The Greek Tragedy

SSUD12-203 Property Investment Analysis

Isabella Knight

Table of Contents
Introduction ................................................................................................................................ 3 The Boom................................................................................................................................... 3 Causes of Crisis.......................................................................................................................... 3 Greece went Euro Happy .................................................................................................... 3 Increasing Debt and Deficits percentage to GDP .................................................................. 4 Falsified Figures and Corruption ........................................................................................... 5 Tax Evasion ........................................................................................................................... 6 Government Response ............................................................................................................... 6 Outcome ................................................................................................................................. 7 Implications................................................................................................................................ 7 The European Banks .............................................................................................................. 7 Domino Effect ........................................................................................................................ 8 What should be done.................................................................................................................. 9 Default & Foster Economic Growth ...................................................................................... 9 Leave the euro ........................................................................................................................ 9 Conclusion ............................................................................................................................... 10 Bibliography ............................................................................................................................ 11

Introduction
On the 15th of November 2004, three years after Greece adopted the Euro, a closer scrutiny of Greeces budget figures revealed that the country did not actually meet the conditions to join the euro zone. European Union (EU) rules specify that a countrys deficit must be equal to or less than 3%, a figure that Greece has not achieved since 1999 (Hadjimichails, 2011). This was just the beginning for Greece, who now stands on the brinks of default with the highest deficit/GDP ratio of than any other euro zone nation since the introduction of the Euro and holds a national debt of 340billion(Abboushi, 2011). This report aims to explain the causes which brought Greece to this economic position, the implications from its financial crisis and likely default, and finally what Greece should have done.

The Boom
Before all the headlines surrounding the Greek debt crisis, what did Greece mean to the average man? Simply a stunning nation tucked away in the heart of the Mediterranean Sea with warm hospitality, clear waters and exotic islands that come alive during the summer seasons. Not only is Greece idolised by travellers but it was host to strong growth rates performance. This was primarily due to the nations accession to the euro the creation of competitive credit and capital markets, the satisfactory deregulation of the telecommunications industry and the improvement resulting from productivityenhancing infrastructure (Pelagidis, 2011). During 2001 to 2007, was good time for Greece as annual growth rate of GDP was 4.3%, compared to standard set by Euro-zone which is 3% (Lapavitsas,

2011).

Causes of Crisis
Greece went Euro Happy
Early 2001 saw Greece become the 12th member to adopt to join the euro zone. The euro spurred capital market integration and allowed Greece to access an abundance of cheap capital due to low interest rates and increased investor confidence. Investors viewed the euro as stable currency as they fellow euro zone nations could assist one another. The Greek Government took advantage of this influx of capital to pay for government spending, offset low tax revenue and to finance its budget deficit (Nelson, 2010). A significant portion of the spending was also exhausted on social welfare programs and workforce retirement (Hallerberg, 2011). Retirement age in Greece is as low as 50 for women and 55 for men which made it the lowest among all euro zone countries (Vanity Fair, 2011). Greece also spends more on their health care system than any other Euro nation. As such a large portion of the Greek

governments borrowed funds were put to finance current consumption obligations, it did not yield stream of revenue in order to repay the debts, but instead increase the nations deficit (Nelson, 2010).

Increasing Debt and Deficits percentage to GDP

In the after math of the 2007-2009 global financial crisis and the related economic downturn strained public finances as government spending on programs increased and tax revenues weakened (Nelson, 2010). Greece, along with other euro zone nations, continued to borrow to the extent that debt exceeded total value of gross domestic product (GDP). Greece also experienced a decrease in real and financial activity with their 2 major industries, tourism and shipping, being affected badly decreasing their revenue by 15% in 2009 (The Guardian, 2011). The European Commission in May this year announced that in 2010 Greeces percentage of debt to GDP reached 143%, the highest in euros history. This percentage is expected to increase to 158% this year, and projected to reach 166% in 2012 (Business Insider, 2011). Another imperative figure which indicates a federal governments financial well being is its budget deficit. In 2010 Greeces budget deficit was at 10.5% of GDP. Recent government policy measures saw this figure decrease to 9.5% of GDP this year (Eurostat, 2010).

Upon amalgamation into the EU all member countries had to comply with certain limits to avoid penalty. These are included in the Stability and Growth Pact which limits governments deficit to 3% of GDP and public debt levels at 60% of GDP. These restrictions would be enforceable by fines of up to 0.5% of GDP(Sajjad, 2011). As can seen below, since joining the eurozone in 2001 Greece at no point has ever satisfied these two requirements.

