FOR TWO years, Europe’s political, business, and press elites have produced disastrous diagnoses and even more disastrous prescriptions for Greece’s ills.
No convincing cure seemed in sight until Oct. 27, when the outlines of a plausible treatment plan emerged in Brussels. Europe’s leaders finally admitted what had been unspeakable: that Greece’s government needed major debt relief — a so-called “50 percent haircut’’; that Greece’s banks needed recapitalization; and that to stem contagion, a turbo-charged, leveraged-up financial stability fund must be created.
The markets soared on the news, and editorials proclaimed a “new beginning.’’ “Merkozy’’ - German Chancellor Angela Merkel and French President Nicolas Sarkozy - had apparently finally delivered a cure.
Within days, however, a call by Prime Minister George Papandreou of Greece for a referendum on the plan appeared poised to destroy Merkozy’s - and Europe’s - victory. Called to the G-20 meeting in Cannes in short order, Papandreou was told to relent immediately. Despite abandoning the referendum - and then surviving an overnight confidence vote - Papandreou surrendered office, hoping to save both the agreement and Greece. No one is sure what will happen next.
To many, it must seem that Dionysian Greece - after precipitating this crisis two years ago by failing its Apollonian neighbors with reckless borrowing and overconsumption - has once again failed. But that is not true - and in maintaining that view, both Europe and America deny the larger illness we all suffer, and the larger disaster we all face. The Brussels agreement was in fact an improvement for Greece over its immediate predecessor, crafted in Brussels in late July.
That midsummer cure - with its spurious “21 percent haircut’’ - was never completed due to disagreement over its details among governments and bondholders. Without agreement, Greece’s situation - and with it, Europe’s - steadily worsened. The Greek government and banks were running out of cash, at serious risk of the disorderly defaults everyone had long feared.
But the October agreement contained its own fatal flaw. The new plan was the outline of a rescue plan, but not a plan itself. Crucial details remained to be settled over the next 60 days - an unsustainable eternity for Greece and Papandreou. European banks, it turned out, had never fully agreed to the voluntary 50 percent haircut.
They quickly began signaling to Greek negotiators that they intended to claw back much of the 50 percent they were supposedly giving up. Meanwhile, Greek bank depositors - fearing delays in the recapitalization plan - began a run on their already cash-short banks.
Within days, German insurer Allianz was warning that such a run posed a new crisis for Europe. Behind the scenes, powerful owners of Greek banks - long accustomed to the banks financing their closely linked network of companies - were terrified by the Brussels accord, because it was ambiguous about how the recapitalization would take place, whether temporary nationalization would be invoked, and how the banks’ shareholders would be treated. They knew already that an audit ordered by the International Monetary Fund had exposed at least 15 billion euros worth of unrecognized non-performing loans, many to companies in their own network, bad loans that would significantly raise the costs of the recapitalization.
The banks are of enormous consequence in Greece - to the economy, which desperately needs lending restarted, and to the country’s most powerful financiers and business owners. Four of Greece’s five largest companies are banks; if not carefully managed, recapitalization could end up wiping out the plutocrats’ control of the banks and the calling of loans to their undercapitalized companies.
Papandreou, deeply committed to making the October deal work, thus faced a firestorm on multiple fronts: competitors in his own party who wanted his job; parliamentarians in his party who threatened to bolt over new austerity measures; the wholesale intransigence of opposition leader Antonis Samaras and his New Democracy party; and an economy that might collapse before rescue could arrive.
Calling for a referendum became his only instrument to fight both fires at once - by forcing Greek politicians and their powerful backers to back down and by forcing European leaders back to the table immediately to finalize a workable rescue plan in final form. He gambled on the referendum - and lost. Europe, however, has lost even more.
The new coalition may force through the October package now, but the divisions among Greek leaders will only widen, and with it, the fragile structure of Greek politics may well implode. With that implosion, the economy will fall even further - and as the economy falls, political violence will likely explode.
We’re now all about to see the consequences.
Harvard economist Richard Parker served as an adviser to Papandreou.