How politicians excited financial markets' attack on the Eurozone

Let’s consider events at critical changes in market spreads. On December 8, 2009, Fitch cut its rating on Greek debt below A grade (event 1), calling markets’ attention to a deteriorating outlook. But the real jump in the spread by 170 basis points raising it to nearly 400 basis points, took place in the fortnight following the announcement that debt data had been falsified on January 12, 2010 (event 3). On that occasion Ms. Merkel declared that Greece’s mounting deficits risked hurting the euro; the statement was subsequently removed from the German government website.

The ensuing days were marked by confusing public statements, with reassurances by the European Commission apparently pushing spreads down (events 5 and 6) and tough German statements pushing them back up (events 7 and 8). March was also marked by great confusion, with Greece declaring that financial assistance was not needed and Germany implicitly using that statement to reassure the public opinion that German money would not be called upon. Germany and other member states at that time also called for the IMF to intervene in case of need. The effect was renewed uncertainty on the real willingness of Eurozone members to support Greece.

On 25 March Eurozone member states agreed on a rescue package for Greece involving bilateral loans as well as IMF financing (event 11); however, Greece still refused to ask for it while the Eurozone member states started bickering in public regarding the conditions applicable to the loan – with Germany demanding above-market rates (event 12) that would of course make Greek debt even less sustainable; the request was later withdrawn (event 13). The spread on Greek paper rose above 400 basis points and started climbing to new heights since early April; other spreads also rose sharply. The key novelty here seems the decision, taken on April 11, to extend aid through bilateral loans (€30 billion from Eurozone member states, to be supplemented by the IMF; event 13), a decision that for the first focussed market attention on the fact that Eurozone governments would be directly liable for Greek debt – trashing the no-bail out clause of the Treaty.

Following pronounced market unrest, on May 2 the Eurozone member states agreed on a €110 billion support package for Greece (event 19), with Greece announcing that it will finally take it. However, after initially receding, spreads widened again even more, with confidence fading on the whole Eurozone. An emergency meeting of the Ecofin then agreed on a new European Financial Stabilisation mechanism entailing loans and guarantees up to €750 billion (event 21). No more bilateral loans – the lesson has been learnt, at a high cost. The ECB followed suit and on the same date announced a new package of liquidity support to meet renewed distress in the interbank market. The package included direct purchases of Greek and other Eurozone government debt bonds by the ECB.