Inside the Euro Crisis

An Eyewitness Account

Simeon Djankov

• Publisher: Peterson Institute for International Economics
• Year: 2014
• ISBN:
  9780881326864
• Topic: Economics
• Subtopic: Monetary Policy
• Index: Economics

In mid-2009 Simeon Djankov, who had dealt with a variety of economic and financial crises as chief economist for finance and private sector development at the World Bank, was suddenly thrust into the job of finance minister of his native Bulgaria. For nearly four years in that post, he attended more than 40 meetings of European finance ministers and had a front row seat at the intense discussions and struggles to overcome the economic and financial crisis that threatened to unravel the historic undertaking of an economically integrated Europe.

In this personal account, Djankov details his odyssey on the front lines, observing Europe's fitful efforts to contain crises in Greece, Hungary, Ireland, Portugal, Spain, Italy, Cyprus, and France. He tells the inside story of how the European Central Bank assumed responsibility for the crisis, pledging to do "whatever it takes" to save the euro area. This candid book recounts the disagreements over fiscal austerity, monetary policy, and banking supervision, while focusing on the personalities who promoted progress—and those who opposed it. He also tells the dramatic story of the events that led to his own resignation as finance minister in 2013 over the policies he was pursuing to spare Bulgaria from getting sucked into the crisis.

1

Introduction

In July 2009, I became the finance minister and deputy prime minister of Bulgaria. I had left Bulgaria nearly 20 years earlier and had spent my entire adult life in the United States, first studying international economics and then joining the World Bank to work on corporate and bank restructuring, regulatory reform, and financial crises. I travelled widely while at the Bank and advised many governments, but had not worked in Bulgaria. As a result, I did not know any Bulgarian politicians. The only politician in my family was my great-great-great-grandfather, who was a member of four consecutive parliaments in the 1880s and 1890s.

Nor had I spent any time dealing with the problems of the European Union, which over the last dozen years had undertaken a transition to a single currency and the establishment of the European Central Bank (ECB). As I arrived at the finance ministry in Sofia, this unprecedented effort at European integration was facing an existential crisis that would require my full attention as a member of the Economic and Financial Affairs Council of the European Union (Ecofin), the monthly gathering of EU finance ministers. Bulgaria had become a member of the European Union in 2007, and so it was still a newcomer at the tables of various European gatherings. Meanwhile, the crisis emerging in Europe was raising doubts about the ability of Greece and other countries in southern Europe to survive continued membership in the eurozone. It also was reviving old questions about the advisability of the unified currency zone—questions that had been raised in Europe a decade earlier. Whether our countries were in the eurozone or not, all of us in Ecofin were forced to confront issues of how to save the eurozone, establish greater powers for the ECB to prevent bank runs, undertake structural reforms, and create a European fiscal union. My leadership position in the Bulgarian government thus bestowed on me an active role in the historic moment unfolding in Europe—a role I had not anticipated when I accepted the job.

This book is an eyewitness account of events in Europe from July 2009 to the spring of 2013. Specifically, it is an insider’s view of how some decisions were made, or not, and what thinking lay behind them. In the narrative, I also draw on my own experience in reforming some sectors in Bulgaria—for example, the painful but ultimately successful experience with pension reform in 2010–11. Meanwhile, during my term as finance minister Bulgaria was actively pursuing the idea of entering the waiting room to the eurozone, the Exchange Rate Mechanism II (ERM II), and therefore I was quite engaged in the euro crisis as it affected Bulgaria’s path to entry.

This book follows chronologically the events leading to the euro crisis and the various attempts at resolving the crisis until the spring of 2013, when my term as finance minister ended. Each chapter describes the important events that shaped the agenda in Ecofin and details the main policy responses whether implemented or not. In fact, many policy prescriptions during the euro crisis were never implemented, either because they were, upon further consideration, discarded as inadequate or because they were too bold and did not have enough political support. Their description here is, in my view, one of the main contributions of this book. It reveals how much energy was spent generating and refuting ideas on resolving the crisis and the small proportion of those ideas that ever turned into concrete actions.

