The Euro Area Crisis - Gikas Hardouvelishardouvelis.gr/wp-content/uploads/2018/03/... · The PSI was finalized in February 2012: Largest restructuring in history Eligible paper for

The Euro Area Crisis and the Role of Greece

Gikas A. Hardouvelis Professor of Finance & Economics University of Piraeus Former Minister of Finance www.hardouvelis.gr

ANNUAL MEETINGS March 2, 2018

The Euro Area Crisis and the Role of Greece

Introduction

Greek vs. US Great Depression

Economic Policy Uncertainty in Greece

I. Greek Crisis Phase I

1) Why so deep?

2) Its aftermath: Debt rescheduling and a banking crisis

3) Euro Area moves to correct some of its deficiencies

II. Greek Crisis Phase II: Unnecessary?

1) Domestic Politics overcomes economic logic

2) Europeans in search of their future: Will the Euro Area survive ?

Concluding remarks

2 Gikas A. Hardouvelis

Greece

Greek Crisis Phase I

Date 0 is 1929 for the US, and 2007 for Greece: Real GDP is set at 100

The Greek recovery of year 10, 2017, is a forecast

After 10 years, the US was at 95 in 1939 but Greece at 74.5 in 2017

Fall 2014: Greece was forecasted to be around 82.4

At minimum, Phase II costs annually 7.9 ppts or ca. €18bn

Greek Depression worse than US Great Depression

Years following previous peak GDP

USA

Gikas A. Hardouvelis

Annual loss 25.5% relative to year 0

82.4

74.5

95

Greek Crisis

Phase II

Annual opportunity cost due to Phase II

Int/alCrisis

Source: Eurostat, European Commission, Focus Economics (Nov 2017)

3

0

50

100

150

200

250

Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

Russian Crisis. 9/11

Iraq War

Global Financial

Crisis.

1st Greek Bailout

Request.

Plans for Referendum by

Papandreou.

Incoclusive

Elections of May

2012.

Elections 2015 -

Syriza wins.

Tsipras'

Referendum.

Brexit

US Presidential

Elections, G.W.

Bush wins.

Plans for military

action against Iraq.New Property tax

is imposed.

Fail to elect new

President of

Hellenic Rebublic

- Snap Elections Notice.

Parliament

approves the

2017 budget.

The second review of the

third bailout program is

delayed.

Source: Hardouvelis, Karalas, Karanastasis, Samartzis, 2018, “Political, Economic and Economic Policy Uncertainty in Greece”

Greek Economic Policy Uncertainty over time


Greek EPU Correlation with EPU of:

Pre-

Crisis 1/1998

7/2007

International

Crisis

8/2007

9/2009

Greek Crisis

Phase I

10/2009

11/2014

Greek Crisis

Phase II

12/2014

12/2017

US 64.6% 78.8% 32.4% 7.8% EU 63.3% 74.3% 50.3% 0.5% Global 66.4% 90.5% 42.9% 0.5% France 34.8% 58.0% 35.0% 18.6% Germany 50.6% 62.2% 44.2% 6.8% Italy 57.9% 56.6% 27.1% 19.7% Spain 58.8% 45.1% 53.5% -3.4% UK 49.4% 66.7% 40.9% -18.2% Average Greek EPU

with (st.deviation)

86.55 (29.7)

89.18 (25.7)

111.31 (27.4)

130.47 (38.9)



Greek Economic Policy Uncertainty and its correlations vary across the different crises

Sources of Greek Economic Policy Uncertainty Relative contribution of Monetary Policy Uncertainty EPUM is minimal and declines Relative contribution of Currency (or GREXIT) uncertainty EPUC rises during the crisis Relative contribution of Banking Uncertainty EPUB rises during the crisis Relative contribution of Fiscal uncertainty EPUF declines during the crisis

Before the crisis Jan 1998 – July 2007

During the consecutive crises Aug 2007 – Dec 2017

Source: Hardouvelis, Karalas, Karanastasis, Samartzis, 2018, “Political, Economic and Economic Policy Uncertainty in Greece” 6 Gikas A. Hardouvelis

EPU Composition

EPU EU POLU EPUB EPUP EPUF EPUC EPUM Actual Change

Ind.Pr -14.2% -6.5% -6.6% -6.4% -2.5% -8.2% -8.7% -4.8% -11.3%

Empl. -8.0% -5.2% -5.7% -3.4% -1.5% -3.9% -5.3% -2.3% -7.4%

Ec.Sent -19.8% -17.7% -11.2% -16.0% -11.9% -6.3% -10.8% -4.4% -14.5%

ASE -69.6% -72.1% -54.1% -36.8% -24.6% -41.3% -41.1% -14.9% -56.3%

10-yr r (bps)

