Two days after the January 25 election that brought the far-left Syriza party to power in Greece, a remarkable op-ed[1] appeared in the Financial Times, arguing that Europe should offer Athens substantial debt relief. What made the article noteworthy was its author, Reza Moghadam, the former head of the IMF’s European Department, who played a major role in managing the Greek crisis from 2010 to 2014. Now a top official at Morgan Stanley in London, Moghadam was free to publicly advocate a solution--a 50% reduction in Greece’s debt--that is vehemently opposed by the European governments and institutions with whom he once worked in tandem.
Moghadam’s article provided stark evidence of divisions that have long riven the Troika, the tripartite group of crisis lenders that includes the IMF, the European Commission, and the European Central Bank (ECB). At many crucial junctures during the Greek crisis, the IMF differed with the other Troika members, although the Fund itself was often internally divided as well. Moghadam was one of the most influential figures in these behind-the-scenes battles, which I have been researching for a book about the crisis in the euro zone.
A look back at these episodes helps illuminate the current debate over how to deal with Greece, whose radical leaders swept to victory after a half decade in which economic output shrank by roughly one-quarter with a correspondingly wrenching impact on living standards. A standoff is underway between the new Greek government and the Troika; if not resolved, the result will almost certainly be Greece’s departure from the euro zone, with unfathomable long-term economic and political consequences. Among the key issues in dispute is whether Athens should be obliged to honor the debt it owes to European institutions and governments.
By retrospectively surveying the positions that major players took during the course of the crisis, the case for debt forgiveness becomes more understandable. It was European governments and institutions that most adamantly opposed restructuring Greece’s debt to private creditors, which economists widely agree took much longer than it should have. And it was European governments and institutions that most fervently insisted on austerity-oriented policies in the mistaken belief that such policies would help revive the Greek economy. The IMF too was guilty of many failings, but most of Greece’s massive debt is owed directly or indirectly to its euro zone partners, which can be fairly accused of having been the primary drivers of an approach that caused more suffering for the Greek people than was necessary.
At the same time, delving into these events makes it easier to comprehend Europe’s rejection of debt forgiveness, a position held especially firmly in northern European countries such as Germany and Finland. These countries’ policymakers have fiercely fought against measures, including some favored by the IMF, that would make the euro zone more like a “transfer union” in which rich member states systematically underwrite the finances of poorer ones. In the northern European view, canceling any part of the debt Greece owes its partners would overtly create a transfer union, with potentially disastrous effects on support for European unity.
The most fateful decisions were taken in the spring of 2010, when the Greek crisis first erupted. It is important to recall that at that time, powerful Europeans strongly resisted IMF participation in the rescue of a euro area country; the Fund secured a role thanks only to the insistence of German Chancellor Angela Merkel, who doubted the Commission’s skills and toughness in designing rescue programs. IMF Managing Director Dominique Strauss-Kahn had to promise that the Fund would be a “junior partner,” putting up a minority share of the loans Greece needed and refraining from the kind of dominant control over policy the Fund traditionally exercises in such situations. Although the Fund usually demands policy changes from the central bank of a country it is rescuing, for example, Strauss-Kahn accepted that the ECB (which sets monetary policy for the entire euro zone, not just Greece) would sit on the Fund’s side of the negotiating table rather than the opposite side.
Those were the circumstances under which the Troika came together in mid-April 2010 to negotiate a loan for Greece aimed at assuring that Athens would not default on its €320 billion debt. The Greek state had incurred this debt over years of deficit spending, and the ECB and the northern Europeans were determined to impose stringent conditions in exchange for a rescue. Apart from the desire to punish the Greeks for their profligacy was faith in the view that budgetary rectitude would generate “confidence effects” that could lift Greece out of recession. Moreover, the Germans were anxious to adhere, as much as possible, to the “no bailout” provision of the treaty establishing monetary union. Loans to a member state for the sake of preserving the euro might not violate those provisions, German policymakers concluded, but Berlin wanted to leave no doubt these were loans rather than outright transfers, which meant that the interest rate must be relatively high.
The IMF, represented in Athens by mission chief Poul Thomsen, tried to soften some of the Europeans’ harshest demands. Although Greece would clearly have to slash its budget deficit, the Fund was concerned about the counter-productive effect of excessive austerity. If Greece remained mired in its slump, its debt dynamics could become “explosive”--that is, its debt-to-GDP ratio, already high at about 115%, would burgeon in a vicious cycle of falling tax revenue, widening deficits, higher interest rates, and deeper recession, with the inevitable result being default. The IMF persuaded its Troika partners to ease Athens’ deficit-cutting targets so that the contractionary impact would be lessened somewhat. This still left the question of how to lift the economy out of recession, which the Troika addressed by demanding a far-reaching list of structural reforms and competitiveness-boosting measures. These reforms included revising laws that protect workers against firing, opening up cosseted professions, and streamlining bloated state enterprises--all of which were incorporated into a package the Greek government accepted in early May as the price for loans totaling €110 billion.
While that program was being hammered out, however, a number of IMF economists back in Washington, including Moghadam, were voicing skepticism about whether it would work, based on concerns that Greece’s debt was unsustainably high. Moghadam was then director of a department called Strategy, Policy, and Review (SPR), which has responsibility for ensuring that Fund programs and advice are applied in conformity with the institution’s standards. At Strauss-Kahn’s behest, a small group of staffers, including one of Moghadam’s top deputies, held secret meetings with officials from the German and French finance ministries to raise the idea of an orderly debt restructuring, in which creditors would agree to swap their bonds for securities of lesser value. These talks went nowhere, in part because there was no time to organize a restructuring before Greece would run out of money to pay bonds coming due. Moreover, as everyone involved was aware, debt restructuring was anathema to some of Europe’s most powerful figures, foremost among them ECB president Jean-Claude Trichet. The failure by any euro country to pay its obligations in full would lead to a region-wide financial conflagration, according to Trichet, who refused to even discuss the idea.
