The Greek debt writedown and Merkel’s role in it

In his personal notes dated a day before the June 2012 general elections, Greece’s caretaker Prime Minister Panayiotis Pikrammenos wrote: “Anxiety is mounting. Anxiety in every respect – even and particularly regarding the banks. The telephone call with [German] Chancellor [Angela] Merkel went very well. […] I gave her a general briefing and then discussed my communications with [European Commission President Jose Manuel] Barroso and [European Council President Herman Van] Rompuy. She was strict on this point. Greece’s declaration that it would abide by its commitments was not enough. She wanted a clear statement that there would be no request for a renegotiation of the memorandum, as is being so gratuitously promised in pre-election campaigns. ‘They,’ she said – referring to the Commission – ‘do not have to answer to parliament.’”

It was the most dramatic moment, up until then, of a crisis that showed no signs of abating – and which was threatening to drag the global economy into another recession.

Twenty-five months after having approved, under pressure from a rapidly deteriorating situation, Berlin’s participation in the first bailout package for Greece, the German chancellor was without dispute the dominant figure on the European stage. In the period following the first Greek bailout and up until the end of 2011, she had managed to convince her eurozone partners to adopt new measures imposing fiscal discipline, while at the same time resisting calls for the mutualization of public debt, for example via the issue of eurobonds.

On the question of Greece she decided on a restructuring of the country’s soaring debt. This process, which took four months of negotiations and was completed (with all the requisite prior actions) just days before the first of two general elections in Greece in May 2012, at first appeared to be a success both because of the response from the private sector and because any legal difficulties had been avoided.

Election drama

However, political developments in Greece stubbornly refused to fall into line with the narrative of a successful restructuring. On May 6, conservative New Democracy and socialist PASOK saw their popularity plummet by a joint 45 percent compared to the support they had had garnered in October 2009. SYRIZA meanwhile shot to second place in the polls on an anti-austerity platform that combined leftist and anti-German sentiment. After a government failed to materialize and a new round of elections was announced, SYRIZA seemed to have the political wind in its sails, compelling New Democracy chief Antonis Samaras to pledge a renegotiation of the bailout deal in an effort to break SYRIZA leader Alexis Tsipras’s momentum. It was these promises that the German chancellor was alluding to in her exchange with Pikrammenos.

The Greek problem was turning into a hydra for Merkel. The initial bailout of 110 billion euros – 22.4 billion of which came from Germany – had failed to put Greece back on the path to growth and allow the country to regain access to international markets. Now, despite her decision to back a writedown of a significant part of Greece’s debt, she was faced with the rise of forces in Greece – both on the far left and right of the political spectrum – whose raison d’etre appeared to be waging war on the German approach to the Greek and – by extension – European debt crisis. Greece was in a deep recession, its economy shrinking for a fifth consecutive year, and unemployment was climbing inexorably toward the nightmarish milestone of 25 percent.

How, after all the twists and turns of the previous months, had the Greek problem reached a point where it was closing in on another dead end?

Going for a haircut

One of the points on which Greek Prime Minister George Papandreou and Merkel converged in regard to the European debt crisis was their suspicion that market “speculators” were compounding the crisis. Nevertheless, the first draft of the memorandum did not include a debt restructuring. Given German banks’ significant exposure to Greek state bonds and the moralistic approach to the crisis she had initially adopted, Merkel resisted the idea. Even at the second meeting between Papandreou and the chancellor, in Berlin in February 2011, the Greek premier continued to deny speculation about the possible participation of the private sector in a debt writedown.

However, the expansion of the European crisis – particularly after the October 2010 agreement between Merkel and French President Nicolas Sarkozy in Deauville, France, for a new approach to sovereign debt crises – along with the realization that the original estimates of the Greek program were wildly optimistic and the chancellor’s abhorrence of speculators – ultimately tipped the balance. In late June 2011, while congratulating Papandreou and publicly decrying Samaras for his resistance to the medium-term program that was voted through the Greek Parliament, and with the crisis spreading to Italy and Spain, her team was negotiating – mainly with the European Central Bank and Sarkozy’s people – the method and size of the Greek debt restructuring. Then-ECB chief Jean-Claude Trichet would overcome his visceral reactions even to a simple rescheduling of Greece’s obligations only after receiving assurances that Greek bonds held by the ECB would be exempted.

After the initial French-inspired proposal presented in July, which did not include a haircut on the nominal value of Greek bonds, Merkel became convinced that such a haircut was the only viable solution. For Berlin, it was a simple matter of arithmetic. Without a nominal haircut, Greece would need additional funding from the eurozone – something that Germany could not agree to. The French plan was rejected by the German chancellor as being too soft on banks.

