Greece’s budget was unraveling, Germany and the European Central Bank were at odds over the fix, revelations of secret meetings and cover-ups were sapping confidence in Europe’s crisis management -- and then came the encounter between Dominique Strauss-Kahn and the maid.
Strauss-Kahn’s May 14 arrest on charges of sexual assault left a void atop the International Monetary Fund, busting the one thing that had gone consistently right in the handling of the euro-area debt crisis: cooperation between European leaders and the Washington-based IMF. The fund’s contribution to Greece’s next loan was no longer a sure thing, said two European officials with direct knowledge of the talks who declined to be identified because the deliberations were private.
Confusion over the IMF share was part of a catalogue of missteps and miscommunication by Europe’s political elite that has scarred their effort to prevent Greece from slipping into the financial abyss. With Athens clinging to a lifeline opposed by taxpayers in Germany and Finland, the margin of error is narrowing and the crisis shows no sign of ebbing as it heads toward year three.
“It’s now not just a Greek, Irish or Portuguese problem: it’s a euroland problem,” said William Rhodes, a senior adviser to Citigroup Inc. whose new book “Banker to the World” recounts three decades of work on debt restructurings. “What’s happening in Europe has been hit and miss from one day to the next and the real danger down the road is contagion. All this squabbling spooked the markets, which now move in nanoseconds.”
The IMF’s approval July 8 to release a 3.2 billion-euro ($4.6 billion) installment for Greece plugged one hole in the rescue strategy just as others are opening up: talks with bondholders over rolling over Greek debt have prompted credit-rating companies to threaten default. Portugal was downgraded to junk by Moody’s Investors Service last week, leading bonds to slump in Ireland, Spain and Italy.
Work on a new Greek package to follow last year’s 110 billion-euro pledge continues at a meeting of finance ministers in Brussels today, with final decisions put off until September.
“No more short-term gimmicks,” Jeffrey Sachs, a Columbia University professor, told Bloomberg Television’s Tom Keene on July 5. European leaders “are treating this as a very short-term set of operations -- get through the next three months, get through the next six months. That won’t work. We need a bigger structure.”
Short-termism appeared to be working as late as Feb. 11, when the IMF and European authorities certified that Greece was “broadly on track” to rebuild its finances and started paving the way for the March loan installment. On April 1, with the yield on Greece’s 10-year government bond at 12.8 percent, then-Finance Minister George Papaconstantinou predicted a possible return to markets this year.
That went by the boards with the April 26 disclosure that Greece fell short of its deficit-cutting objectives in 2010, forcing it to look for more savings and pushing the 10-year yield to 16.2 percent. Simultaneous talks over a 78 billion-euro aid package for Portugal ate up more policymaking energy.
A private May 6 brainstorming session at Luxembourg’s secluded Senningen Castle captured the tension. A core group of finance ministers and ECB President Jean-Claude Trichet discussed Greece’s shortfall and German-driven talk of a debt restructuring, said Luxembourg Prime Minister Jean-Claude Juncker.
When German magazine Der Spiegel reported that the inner circle was discussing Greece’s exit from the euro, the currency tumbled the most against the dollar in a year. Juncker denied the meeting was taking place -- a line, he said a week later, that “immediately prevented further speculation on the markets.”
Ten days after that, deficits, deceit and restructuring formed the backdrop for a euro finance meeting that unfolded with Strauss-Kahn in solitary confinement in New York’s Rikers Island jail. John Lipsky, the fund’s second-ranking official, stayed in Washington to organize the stopgap IMF management.
Off to Brussels went Nemat Shafik, a deputy managing director barely a month at her post -- a technocrat specializing in the Middle East and Africa instead of the politically connected Frenchman. She reminded the Europeans that the IMF needed a 12-month funding program before committing its own money.
Greece was caught in the middle as it became increasingly clear that a 12 billion-euro disbursement due for July was the only thing standing between the debt-stricken country and default.