A caveat—upon entering the Bulgarian government, I quickly learned that every day spent out of the country brought trouble at home. For this reason, I was forced to miss some important discussions with fellow finance ministers and European Commission experts. These discussions may have changed my mind on some of the topics discussed in this book. But this was the reality not just for me—one or another finance minister was absent for long stretches of Ecofin meetings. And one did not even have to wonder why: The international media would dutifully report rifts within the particular government or difficulties in upcoming elections. Domestic politics came first. Thus the view presented here is not objective. It shows the euro crisis through my eyes, and is limited by the great difficulties I faced in participating in euro crisis discussions while surviving Bulgarian’s rough and tumble politics.

How the Crisis Unfolded: Seven Tipping Points

Before describing my own involvement in the unfolding of the euro crisis, I briefly describe in this section the chronology of the crisis itself by framing it in seven tipping points that determined how it progressed.

Tipping Point 1. The first came on October 23, 2009, when Greek prime minister Georgios Papandreou admitted that Greece had lied about its budget deficits and debt for over a decade, and that the country’s public deficit would exceed 12 percent of GDP, or twice the level announced by the Greek government just a month earlier. Financial markets responded strongly to the admission of false statistics by demanding much higher rates on Greek bonds. Soon, the situation spread to three other countries with high government debt ratios and wobbly banking systems—Italy, Portugal, and Spain.

Tipping Point 2. This tipping point also came in October, but in 2010, when German chancellor Angela Merkel and French president Nicolas Sarkozy met in Deauville, France, and declared that the establishment of a permanent crisis management mechanism, to take over the temporary European Financial Stability Facility (EFSF) in 2013, was conditioned on amending the EU treaty to provide for the participation of private creditors. Introducing this idea publicly in the midst of a volatile market and without detailing how it would work was a mistake. Ecofin was blindsided—it did not have such a discussion in September. After Deauville, the crisis in Ireland spread outside the banking sector.

Tipping Point 3. A year later, on October 13, 2011, Slovakia became the 17th and final country to approve the expansion of the eurozone’s rescue fund, two days after its parliament rejected the plan. Legislators in Bratislava ratified expansion of funding for the EFSF to €440 billion ($610 billion). Ratification came at a high cost, however—the conservative government of Iveta Radičová fell as a result, less than a year into its term. But the eurozone now had a powerful instrument for acting quickly in case trouble befell another one of its members.

Tipping Point 4. The same month, on October 31, 2011, in a move that caught people by surprise, Greek prime minister Papandreou, announced plans for a referendum on the new bailout plan. Even his finance minister, Evangelos Venizelos, was unaware of this plan in advance. The eurozone leaders were seething. All the work in past months to show European resolve in dealing with the Greek crisis was put in jeopardy. Public opinion in Greece was clearly against the proposed conditions of the bailout, and the referendum would probably result in a rejection of these terms. But where to go from there? A suspension of aid to Greece and a subsequent default and exit from the euro seemed the most likely route.

Tipping Point 5. The fifth and most positive tipping point arrived on July 26, 2012. By then, the crisis was getting out of control, and so ECB president Mario Draghi announced that the bank would do “whatever it takes” to keep the eurozone together. The markets were relieved, and yields in the troubled European countries fell sharply. Responding to Draghi’s statement, investors became more comfortable buying bonds of the region’s southern rim governments. This was the single key decision that saved the eurozone and changed the course of the crisis. Draghi’s determination made everyone more confident that the remaining issues would be resolved with time.

Tipping Point 6. Another tipping point was the decision by Ecofin on December 14, 2012, to adhere to a single banking supervisor. Ecofin’s decision was confirmed by the heads of state the following day. This decision wiped out any remaining questions about whether European politicians were united in strengthening the euro. The reform required governments to yield control over the supervision of national banks to the ECB in November 2014.