1081 978 1174 302 426 326 736 229 1126

H.Dep. -21.3% -24.8% -27.9% -8.5% -6.2% -0.9% -14.0% -4.8% -30.4%

G.D.P. -8.2% -4.7% -6.4% -2.5% -1.5% -8.2% -9.3% 1.4% -26.0%

Invest. -24.4% -11.9% -17.8% -6.6% -3.6% -24.6% -28.2% 5.5% -69.0%

3-year cumulative effect of 30% uncertainty shock

Crisis sample VAR model estimates (Aug2008 – Dec 2017). Eight separate models in 8 columns. The actual changes of Industrial Production, Employment, Economic Sentiment, Athens Stock Exchange index and

10-yr yield are the % changes of their average values from the period 1/98-7/07 to the period 8/07-12/17. The actual changes of Household Deposits, GDP and Investment are the % changes of their values from July 2007

to December 2017.


7

I. Introduction

Greek vs. US Great Depression



1) Why so deep?





2) Europeans in search of their future: Will the Euro Area survive

Concluding remarks


CY

GR

PT

IT

FR

DE

EA-12

AT

NL

BE

IE

ES

LU

FI

y = 1,96x + 3,22

R2 = 0,64

-15

-10

-5

0

5

10

15

-8 -6 -4 -2 0 2 4General Government Balance

% GDP, avg. 1999 - 2009

Cu

rre

nt

Ac

co

un

t B

ala

nc

e

% G

DP

, a

vg

. 1

99

9 -

20

09

Twin Deficits

Twin Surpluses

I. IMBALANCES DIVERGE WITHIN EMU

Source: European Commission

Average annual external and fiscal balance in EA-12 before the Greek/EMU crisis hit in early 2010

Greece is the biggest outlier, needs to improve competitiveness and its fiscal balances

Post-EMU, a competitive North and an uncompetitive South emerged

Greece suffered from lack of fiscal discipline and lack of competitiveness as shown in the Figure

Private sector leverage was not the problem

I. Severe macroeconomic imbalances bring Greek Crisis Phase I


I. Greek Fiscal imbalances over time

5.9%

6.7%

10.2%

15,1%

11.2%

10.3%

6.6%

3.7% 4.1%

3.1%

-3.3% -0.7% -0.3% -1.7%

1.5% 2.2% 5.4% 10,1% 5.3%

3.0%

1.5% -0.4% 0,1%

-0.5%

-3.8% -2.4% -3.8% -3.5%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Fiscal Balance (€ bn) Prim. Balance (€ bn)

Fiscal Balance (%GDP) Prim. Balance (%GDP)

%

GDP € bn

Fore-

casts


Peek imbalance in 2009 By 2013 the Primary Balance was back to almost zero

I. Fiscal austerity brings Recession

A vicious cycle of more fiscal austerity causing a deeper recession

An apparent fiscal multiplier close to 2 as a reduction in primary deficit of 9% GDP resulted in a drop of 17% in real GDP

FRBE

DEFI

ATLU

EESK

NL

SI ITES

PT

IE

ELy = -1,73x + 8,05

R2 = 0,51

-20

-15

-10

-5

0

5

10

15

-2 0 2 4 6 8

General Gov. Primary Balance % of GDP

Δ(2012 - 2009)

Re

al G

DP

% c

ha

ng

e 2

01

2 -

20

09


I. Greek Current Account imbalances over time

-16.0%

-14.0%

-12.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0% 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Fore-

casts

%

GDP


Peak imbalance in 2007-2008 Complete correction by 2015

0

400

800

1200

1600

2000

2400

2800

Sep-92 Sep-94 Sep-96 Sep-98 Sep-00 Sep-02 Sep-04 Sep-06 Sep-08 Sep-10 Sep-120

200

400

600

800

1000

1200

1400

10-yr spreads over bunds (September 1992 – September 2012)

Note: Data are monthly averages Source: Eurostat

Start of Euro Area

I. The crisis decouples bond yields in the Euro Area

bps (GR) bps

(Greek spreads are measured on the left axis)

Greece

Portugal

Cyprus

Spain

Italy Ireland


Ι. Major debt restructuring brings a banking crisis


The PSI was finalized in February 2012: Largest restructuring in history

Eligible paper for restructuring : €205.5bn

€177.3bn (86,3%) under Greek Law, retroactive CACs were imposed on them

€28.2bn (13.7%) mostly under British Law

About €198.2bn were swapped for new bonds:

“Cash” 15% of old FV or €29,7bn

New Bonds under British Law with FV = 31.5% old FV (or €62.4bn) with annual maturities from Oct 15, 2023 to Oct 15, 2042 and with coupon 2%, rising to 3.4%

Detachable GDP-linked securities (if GDP > forecasts) whose ≤ 1% FV)

Greek banks lost €38bn or 170% of their capital (equivalent to 10.1% of their assets)

Four deemed to be systemic and were recapitalized mostly with funds from the second economic adjustment program. Most others were liquidated and sold.