These results expose a flaw in the European Monetary Union, as Greece was able to continuing borrowing despite breaching the EU limitations. Since 2003 the EU did initiate investigations on 30 nations that were in violation of the deficit and debt limits, including Greece. The extent to these investigations only included EU institutions providing warnings and pressures to consolidate their public finances. However these demands were not followed through and no financial sanctions were imposed on Greece or any of the other 29 nations (Baumgarten, 2010).

Falsified Figures and Corruption

Greece came under the spotlight again in late 2009 when newly elected government of George Papandreou announced that the actual budget deficit was nearly double that of the original amount. The 2009 deficit of 6.7% was revised to 12.7% which further increased in 2010 to 13.6% (Abboushi, 2011). The previous government of Costas Karamanlis had been under reporting the budget deficit by concealing the real figures in order to join the euro zone.

Through the crisis it became clear that the major investment bank Goldman Sachs assisted the Greek government with complex financial instruments to massively understate Greek deficit and mask its true debt (Louise, 2011). Additionally, in early 2010 Greece also replaced its head of Greek debt management agency with Petros Christodoulou, who ironically (and not surprisingly), is an ex Goldman Sachs investment banker, and head of derivatives at JP Morgan (Lapavitsas, 2011).

Furthermore, John Carey, senior editor at CNBC.com, explains that while Goldman Sachs engaged in long term trades with Greek debt, the firm simultaneously was hedging its bets against Greek debt in the short term, profiting from the Greek debt crisis that it helped created (Business Insider, 2011).

Greek economist Dr. Kiriakos Tobras who is suing Goldman Sachs, JP Morgan and other derivative dealers for fraud , explained; This is a well organised criminal plan that was executed in a very smart way here in Greece. The politicians who governing this country dont have any idea what markets mean, dont know how to regulate the markets and this gives the opportunity to all these kinds of institutions to manipulate the government debt and to create this huge problem that Greece has today.(Tobras, 2011) The disclosure of false debt figures led to uncertainty regarding quality of its statistical data and reporting (Hadjimichails, 2011). In response, credit rating agencies downgraded Greeces bonds ratings to BB+ and A2 by Standard & Poor's rating services and Moody's standard respectively (Genacy, 2010).

Confidence in the euro started falling and the bond market sunned Greece and raised the yield on twoyear bonds to a punitive level of 15.3% (Abboushi, 2011). It became clear once again that Greece would not be able to afford to raise new funds in hope to satisfy its short term debts.

Tax Evasion
A weak tax collection for Greece is argued as a main source for the nations large budget deficit (Abboushi, 2011). Tax evasion weakens the governments financial standing and prevents the government from preventing high quality public services. Between 30 and 40 percent of the activity in the Greek economy that might be subject to the income tax goes officially unrecorded, compared with an average of about 18 percent in the rest of Europe (Vanity Fair, 2011) .Tax evasion is common in Greece as it has become a cultural trait, there is simply not enough internal measures put in place to firstly detect the tax cheats and then to enforce penalties. Vanity Fair reporter Michael Lewis travelled to Greece to discuss this topic with ex-tax collector, No one has ever been punished. Its a cavalier offenselike a gentleman not opening a door for a lady (Vanity Fair, 2011). While tax evasion is illegal, enforcement is the issue. Greek courts take up to 15 years to resolve tax cases (Vanity Fair, 2011). However in the instances where someone does get caught, he or she can simply bribe the tax collector and call it a day. While there are laws against this also, it can take seven or eight years to get prosecuted. So in practice no one bothers. The ex tax collector explained.

Government Response
As the crisis worsened and the fear of default loomed the Papandreou government in early 2010 officially requesting a bailout by the EU. The EU approved the Greek governments request. Financial assistance and a major policy response were implemented by Europeans, the International Monetary Fund (IMF) and the Greek government in May 2010. The IMF and Euro zone leaders announced a three year 110 billion package for Greece at market based interest rates (Nelson, 2011). These funds were assembled by Eurozone countries pledging to contribute 80 billion with the IMP pledging to contribute the remaining 30 billion.