Tipping Point 7. The seventh and final tipping point came on March 25, 2013, when the Eurogroup, European Commission, ECB, and International Monetary Fund (IMF) agreed on a €10 billion ($14 billion) bailout for Cyprus. It safeguarded small savers, but inflicted heavy losses on uninsured depositors, including wealthy Russians. The European Union was moving toward putting more burdens on bondholders and fewer on taxpayers. That approach was directed as much at Cyprus as at Slovenia, Spain, and other countries that might fall into further difficulties. The remedy in Ireland was quite different—the taxpayers footed the whole bill.

My First Impressions from Ecofin

How did these events look from my seat in Ecofin? Before providing these impressions, I will fill in the backdrop. In addition to the euro crisis, my team at the finance ministry had to deal with several other international issues. Relations with Russia on various energy projects occupied the top spot. In the course of my term in government, we cancelled a deal to build a second nuclear power station with Russian technology and terminated a project to build an oil pipeline transporting Russian oil to the Greek coast of the Adriatic. The second issue was one of continuous worry about the Bulgarian subsidiaries of several Greek banks. Analysts and investors feared that these subsidiaries would bring down the Bulgarian banking system, and we spent a lot of time arguing otherwise. Third was the euro crisis. I rank these issues to make the point that the euro crisis was not my foremost concern while in government, but it had an effect on most other decisions.

Ten days after my inauguration in July 2009, I went to my first Ecofin meeting in Brussels. Two things made an immediate impression. First, few of my colleagues had a formal education in economics or finance—5 of the other 26 finance ministers to be exact. Second, there was little urgency. We had to work around the expansive holiday schedules in Europe, and so my second Ecofin was in late September. By then, the Greek government had become mired in corruption scandals, and a week later, on October 4, 2009, Prime Minister Konstantinos Karamanlis resigned halfway through his second term.

During the next four years, Ecofin met over 40 times, and so I had plenty of opportunities to consider the main topic of the moment: the euro crisis. There was a constant focus on keeping Greece afloat and building a common fiscal policy to save the eurozone. In late 2011, the idea of a banking union surfaced and gathered speed the following autumn. The remaining agenda varied: saving Hungary, saving Ireland, saving Portugal, punishing Hungary, becoming worried about Spain, becoming worried about Italy, wondering when France would face up to its banking problems. By the time Cyprus blew up, we had been in the saving business for too long, and this is why Cyprus got the short stick.

There were moments of joy such as Estonia adopting the euro in January 2011. “A political decision,” the Estonians would say. “We want to be as far from Russia as possible.” During my last Ecofin, Latvia applied as well and was given the go-ahead to join the eurozone in January 2014. Latvia fully deserved it. It had suffered an 18 percent drop in output, accompanied by a rise in unemployment in 2009 and further fiscal tightening in 2010 and 2011, to maintain its version of a currency board.

There was success at home as well. After recording a 4.4 percent budget deficit in 2009 because of the previous government’s preelection spending spree, Bulgaria reduced its deficit to 2 percent in 2011 and 0.5 percent in 2012 and exited the excess deficit procedure at the same time as Germany. That put Bulgaria in the small group of fiscally responsible countries. Moody’s raised Bulgaria’s credit rating to BB+, the only rating increase in Europe between 2009 and 2012, before Estonia and then Latvia received upgrades. The ECB’s Convergence Report in 2012 noted that Bulgaria met all the quantitative Maastricht criteria, one of only three EU countries to do so. The remaining step was entry into ERM II. But I decided that this step had to wait until...

Table of contents

• Cover
• Title page
• Copyright
• Table of Contents
• Preface
• Board of Directors
• Overview of the European Union's Organizational Structure
• Chapter 1
• Chapter 2
• Chapter 3
• Chapter 4
• Chapter 5
• Chapter 6
• Chapter 7
• Chapter 8
• Chapter 9
• Chapter 10
• Chapter 11
• Chapter 12
• References
• Chronology
• Who's Who
• Glossary
• Abbreviations
• Index
• Back cover