The banking crisis was equally big in Europe

0

50

100

150

200

250

300

Oc

t-0

4

Ap

r-0

5

Oc

t-0

5

Ap

r-0

6

Oc

t-0

6

Ap

r-0

7

Oc

t-0

7

Ap

r-0

8

Oc

t-0

8

Ap

r-0

9

Oc

t-0

9

Ap

r-1

0

Oc

t-1

0

Ap

r-11

Oc

t-11

Ap

r-1

2

Oc

t-1

2

Ap

r-1

3

Oc

t-1

3

Ap

r-1

4

Oc

t-1

4

Ap

r-1

5

Oc

t-1

5

Ap

r-1

6

Oc

t-1

6

Ap

r-1

7

Oc

t-1

7

Euro Stoxx Banks Index Euro Stoxx ex Banks Index Greek Banks Index S&P 500 Banks Index

Index, September 30, 2004=100

II. ΟΙ ΤΡΑΠΕΖΙΚΕΣ ΜΕΤΟΧΕΣ ΧΤΥΠΗΘΗΚΑΝ ΠΕΡΙΣΣΟΤΕΡΟ ΣΕ ΣΧΕΣΗ ΜΙΣ ΥΠΟΛΟΙΠΕΣ ΜΕΤΟΧΕΣ

Feb 2018: European financial stocks at 80% of Sept 2004 vs US financial stocks at 147% of Sept 2004

Yet European non-financials at 280% in Feb 2018

Greek banks at zero at the end of 2011

I. The evolution of stock prices

Gikas A. Hardouvelis 15

Note: Indices include Dividends

Source: Bloomberg

Int/nal Crisis begins

Greek crisis begins

Greek Banks

European Banks

European Non-Financial Stocks

US Banks

0

50

100

150

200

250

300

350

400

Jan-07 Aug-08 Mar-10 Oct-11 May-13 Dec-14 Jul-16 Feb-18

Ι. CDSs reveal the European Banking Crisis

itraxx 5-yr CDS spreads of senior European financials

bps

Source: Bloomberg

May 2010 1st Greek bailout program

Mar. 2008 Northern Rock Bear Sterns Incidents

Sep. 2008 Lehman Brothers collapse

Mar. 2009 AIG record quarterly losses

Dec. 2011 ECB announces 3-yr LTROs

May 2012 Greek Elections

Mar. 2013 Monte dei Paschi incident

Jul. 2012 Draghi: “whatever it takes”

58.8 22/2/2018


Despite the conflict, some reforms were initiated:

Banking Union Single Supervisory Mechanism (on 130 large banks since November 2014)

Single Resolution Mechanism (Bail-in feature, Bank Recovery and Resolution Directive, a further backstop proposed in Dec 2017)

European Deposit Insurance scheme - still pending

European Stability Mechanism (since Sept 2012)

Stricter fiscal rules

The crisis was avoided thanks to an expansionary monetary policy by the ECB , also with unconventional measures (SMP, LTRO, OMT, QE, etc.)


Ι. Euro Area responds to the crisis

During the crisis, the European response seemed to be too little too late as there was a conflict between

those who wished to mitigate the crisis and demanded quick action

and those who worried abut moral hazard and preventing a future crisis by copycats

This conflicts continues to split Europe today

Introduction Greek vs. US Great Depression



1) Why so deep?





2) Europeans in search of their future: Will the Euro Area survive

Concluding remarks


II.

Source: European Commission

II. Politics brings Greek Crisis Phase II in January 2015


By 2014 macroeconomic imbalances were cured and the economy was growing again

Yet a new government of leftist ideology in January 2015 decided to refuse cooperation with the lenders and “to export revolution” to the rest of Europe as well

