance companies, and pension funds holding Greek government bonds.  Approximately 80% of the Greek public debt in 2010 was held by European banks (mainly French and German).  Analyst Ronald Janssen concluded that the Greek bailout transferred Greek public debt from the banks’ balance sheets to European governments. 13

14. © 2016 George K. Zestos  This analysis led Janssen and a few other analysts to believe that Greece would experience a deep recession.  During the second bailout only a small amount of the funds went to the Greek economy, and much of the money was spent rewarding speculators for gambling in high-risk investments. 14

15. © 2016 George K. Zestos  The prediction that Greek public debt would come down to 120% of GDP in 2020, as a result of the second bailout agreement, was overly optimistic and has little or no chance of being attained.  Figure 7.2 shows the total Greek saving from 1993 to 2014. Savings played a major role in the overall indebtedness of Greece.  In most of these years public saving was negative, thus reducing total Greek saving. 15

16. © 2016 George K. Zestos Source: European Statistical Annex 16

17. © 2016 George K. Zestos  Since high indebtedness is caused by low domestic saving and large trade deficits, it can be concluded that negative Greek public saving caused the rise of Greek public debt.  Several other factors also played a role in the high increase in the Greek public debt; one such factor was reckless public fiscal management. 17

18. © 2016 George K. Zestos  According to Figure 7.3 the performance of the Greek economy has been mixed.  From 1961-73 Greece experienced a period of high real GDP growth.  The period 1974-1993 was mixed, with both positive and negative growth rates.  During the period 1994-2007, Greece attained a relatively high annual real GDP growth of 3.26%.  From 2008 to 2014 Greece experienced a period of stagnation due to the Eurocrisis.  Therefore it was fiscally imprudent for the Greek governments to have applied expansionary pro-cyclical fiscal policy during the 1994-2007 period of high economic growth. 18

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20. © 2016 George K. Zestos  Figure 7.4 below shows the trade balance, current account, and public deficit for Greece from 1998 to 2014.  The public deficit declined almost every year from 1990 to 1999 in order to meet the Maastricht criteria. However, from 1999 to 2009, the Greek public deficit increased.  Such statistics constitute evidence that Greece applied expansionary fiscal policies during this period, implying reckless fiscal management. 20

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22. © 2016 George K. Zestos  Since 2009, the year the recession began spreading in Europe, the Greek government deficit has been decreasing to reach 1.6% in 2014.  This constituted the most astonishing fiscal consolidation in Europe during this period. 22

23. © 2016 George K. Zestos  From 1998 to 2008 Greece generated negative and increasing trade deficits, ultimately reaching a trade deficit of -19% in 2008.  Since 2008 the Greek trade deficit also began decreasing, helping Greece to generate a positive economic growth rate in 2014.  Prior to this period Greece suffered from high labor unit costs, high profit margins, and an overvalued currency since joining the EMU. 23

24. © 2016 George K. Zestos  Some analysts say the turnaround of Greece and other periphery EA countries provide evidence that internal devaluation works well.  Such a claim cannot be supported because a recovery through internal devaluation takes a long time, causing millions of people to suffer unnecessarily. 24

25. © 2016 George K. Zestos  It has often been pointed out that the increase in Greek public debt resulted from the failure of the Greek government to raise sufficient taxes.  Prior to joining the EU Greece relied mainly on printing money, inheritance taxes, import tariffs, and a few other taxes. As a result Greece did not have an efficient and equitable tax system. 25

26. © 2016 George K. Zestos  Additionally many Greeks were able to evade the Value Added Tax (VAT).  It was possible to conduct many transactions without paying the VAT and without being reported to the tax authorities. This was particularly true for those small villages where people tended to be friends and relatives.  Greeks did pay payroll taxes, however, as such taxes could not be evaded. 26

27. © 2016 George K. Zestos  After the crisis, the Greek government desperately needed to raise tax revenues to comply with the bailout conditions. As a result, it began placing taxes on almost anything that could be taxed.  Despite the government’s efforts to raise public revenue, it became more and more difficult to increase tax revenues as the Greek economy contracted. 27

28. © 2016 George K. Zestos  As a condition of the first Greek bailout of €110 billion, Greece launched a contractionary program of €30 billion between 2010 and 2013.  This fiscal program was to be implemented by increasing the VAT on many goods, and by raising the retirement age of many professions to 60; in 2015 the retirement age was further increased to 67 years of age.  The latter condition was a priority to appease the Germans who complained that they had to work longer years to bail out Greeks who retire early. 28