Despite deep misgivings among many members of its staff and executive board, the IMF accepted its lot as junior partner and approved its portion of the loans. In a move much criticized[2] as a cave-in to Europe, which holds a disproportionate share of the IMF’s voting power, the Fund even changed rules it had adopted in 2003 following the catastrophic default of Argentina. These rules, aimed at preventing the Fund from piling more loans on countries that are already insolvent, required Moghadam’s department to certify a “high probability” of confidence that Greece’s debt was sustainable. He balked, triggering a fight with other departments whose staffers believed the rescue stood a chance of succeeding. The rules were hastily re-written, watering down the “high probability” requirement, so that the loan could win board approval.
As months went by, it became increasingly clear that skepticism about the rescue was justified, and Greece would need a major debt restructuring. Athens was partly at fault for failing to deliver on some of its promises, especially regarding structural reforms. But a bigger problem was that the Greek economy was faring much worse than the Troika had projected, and the debt-to-GDP ratio was swelling alarmingly. Unfortunately, nearly two years would pass before a deep cut was made in Greece’s private debt burden.
At first, in the spring and summer of 2011, Greece’s overseers contemplated nothing more than a rescheduling of its private debt--that is, a stretching out of payments owed rather than an actual reduction. This merely delayed the inevitable and prolonged the country’s agony, a mistake for which responsibility is mixed. Much blame belongs with Trichet and his ECB colleagues, who threatened to cut off emergency aid to Greek banks if Athens tampered in the least with its debt obligations. The ECB’s rigid stance stifled discussion of more far-reaching debt restructuring proposals, even though German officials were by then eager to make private lenders share some of the burden of the Greek rescue.
The IMF, too, deserves criticism for its approach during this period. The Fund’s European Department had a new director, Antonio Borges, who was convinced that privatization of state assets could save Greece from its debt trap, and in early 2011 he got the Troika to set a new goal for Athens to obtain €50 billion by 2015 from asset sales and leases. Although many critics scoffed that privatization couldn’t generate anywhere near that much revenue in Greece (a prediction that proved dismally accurate), the insertion of this €50 billion bonanza into the program made Greece’s debt appear more sustainable, at least on paper. Later in the spring, Strauss-Kahn resigned after being arrested for assaulting a hotel maid, and the IMF was essentially rudderless for a number of weeks while European officials stitched together a plan for a debt rescheduling, which was agreed with private creditors on July 21.
By the fall of 2011, the Greek economy was emitting such dire signs that the July 21 pact was scrapped as woefully inadequate even before implementation could begin. At the IMF, where Christine Lagarde was now managing director, other key players were asserting themselves--David Lipton, the newly-appointed first deputy managing director, and Moghadam, who took command of the European Department. (Borges, who was seriously ill, left after just a year on the job.) Under this new team, the IMF’s debt sustainability analyses became much less rosy, showing that Greece’s debt-to-GDP ratio was on an explosive course that would peak at 186% of GDP in 2013 and, even assuming all went well, decline only modestly thereafter. On October 26, five days after that analyses was presented to European governments, leaders at a summit demanded that private creditors “voluntarily” accept a 50% cut in the value of their claims, which then totaled a little over €200 billion. It took until mid-March 2012 before that deal could be effectuated--the biggest debt restructuring in history, with the reduction in the net present value of Greece’s private debt estimated in the 60 percent to 70 percent range.
Even then, though, Greece’s debt remained mountainous--it currently totals about 175% of GDP, which instead of being owed mainly to private creditors is owed mainly to official bodies including the European Financial Stability Facility, the IMF, ECB, and European governments. Sadly, much of the money Athens borrowed from those bodies went to pay interest and principal on privately-held bonds. The IMF has tried to persuade European official creditors to write down some of their claims, with the aim of shrinking the debt-to-GDP ratio to 120% of GDP by 2020, an admittedly arbitrary target. But those creditors have been willing only to give Greece more generous terms--lower interest rates, extended payment periods, etc.--which, they point out, makes the country’s debt burden more sustainable. Having vowed to their voters that they were lending money to Greece rather than giving it away, they have been unwilling to reduce the total sum Athens owes them.
Small wonder, in light of the facts above, that Greeks feel justified in expecting debt forgiveness from Europe; the loans that Europe made funded a rescue program that failed, piling debt atop existing debt. Small wonder, too, that European governments recoil at this demand; from the outset of the crisis they have consistently clung to the principle that the euro zone must not become a transfer union.
One possible compromise is for Greece’s creditors to accept GDP-linked bonds, on which payments would vary according to whether the Greek economy is growing or not. But clearly, reconciling the conflicting positions is going to be difficult. If the current impasse is to end without Greece becoming the first country to abandon the euro, one side or the other—or perhaps both—will have to overcome a lot of history.
[1] Reza Moghadam, “Halve Greek debt and keep the Eurozone together,” Financial Times, January 27, 2015.
[2] The most trenchant critic is Susan Schadler, the former deputy director of the IMF’s European Department and now a Senior Fellow at the Centre for International Governance Innovation, where I am also a fellow. See, for example, Schadler, “The IMF Adrift,” November 8, 2012,https://www.cigionline.org/publications/2012/11/imf-adrift