The Alchemists: Three Central Bankers and a World on Fire (29 page)

With the value of Greek bonds plummeting along with the nation’s credit rating, global investors were quick to ask, “Who’s next?” The answer, to many in the financial sector and the media, was an acronym: “PIIGS,” for Portugal, Ireland, Italy, Greece, and Spain. Within the ECB, officials favored a different ordering of the same places. Their preferred acronym both put the nations roughly in order from most to least financially troubled and was at least somewhat less offensive to people who were natives of the countries in question. So the ECB focused on the “GIPSI” nations: Greece, Ireland, Portugal, Spain, and Italy.

Greece’s financial problems should have been inexpensive to solve. But by moving slowly and timidly in addressing the nation’s deteriorating financial position, European leaders ensured that a different price would be paid. Over the month of April 2010, the cost for Greece to borrow money soared to nearly 10 percent. The other GIPSIs also faced increases. Irish ten-year rates rose from 4.48 percent at the start of the month to 5.12 percent at the end. Portuguese borrowing costs rose from 4.22 percent to 5.14 percent.

It was herd behavior by global investors. In fact the GIPSI nations were very different from each other. The list included one country that was running huge annual budget deficits before the crisis (Greece) and four that weren’t. It included two countries that had very large amounts of total debt relative to GDP (Greece and Italy) and three that didn’t. (At this point, Spain actually had less public debt than fiscally sound Germany.) It included one country with flexible labor markets and a pro-business environment (Ireland) and four that put many obstacles in place to firing workers, cutting pay, or otherwise allowing businesses to adjust to a changing economy. Two nations were weighed down by huge losses in their banks (Ireland and Spain), while the others weren’t. Three countries are small enough that their financial rescue would have been easily affordable by Europe as a whole (Greece, Portugal, and Ireland); two are so large that a financial rescue could strain the continent’s resources to the breaking point.
Here’s a by-the-numbers summation
along with Germany’s numbers for comparison:

Even though the five GIPSI countries faced very different challenges, the markets started to view them as all in the same situation. Perhaps more problematic, so did many in the stronger European governments, imagining that the crisis was simply the result of profligate Southern Europeans spending money they didn’t have—and they tailored their solution accordingly.

As interest rates rose steeply for Greece that April, it was becoming clear that the March 25 strategy of merely pledging to back the nation wasn’t working. Greece had €8.5 billion in bonds coming due in May, and it was looking increasingly impossible for the government to roll that debt over—to find buyers for newly issued bonds—at an affordable rate. On April 23, Prime Minister George Papandreou acknowledged what had become obvious to anyone who understood the perils of debt dynamics in a country that owed so much money. Standing in front of a picturesque seaside scene on the Greek island of Kastelorizo, just off the Turkish coast, Papandreou invoked his country’s ancient history: “
It is a national and imperative need
to officially ask our partners in the EU for the activation of the support mechanism,” said the prime minister, saying the country would need €45 billion in emergency loans. “All of us—the present government and the Greek people—have inherited a ship that is about to sink. . . . We are on a difficult course, a new Odyssey for Hellenism. But we now know the way to Ithaca and have charted our route.”

It’s worth remembering that the original Odyssey lasted a decade and included run-ins with cannibals, a witch who turned the captain’s men into swine, and a violent one-eyed giant. The voyage Greece was about to undertake wouldn’t be that much more relaxing.

•   •   •

F
our days after Papandreou’s acknowledgment that Greece was out of options without an international bailout, the markets again turned against the nation, and hard. Standard & Poor’s cut Greece’s debt to junk status, judging the country no more creditworthy than the shakiest borrowers. The cost for the nation to borrow money for ten years rose to a new high of 9.7 percent on April 27. But that actually understates the challenge. It wasn’t just a higher interest rate that Greece was facing, but a shutdown in the function of its markets; there was, in effect, no longer a workable market in which the nation could borrow money. European leaders and the IMF returned to their negotiations to transform their vague concept of a Greek rescue into something more tangible.

All involved hoped that the deal announced on May 2 would be the end of the affair. It called for €110 billion to be provided to Greece over three years—the latest in an ever-escalating amount of cash being deployed to the country. Some €80 billion would come from the nations of the eurozone, the rest from the IMF—and they came with strings attached. Signed by Papaconstantinou and Provopoulos, the eighty-one-page memorandum of understanding with the IMF laid out what the Greek government would do to slash its spending and step up tax collection. It pledged a “
frontloaded multiyear adjustment effort
” reducing the annual budget deficit from more than 15 percent of GDP in 2009 to less than 3 percent by 2014. To make that happen, the Greek government agreed to raise taxes on cigarettes and alcohol, to put in place “presumptive taxation of professionals” so that doctors and other high earners couldn’t evade their taxes so easily, and to cut pay for public employees.

The ECB was neck deep in the negotiations; if the other eurozone governments were to come up with cash to bail out Greece, they wanted their central bank to be on board as well. “
We were also asked by the Heads of State and Government
, to make an independent judgment on whether or not it was appropriate for them to activate the bilateral loans that they envisaged,” Trichet said a few days later. “Their own decision would be taken only on the basis of our independent judgment.” To show its dedication to the cause, the ECB once again extended its willingness to help Greece by taking its downgraded debt as collateral from banks around Europe. This time, the central bank pledged to accept the nation’s debt indefinitely, no matter what might happen to its credit rating.