Payment of these funds was conditional upon Greece implementing economic reforms and fiscal consolidation measures, commonly referred to austerity measures. The agreed austerity measures include, inter alia, a deep cut in public spending, increased tax rate and a crack down on tax evasion, recruitment freeze, wages cut, increase retirement age and reduce social welfare payments (Sajjad, 2011).

Shortly after the Greeces first bailout of 110 billion the EU and IMF created the European Financial Stability Fund (EFSF), a new vehicle for providing financial assistance for other weakened economies who may be adversely affected by the Greeces debt crisis (Pelagidis, 2011). EFSF is backed by guarantee commitments (pledges) from the euro area Member States for a total of 780 billion and has a lending capacity of 440 billion (EFSF, 2010). The EFSF attempts to prevent the consequences of contagion and safeguard the financial stability of Europe.

Outcome
The outcome of bailout package caused a substantial decrease in demand for goods and services which in turn caused the Greek economy to contract more severely than expected. With little progress made Greece veered in default again a year later which instigated another crisis response in June 2011. A second financial package of 109 billion package was provided to Greece, in exchange for new austerity measures and structural reforms. During this time Moody slashes Greeces credit rating to junk the lowest credit rating in the world (The Economy Collapse Blog, 2011) Bond spreads for several European countries spiked, stock markets in Europe declined heavily, the euro depreciated to its lowest value in years, and the cost of insurance against default skyrocketed (Abboushi, 2011).

In response to the new bail-out package a survey was conducted which indicated that close to 50% of Greeks wanted their party to reject the new austerity measures, with 35% in favour of the new reforms (Nelson, 2011). Unemployment has doubled from 7.7% to 15 between the years 2008 to 2011. Public uproar continued, with public sector workers staging a 48-hour nationwide strike resulting in three deaths when a bank was set on fire. Protest activity continued to escalate leading to widespread social unrest and anti-government sentiment. Public services, such as healthcare, education and transport have also severely disintegrated (The Guardian, 2011).

Implications
The European Banks
If Greece defaults, a major complicating factor is the vulnerability of the largest (mostly French and European) banks which are major holders of Greek debt. The Bank for International Settlements (BIS) revealed information that Germany and France banks (EU dominant powers and main bailout sources) account for roughly half of all European banks exposure to Greece, Spain, Italy and Portugal sovereign debt, totalling to $1.8 trillion, nearly half of which is Spain alone (Business Insider, 2011).

Unfortunately, major banks all over Europe are very highly leveraged and are also very heavily invested in the sovereign debt of nations such as Greece, Portugal and Italy. If, as predicted, more than one EU nation defaults it could cause a mass wave of bank failures and trigger another banking crisis (Pelagidis, 2011). Today, major German banks that are holders of enormous amounts of sovereign debt and its leverage ratio - the ratio of total assets to shareholders equity - is at 32 to 1, making it incredible vulnerable to market conditions, or more specifically, sovereign debt defaults. This ratio is also alarming considering when Lehman Brothers declared bankruptcy it was leveraged 31 to 1(The Guardian, 2011). Provided how interconnected the EU is with large heavy weights such as the U.S and U.K an EU banking crisis will have catastrophic implications on a world wide scale.

Domino Effect
According the US Congress Research Commission, the crisis spread not because of what happened in Greece but simply because other euro zone countries faced fundamental fiscal challenges and were unsustainable. Greek Foreign Minister Stavros Lambrinidis agrees with this notion, "Greece is in the middle of the storm, but it is not the source of the problems of European debt and deficits(BBC, 2011). Portugal, Ireland and Italy also have debt to GDP ratios that are well above 100%. These three nations in combination with Greece, Spain, commonly referred to as the PIIGS in the media, owe the rest of the world 3 trillion euros combined (The Economy Collapse Blog, 2011). The main fear surrounding these nations in a fragile financial status was simply put by Frances Prime Minister, Mr Sarkozy, If Greece defaults, there would be a domino effect carrying everyone away (BBC, 2011). As Greece on its own accounts for only 2.4% of the total Eurozone GDP (Business Insider, 2011), the real threat lies with the other, far more substantial economies. Italy and Spain are the 3rd and 4th largest economies in the eurozone. They accounted for 16.9% and 11.6% of eurozone GDP respectively in 2010 (BBC, 2011). This chain reaction will be sparked by weakened investor and consumer confidence. If Greece defaults, this would tell the market that a precedent has been set for the other weakened economies. Uncertainly amongst the financial markets will push interest rates up, this would make borrowing money for the other nations far more expensive, and increase the likelihood of them being unable to satisfy their debt obligations. The most recent eurozone summit on the 27th of October 2011 resulted in a banks agreeing 50% writedown in the face value of Greek government bonds. This could see other euro nations, specifically PIIGS, demanding the same relief (The Guardian, 2011).

