Washington – The first time that Timothy Geithner, the former US Treasury Secretary, realized that Europe was in deep trouble was in early February 2010, at the Canadian outpost of Iqaluit, just south of the Arctic Circle. It was the most unlikely place to ever hold a G-7 summit, he writes in his book “Stress Test”, which was published this week in the United States and is already sending shockwaves across the Atlantic.
He remembers that it was just before the opening dinner when he checked his BlackBerry for the market report: European markets were in turmoil, as Greece looked like it might be heading toward default. “The sudden panic in Europe was shocking. And the discussion over dinner was not reassuring. The Europeans spent most of the meal complaining about Greek profligacy and mendacity. There were strident calls for austerity and Old Testament justice, determined vows to avoid moral hazard, confident assertions that the crisis could be contained to Greece,” he writes.
He warned the Europeans that “if they were planning to keep their boots on Greece’s neck”, they also needed to assure the markets they wouldn’t allow defaults by sovereign countries. “Just don’t overdo it. If you don’t take out the risk of catastrophic failure, you have no chance of solving this,” he said. Still, Geithner realized that his position was compromised, as the Europeans didn’t want lectures from the US.
“They surely thought of me as the walking embodiment of moral hazard,” he writes, as Germany and France “still blamed our Wild West financial system for the meltdown of 2008. They weren’t going to be swayed by suggestions from the reckless Americans that they should take it easy on the reckless Greeks.” However, he notes that “Europe had enjoyed a wild credit boom of its own, with much of the risky borrowing in the periphery funded by risky lending by banks in the German and French ‘core’.”
His initial concern was nothing compared to what was to follow at the end of July 2012. Following two tense elections, Greece had formed a new government that vowed to proceed with the IMF-EU program, which had been boosted following the haircut on Greek sovereign bonds held by the private sector. On July 30, he flew to meet Wolfgang Schauble for lunch in the resort island of Sylt, where the German finance minister was vacationing. As he recalls in his book, “Schauble was engaging, but I left feeling more worried than ever.”
According to Geithner’s account, during the visit Schauble told him that “there were many in Europe who still thought kicking the Greeks out of the Eurozone was a plausible -even desirable- strategy. The idea was that with Greece out, Germany would be more likely to provide the financial support the Eurozone needed.”
It was a matter of public opinion: The German people “would no longer perceive aid to Europe as a bailout for the Greeks”. At the same time, “a Grexit would be traumatic enough that it would help scare the rest of Europe into giving up more sovereignty.” A Greek sacrifice could be just what was needed to form a stronger banking and fiscal union.
“The argument was that letting Greece burn would make it easier to build a stronger Europe with a more credible firewall. I found the argument terrifying,” he writes. As he goes on to explain, letting Greece go could create “a spectacular crisis of confidence.” The flight from Europe “might be impossible to reverse”. It wasn’t clear to him either “why a German electorate would feel much better about rescuing Spain or Portugal or anyone else.”
Geithner went on to Frankfurt to visit European Central Bank president Mario Draghi, who had recently promised to do “whatever it takes” to support the common European currency. After the meeting, however, the US officials was still unclear about what the ECB was prepared to do.
So when Geithner went back to Washington, “I told the President that I was deeply worried and he was, too”, he writes. As Geithner explains, the US recovery was still fragile and “a European implosion could have knocked us back into recession, or even another financial crisis. As countless pundits noted, we didn’t want that to happen in an election year, but we wouldn’t have wanted that to happen in any year.”