‘Lack of Leadership’
The absence of Strauss-Kahn, 62, who as French finance minister from 1997 to 1999 had played a role in setting up the euro, made itself felt. On the heels of the Brussels meeting, European Union President Herman Van Rompuy urged the IMF to quickly appoint a new full-time chief, saying on May 19 there was “a lack of leadership in solving the Greek crisis -- even the last days it was very clear.”
Lipsky came to his interim position aware of market doubts about Greece and European political solidarity. Investors “want to see delivery,” he told Bloomberg Radio on April 15. “They’re skeptical, they’re worried and now it’s up to the Greek authorities to carry through the rest of their European partners to provide the support.”
A former JPMorgan Chase & Co. economist nearing the end of a five-year term as the IMF’s first deputy managing director, Lipsky, 64, said two days before the arrest that he wouldn’t seek reappointment after his term expires in August.
‘By the Book’
Lipsky “played it by the book: he was staff-led,” said Peter Ludlow, a Brussels-based historian and author of “The Making of the New Europe.” “Strauss-Kahn was much more of a political animal who felt himself, and indeed was, above the book.”
European policy makers had operated on the understanding that Strauss-Kahn would deliver the IMF’s share, said the two EU officials. It soon dawned on them that, in his caretaker role, Lipsky couldn’t steer the IMF board in the way Strauss-Kahn could, they said.
More miscalculations followed. Lipsky didn’t spell out the assurances the IMF required to release its share of the July loan, first saying Europe needed to come up with a new three-year program for Greece, then that it didn’t, the EU officials said.
The IMF rejects suggestions of inconsistency. “The fund’s position on Greece has not changed,” Conny Lotze, an IMF spokeswoman, said in an e-mailed response to questions. “The fund has worked closely with the Greek authorities and the European partners in supporting Greece’s economic program. The success of Greece’s program has always been and still is the primary objective.”
Europe, meanwhile, was manufacturing its own distractions. Fueled by Juncker’s May 16 proposal of a “reprofiling” or “soft restructuring,” speculation swirled that Germany would force an extension of Greece’s debt-repayment schedule, leading to a formal default.
Greek debt continued to get hammered, with the yield on 10-year bonds reaching 17 percent on May 23.
Debt-restructuring speculation contributed to the worsening market psychology, EU Economic and Monetary Commissioner Olli Rehn said. “There was some distortion of attention to a discussion on debt restructuring and too little focus on program implementation,” he said in a July 1 interview.
Germany, which as Europe’s biggest economy is the main underwriter of the bailouts, faced pressure from all sides. The French government and ECB pressed for a “voluntary” bond rollover. President Barack Obama told Chancellor Angela Merkel at the White House that it was her job to halt an “uncontrolled spiral of default.”
While Merkel’s abandonment on June 17 of a forced restructuring bettered Greece’s long-term prospects, its chances of escaping default in July still hinged on the euro zone and IMF reading from the same script.
The two sides met again on June 19 in Luxembourg, with the EU’s Rehn forecasting an IMF green light after 10-year yields reached almost 18 percent. It didn’t happen. The European side was unable to commit to another Greek funding program until Greece passed a new, 78 billion-euro set of savings measures.
The IMF, in turn, wouldn’t move until Europe did. “The assurances that we need are typical,” Lipsky said June 21. The budget cuts squeaked through the Greek parliament a week later.
It took European government leaders, together tackling the crisis again after a three-month hiatus, to break out of the loop. Even then, they weren’t sure whether a June 24 pledge to set up the “main parameters of a new program” would bring the IMF on board.
And on July 2, a day after Strauss-Kahn was released from home confinement and New York prosecutors told a judge the case had been hurt by “substantial credibility issues” with the accuser, euro-area finance ministers approved their share of the 12 billion-euro payment to Greece, providing a lifeline to September.
“We’re entering a more critical phase because now the important decisions have to be made how the debt will be financed over the next three or four years,” said Christopher Pissarides, a Nobel Prize-winning economist who teaches at the London School of Economics. “So there is a lot more uncertainty in the market.”