What should be done

Default & Foster Economic Growth
The bail out money that has been poured into Greece, only seems to protect the investors from taking losses on the sovereign debt they are owned. The bailout was for the ECB itself and foreign banks in Europe. This was supported by journalist and former options and broker trader, Max Keizer The 110 billion comes into the Greek system then immediately leaves to pay off foreign interest (RawReplay, 2011). It seems as though the bond holders never lose and the Greek people can never win. However this was not always the case. In 1934 Greece declared bankruptcy. In 1939 Greece was under the rule of the dictator Ioannis Metaxas who explained to its lenders, France and Belgium, that Greece does not have the money to repay their loans as that would deprive the Greek people of their basic needs. The foreign bankers took Greece to the International Court of Justice. Judgement was found in favour of Greece who concurred that Greece has the duty to cover the needs of its people first and did not pay a single drachma to its lenders (Keizer, 2011). Unfortunately in this current day Greece does not have the political will to default. Meanwhile the nation is burdening itself by paying off old debt with new debt. The only salvation for Greece to put itself on the path of debt sustainability is by generating future economic growth. The austerity measures are centred on measures that provide a short term solution but have also depressed economic sources of growth. GDP falls as employment and consumer spending is cut, closure of publicly owned companies and growing new taxes on the private business sector (Nelson, 2011). The IMF reported that the Greek economy contracted by 3.9% in 2011 (Nelson, 2011). There is no substitute to the more important goal of economic growth, the Greek government along with the EU need make this their centre main to alleviate Greece of its financial turmoil.

Leave the euro

A nation with its own currency has the tool of printing more money, allowing devaluation to occur which in turn stimulates exports and help growth return to the economy. This tool, unfortunately, is not available to EU nations as they all share a common currency and must entirely depend on others to bail them out. Therefore many analysts have recommended that Greece leave the EU and issue a new national currency (Nelson, 2011). A devalued currency would effectively make Greece a cheaper place to do business, encourage foreign investments and exports and ultimately enable Greece to restore competitiveness and start to recover.

Conclusion
Greece is becoming engulfed in a financial and economic tragedy and is imprisoned into a currency union to which its just not suited. EU sceptic British politician and leader of UK Independence Party (UKIP)

Nigel Farage said the following in EU Parliament in July 2011; Its a truly sickening site to see the country that actually invented democracy being bullied by you [EU Parliament] and being told they have to accept this austerity package.. Youve stripped them not just from money; youve stripped them of their democracy. (RawReplay, 2011) As outlined in this paper Mr. Farage also signifies the real dangers of fusing together different economies, with different growth rates and different patterns of trade around the world, into one economic and monetary union. The European Union was formed on the objectives of freedom, security, strengthen economies and promote humanitarian and progressive values. This is a far cry from what can be witnessed in Greece and other EU nations which are buckling under the pressures of a united currency. The European Union is fundamentally flawed, with its leaders refusing to adopt a plan B or any form of an alternative. Flexibility in policy response and solutions by EU leaders is essential as there is no successful precedent for the financial crisis they are currently experiencing. Thus, the EU must be merciful to a reasonable extent and respond appropriately in a bid to uphold the integrity and livelihood of the European Union citizens, ensuring their veracity remains unscathed.

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Bibliography
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Pelagidis, T & Mitsopoulos, M 2011, Understanding the Crisis in Greece: From Boom to Bust, Palgrave Macmillan, London.

The Economy Collapse Blog 2011, viewed 22 October 2011, <http://theeconomiccollapseblog.com/archives/20-signs-of-imminent-financial-collapse-ineurope>

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Lapavitsas, C 2011, Greece must default and quit the euro, viewed 22 October 2011, <http://www.guardian.co.uk/commentisfree/2011/sep/19/greece-must-default-and-quit-euro>

The Economy Collapse Blog 2011, viewed 22 October 2011, <http://theeconomiccollapseblog.com/archives/20-signs-of-imminent-financial-collapse-ineurope>

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