29. © 2016 George K. Zestos  After following strict austerity for one year, the Greeks revealed signs of fatigue; this led the government to slow down its reforms. Consequently, the Troika refused to release the fifth installment (tranche) of the bailout to Greece.  The Troika then imposed even stricter austerity measures in order for Greece to qualify for the fifth tranche. Specifically, Greece was required to pass the Medium-Term Fiscal Strategy (MTFS) into law.  This was a fiscal consolidation program of €28 billion; the reduction in expenditures required by this program was equal to the increase in taxes during the period 2012-15. 29

30. © 2016 George K. Zestos  In Autumn of 2011 conditions deteriorated not only in Greece, but in other countries including Italy and Spain.  Protests against the austerity conditions continued almost on a daily basis in Greece.  Most participants in the demonstrations were members of political parties or the labor unions, and protested peacefully.  The protests began as a grassroots movement inspired by a similar movement in Spain known as Indignados (Outraged). 30

31. © 2016 George K. Zestos  Amongst the peaceful protest groups a distinct one was the Anarchists, a single violent group that received much mass media attention.  The Anarchists, however, had been protesting “with or without cause” for many years prior to the crisis, and their concerns had very little to do with the austerity programs or the bailouts (Visvizi, 2013). 31

32. © 2016 George K. Zestos  Many studies have found that the most effective way to reduce public deficits is through a reduction in government expenditures, as opposed to an increase in taxes.  As shown in Figure 7.5 below, the fiscal consolidation designed by the Troika actually reduced both the fiscal expenditures and the tax revenues of Greece. 32

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34. © 2016 George K. Zestos  It is evident from Figure 7.3 that the bailout programs triggered an unprecedented depression in Greece, the worst in Europe since World War II.  Evidence shows that tax revenues decreased in Greece after tax rates increased.  Such a huge reduction in Greek GDP reduced the tax base, and this explains how tax revenues declined. 34

35. © 2016 George K. Zestos  Greece has failed to generate public revenues through privatization of public assets. As a condition of the first bailout Greece was, however, expected to raise €50 billion from the sale of public assets.  Negative publicity against Greece, that often came from Eurosceptic EU politicians and the Greek PSI (haircut) program, played a negative role in attracting investors to Greece. 35

36. © 2016 George K. Zestos  Toward the end of 2015 the Syriza government agreed to a 40-year lease of its regional airports to a German firm, Frankport.  The Syriza government only agreed because privatization programs were a condition for receiving the remaining amount of €86 billion of the third bailout, which was needed to avoid expulsion from the EMU.  This deal was heavily criticized by many Greeks as a sale of their country to Germany, who appeared to be determined to exploit Greece through some type of neocolonialism. 36

37. © 2016 George K. Zestos  The bloated Greek public sector was to a large extent caused by the continuous increases in public sector employment. ◦ Clientelism, a system under which politicians exchange jobs for votes during elections, was for many years a very common practice in Greece; thus this practice contributed to the increases in public sector employment.  Large military expenditures have also played a crucial role in expanding the public sector. 37

38. © 2016 George K. Zestos  On October 13, 2014 the Greek government decided to exit the bailout and borrow directly from the market, without a supporting credit line from the EU or the IMF.  Markets reacted nervously to the announcement of prime minister Antonis Samaras, who intended to borrow €9 billion from the market. As a result the 10-year Greek bond yields increased to 9%.  Markets reacted asymmetrically to Greece’s decision to refinance its public debt by not reacting as they did in the cases of Ireland, Portugal, and Spain when they made similar announcements. 38

39. © 2016 George K. Zestos  Several factors played a role in the asymmetric treatment of Greece by the markets compared to other bailout recipient countries: 1.Greece had triggered the Eurocrisis when Prime Minister George Papandreou revealed that the previous government had fabricated fiscal data. 2.EU country leaders never spoke with one voice in regards to Greece, so every few weeks mini-crises would cause people to wonder “if” and “when” Greece would leave the euro. 39

40. © 2016 George K. Zestos 3.The election of Syriza twice in 2015 demonstrated that the Greek people were opposed to the harsh austerity measures. 4.The elected left-wing party, Syriza, had promised to tear up the memorandum of understanding (the bailout). 5. The EU, guided by Germany, led Greece to the verge of total financial collapse in the summer of 2015, when Greece was forced to shut down its banks and implement capital controls. 40