During Papandreou’s third visit to Berlin in late September, the chancellor expressed Germany’s support for a “strong Greece inside the eurozone.” However, within the German coalition government the voices against providing more assistance to Greece were growing louder. Philipp Roesler, the German economy minister and chairman of coalition partner Free Democratic Party (FDP), started talking publicly about the possibility of Greece being ousted from the eurozone. Even more instrumental to the change in atmosphere was the stance of Finance Minister Wolfgang Schaeuble, erstwhile champion of a strong united Europe and a powerful support mechanism for Greece, who came to lead calls for an “amputation” of Europe’s infected limb – Greece – to stop the sickness from spreading.

A winning issue

Despite these objections, Merkel managed to turn the Greek crisis, which had initially hurt her image because of the hesitation she showed in dealing with it, to her advantage.

Anton Hofreiter, co-leader of Germany’s Greens and a severe critic of the chancellor’s European policy, says she has been able to turn it into an asset because “it was considered a success that Greece remained in the eurozone.” At the same time, “because of the excellent relationship she has discreetly cultivated with the media, where she enjoys universal support, she convinced public opinion that the economic catastrophe in Greece is solely the fault of its corrupt governments.”

“It is really unfortunate that the euro crisis first broke in Greece because it shaped the German view of the euro crisis as a morality tale, with fiscal profligacy assumed to be the main cause of the crisis,” said Megan Greene, managing director of Manulife Asset Management. It is this narrative that lies behind Merkel’s dominance over German politics but also behind her obsession with front-loaded austerity on a pan-European level.

The summits

At the end of October at two summits held over the course of five days, European leaders agreed on a second Greek program that included a 50 percent haircut on the nominal value of Greek bonds. Berlin’s insistence that the private sector shoulder its share of the restructuring was a catalyst for the decision. Papandreou, having realized that Berlin would not shift on this point, let the Germans lead the way.

On October 31, four days after the negotiations were completed, the chancellor learned, while watching TV, that Papandreou was planning to call a referendum on the issue. To this day her people insist that it came as a complete surprise. Papandreou’s aides, however, claim that the Greek prime minister had informed Merkel of his intentions during their meeting in Berlin weeks earlier.

At the G20 summit in Cannes, France, in November, Merkel let Sarkozy be the first to lambast Papandreou. The two leaders wanted to know how the Greek prime minister intended to handle the chaos that was bound to precede the referendum. They also stressed that the vote could not concern the terms of the memorandum. “They made it clear that the question of the referendum would be whether Greece should remain in the euro or not,” a source close to the talks told Kathimerini. This sealed the fate of the referendum idea, and also Papandreou’s political career.

The Papademos days

Leading a provisional government from November 2011 to May 2012, Lucas Papademos was the only Greek prime minister not to meet face-to-face with Merkel.

Nevertheless, they spoke on the telephone eight times, mostly during the critical period of January-February 2012, when negotiations about the debt writedown and the second memorandum reached a crucial juncture.

Athens was coming under increasing pressure to impose new cost-cutting measures, among them scrapping the holiday bonuses known as the 13th and 14th salaries in the private sector – a measure that had already been implemented in the public sector.

The writedown had to ensure the sustainability of the debt (set at 120 percent of GDP through 2020, with Italy in mind), while whatever deal was eventually signed had to also have the support of the political parties backing Papademos’s interim administration.

Relationship of trust

The former central banker had a relationship of trust with the Germans and particularly with Finance Ministry officials, many of whom he had gotten to know at Eurogroup meetings, where he was a regular participant between 2002 and 2010, as vice president of the ECB. The chancellor also knew Papademos personally and considered him a reliable partner from the days of the first crisis summits held in the wake of the Lehman Brothers collapse.

Merkel was not concerned with matters such the percentage of the haircut (eventually set at 53.5 percent). She intervened in other ways: Papademos’s decision to attend the crucial February 21 Eurogroup summit, for example, was taken after a teleconference a few days earlier with Merkel and Italian Prime Minister Mario Monti, during which the Greek premier was told that his presence would help soften Schaeuble’s opposition to the agreement.

Overall, however, the German chancellor allowed the technical teams to deal with most of the contentious issues. This was mainly out of respect for the hierarchy of the process, but also to limit the scope of the political negotiations.

“This is something we don’t get, even today,” said a Greek source who was part of the negotiations at the time. “Talks at the top political level can create a positive climate at the start and bridge certain divides later on. But all the hard work is done by the technocrats.”


* Next week, the last installment of the analysis will look into Merkel’s relationship with Antonis Samaras and the new era under Alexis Tsipras.

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