Economy stalled

Pessimism rose again

New wave of bank deposit withdrawals brings capital controls in June 2015

Euro Area 19

Greece Greek Crisis Phase II

Index of Economic Sentiment

Gikas A. Hardouvelis

Two waves of cash withdraws

Two waves of ELA use

€bn

Crisis Phase II

Source: BoG

II. A second wave of deposit withdrawals

During the international crisis deposits were rising

Two waves of cash withdrawals since 2010

The second comes with phase II of the Greek crisis

Dependency on the Eurosystem climaxed in 2011-12 and again in 2015

20

Source: BoG

Crisis Phase II

II. Banks remain vulnerable on the Asset side as well as NPLs rise

The NPL improvement of late 2014 was reversed due to Phase-II of the crisis Greek banking sector NPEs the highest in Europe, followed by Cyprus. Target volume reduction by 38% by end of 2019 Unless economy picks up and NPL problem is gradually resolved, banks

Would stay zombies, unable to provide new credit to healthy companies May need additional capital infusion, with no foreigners willing to come in

this time Gikas A. Hardouvelis

Greece and Cyprus are outliers in NPEs

2016 improvement in Cyprus, not in Greece

% NPEs (% of total exposures, 2017:Q3)

Crisis Phase II

Ending NPL crisis

Source: Bank of Greece

Source: EBA

ΔNPLs (% of loans, 2007Q1-2017Q1)

21

ΙΙ. Negative growth in lending since April 2011

-10

-5

0

5

10

15

20

25

Ma

r-07

Sep

-07

Ma

r-08

Sep

-08

Ma

r-09

Sep

-09

Ma

r-10

Sep

-10

Mar-

11

Sep

-11

Ma

r-12

Sep

-12

Ma

r-13

Sep

-13

Ma

r-14

Sep

-14

Ma

r-15

Sep

-15

Ma

r-16

Sep

-16

Ma

r-17

Sep

-17

Greece Euro area

%

Source: Bank of Greece, ECB

Loans to Private Sector (%yoy)


BANK INDICES = 100 at 30/3/2012 Bank stocks

reached zero value for a second time in November 2015

BANK INDICES = 100 at 30/11/2015

After the third recapitalization, the Greek bank index fluctuated and now is 20% lower, due to the fears of additional capital needs in 2018

Stock prices for a second time at zero in Nov 2015


0 20 40 60 80

100 120 140 160

Mar

-12

Jun

-12

Sep

-12

De

c-1

2

Mar

-13

Jun

-13

Sep

-13

De

c-1

3

Mar

-14

Jun

-14

Sep

-14

De

c-1

4

Mar

-15

Jun

-15

Sep

-15

De

c-1

5

Mar

-16

Jun

-16

Sep

-16

De

c-1

6

Mar

-17

Jun

-17

Sep

-17

De

c-1

7

FTSE/Athex Banks Index Stoxx Europe 600 banks Price Index

Greek Banks

European Banks

30 40 50 60 70 80 90

100 110

No

v-1

5

Jan

-16

Mar

-16

May

-16

Jul-

16

Sep

-16

No

v-1

6

Jan

-17

Mar

-17

May

-17

Jul-

17

Sep

-17

No

v-1

7

Jan

-18

FTSE/Athex Banks Index Stoxx Europe 600 banks Price Index

European Banks

Greek Banks

As the economy rebounded in Europe, reform pressure subsided

The IMF came out in Feb 2018 with a proposal for a tighter fiscal union

In Jan 2018 , without proposing a fiscal union, a dozen French & German CEPR economists offer ideas on a number of financial, fiscal and institutional reforms that would both improve market discipline (→ lower moral hazard) and risk sharing (→ mitigate a crisis) in the Euro Area:

1) Break the Bank-Sovereign doom loop via sovereign bond concentration charges for banks and a common deposit insurance

2) Switch to fiscal targets based on simple expenditure rules and finance possible planned deviations from those targets with subordinated debt

3) Make the “no-bailout” clause time-consistent by designing orderly debt restructurings through legal and economic means

4) Create a Euro Area fund to absorb large economic disruptions

5) Create a synthetic Euro Area safe asset (like a CDO)

6) Reform the Euro Area institutional architecture by separating the watchdogs from the political decision makers


ΙΙ. Euro Area reform has stalled What is to be done?

Concluding remarks


Challenging times ahead for the European Monetary Union the moment cyclical recovery is over or the moment ECB begins restricting monetary policy

Yet, EMU will not dissolve as easily as some colleagues of ours tend to think

The Greek crisis brought many changes in its architecture and more is to come

Finance, Economics, but also Politics play important roles

My recent research on Political, Economic and Economic Policy uncertainty suggests the variables are highly correlated, yet political uncertainty seems dominant during the Greek crisis

THANK YOU FOR YOUR ATTENTION! www.hardouvelis.gr

Documents

The Euro Area Crisis - Gikas Hardouvelishardouvelis.gr/wp-content/uploads/2018/03/... · The PSI was finalized in February 2012: Largest restructuring in history Eligible paper for