All this came at a price, however. If Trichet were to offer such extraordinary help to Greece and put its own balance sheet at risk, he would require that his staff have firsthand information about how Greece was faring in its austerity measures and reforms. Under the Greek memorandum of understanding, four times each year, a team of staffers from the IMF, the European Commission, and the ECB would travel to Athens to check on Greece’s progress in fulfilling its end of the agreement—with a passing grade needed to receive the next disbursement of bailout funds. Greek officials started calling this group the “troika.”

Suddenly, three organizations run by unelected officials—one of them the central bank—would effectively gain power over the taxing and spending policies of a democracy of eleven million people. The ECB was supposed to be insulated from politicians who might influence its decisions. But now the ECB would be doing quite a bit more than influencing the decisions of Greek politicians—it would, along with the IMF and the European Commission, be dictating them.

In the financial markets, there was a sense of relief. The Monday after the announcement, borrowing costs for the GIPSI nations fell and stock markets rallied. But, in an emerging pattern, the relief would be startlingly short-lived. As the week progressed, two things became clear: While Europe and the IMF might have come to Greece’s rescue, they had no broader plan to deploy financial force in other nations that might get into trouble. And within Greece, there were signs that the agreement the government had struck would have a hard time sticking.
The streets of Athens erupted in protests
, as tens of thousands of people assembled in Syntagma Square in front of parliament, many carrying bats or hammers, throwing rocks, or heckling the ceremonial guards at the Tomb of the Unknown Soldier. On May 5, the demonstrations turned deadly when suspected anarchists threw a firebomb into Marfin Egnatia Bank. Three people inside perished.

On financial markets, developments were also ominous. Greek ten-year borrowing costs, 8.5 percent at the start of the week in the warm afterglow of the IMF deal, soared to nearly 11.3 percent by Thursday and 12.4 percent Friday. And the contagion was spreading rapidly to the other GIPSIs. Ireland, for example, saw its rate rise from 5.1 percent to 5.9 percent. These blips on traders’ screens could cost the affected governments billions of euros a year in extra interest payments, making their already dire fiscal situations all the worse. If the trend were to continue, five countries with more than 130 million residents could very soon become insolvent. At that point, their only financial option might be to withdraw from the supposedly eternal eurozone and reintroduce their own currencies, which they could promptly devalue to lower their debt burdens. The result would surely be economic chaos across Europe and beyond.

Investors began to wonder just what the ECB might do to stop the panic from spiraling out of control. The core of the problem was that private buyers were selling off bonds. Could the ECB use its bottomless supply of euros to buy those bonds, thus pushing their interest rates down to more manageable levels? It would violate the spirit of the Maastricht Treaty, which specifies no money printing to fund governments. But by buying bonds on the open market instead of directly from governments, the ECB could get around that technicality. As analysts from the Royal Bank of Scotland wrote in a May 5 research note advocating such an action, “
Better breaking the rule-book
than breaking up the euro area!”

On May 6, the ECB’s Governing Council held its regularly scheduled meeting to decide on whether to raise or lower interest rates. Twice a year, the bank holds the meeting not at its headquarters in Frankfurt, but in one of the capitals of the eurozone. This was one such occasion—the council had gathered in Lisbon. Trichet led a session that Thursday morning that was utterly routine, with officials from across Europe all offering their five minutes’ assessment of the state of the economy. By Trichet’s design, they left unmentioned the burgeoning debt crisis, instead looking at data on inflation and concluding that interest rates should remain unchanged. The first question asked of Trichet at his press conference that afternoon was the obvious one: “
Is the purchase of government bonds an option
to fight the consequences of Greece’s fiscal crisis on financial markets? Did you discuss this option today?”

“On your first question, we did not discuss this option,” Trichet said, leaving the matter at that. When another reporter followed up a few minutes later, he replied, “I will simply repeat that we did not discuss the matter, and I have nothing further to say.”

Stock markets worldwide sold off on the sense that Trichet had no bond-buying plans up his sleeve. It wasn’t so different from the runs the likes of Northern Rock and Lehman Brothers had experienced two years earlier. Except now the entities losing their access to cash were the nations of Europe.

At 2:32 p.m. New York time—the ECB officials in Lisbon had already gathered for dinner, though their work for the day was hardly done—a large mutual fund company placed an order to sell $4.1 billion worth of contracts tied to the overall value of the Standard & Poor’s 500. Trading had already been choppy, with more dramatic ups and downs than usual as investors reacted to the latest news and speculation out of Europe.
The market was already down
about 3 percent for the day. Through a strange sequence of events still not fully understood, the $4.1 billion sell order—which, given the $10 trillion value of the S&P 500 index, shouldn’t have moved markets much—interacted with ultra-high-speed electronic trading systems to create a massive collapse in the market.

By 2:47 p.m., the Dow Jones Industrial Average had fallen 1,010 points, a loss of 9 percent of U.S. stocks’ total value. Prices for a share of some major companies, like consulting firm Accenture and Samuel Adams brewer Boston Beer Co., fell from double digits to a single penny in a matter of moments. By shortly after 3 p.m., the market was climbing back to its normal level, and it closed the day down 3.2 percent, not far from where it had been before what would soon be known around the world as the Flash Crash.

The episode had more to do with frailties in the U.S. stock market in a world in which trillions of dollars gush around through automated trades than anything that the ECB had done. But it wasn’t wholly unrelated to the crisis in Europe. The market had been falling all week as investors fretted about the Greek debt crisis. The Flash Crash was merely one particularly jarring piece of evidence of just how on-edge global investors had become over whether Trichet and his colleagues would intervene to keep Europe together. And given the uncertainty in those early hours (and days) about why it had happened, among the ECB officials themselves, it prompted a particular unhappy reaction:
Did we do that?