Greek Financial Crisis: An Analysis Paper

Greek Financial Crisis

In the aftermath of the 2007-2008 global financial crisis, nearly all nations worldwide were impacted by the recession that started in the United States, though at a different level. In Greece, a member of the European Union, the events in the political and financial sector at the turn of the new millennium shaped the reaction of their economy into one of the most adverse and long-felt disastrous impacts. Local mismanagement and deregulation of the financial sector led to risky borrowing behaviour in the local banks, whose reliance on foreign banks got cut off in the crisis. Additionally, local lending grew substantially to destabilize the previous favourable loan-deposit ratio in the country due to massive government-aided campaigns to increase loan uptake. The global recession hit the vulnerable Greek economy hard, leading to the most significant economic challenge in the history of the European Union. As a result, the Greece crisis exposed the financial risk of political mismanagement and unregulated borrowing in global banking systems. The economic collapse from the impact of the worldwide recession scared away foreign investment and dug the nation deeper into debt.

Borrowing and Debt

After Greece entered the European Union (EU), the nation enjoyed robust economic growth but faced two significant challenges due to the country’s low competitiveness and massive fiscal deficits that ultimately played a role in the Greek financial crisis. For some time, Greece enjoyed the second-largest Gross Domestic Product (GDP) growth due to the elimination of exchange rate fluctuations and the reduction of nominal interest rates on servicing public-sector debts (Gibson et al., 2012). In the case of the 10-year German and Greek government bonds, interest rate spreads dropped sharply from over 1100 basis points in early 1998 to about 100 basis points in the year before entering the EU (Gibson et al., 2012). However, the fiscal deficits continually exceeded the 3 per cent Stability and Growths Pact’s limit during that period, while competitiveness declined (Gibson et al., 2012). Consequently, the 2008 global financial crisis found the Greek financial market, particularly with high fiscal deficits and declining competitiveness. This situation explains why the impact of the crisis triggered a more substantial economic fallout in the nation and the Greek crisis.

In Greece and many parts of the world, national banking systems got privatized, and the sector was deregulated in the period before the 2008 financial crisis. The private banks in Greece received government support as the largely-public banking system slowly became privatized at the turn of the century. Between 1998 and 2000, the Greek government sold most of the stakes it owned in the public banks at discounted prices reducing the government stake in the banking sector from 70 per cent to 40 per cent (Toussaint, 2017). Additionally, the Greek banks started pushing their citizens to borrow massively with the government’s help through deregulation and widespread communication campaigns to middle-class households, companies, and pension funds to invest in the stock market. As a result, household loans increased fivefold, while business loans increased two-and-a-half-fold between 2001 and 2008 (Toussaint, 2017). During this period, the private sector became a crucial part of the Greece economy as the primary banking service. In turn, the government lost its ability to control a more substantial part of banking operations.

International banks also had a hand to play in the Greece financial crisis that followed the collapse of the banking system in the United States and rippled through global markets. Between 2007 and 2009, Private European and American banks lent extensively to the Greece government, with their confidence built on the country’s inclusion in the European Union. For instance, the lenders believed that the big European countries would come to their aid if anything went wrong (Toussaint, 2017). An analysis of the external debt in America and European countries reveals that most private banks used money lent from their government reserves during the 2008 financial crisis to loan to countries such as Greece (Toussaint, 2017). International banks became primarily responsible for Greece’s excessive debts, leading to a prolonged crisis after the global recession. Foreign banks invested in Greece as it offered better returns but ignored the warning signs from the nation’s financial sector’s high fiscal deficit.

The 2008 global financial crisis exposed the risk of mismanagement of Greece’s national economic sector. Due to the highly integrated European and international financial systems, the global recession met Greece in a very vulnerable and unprepared state. When prime minister George A. Papandreou took office in October 2009, he admitted that the public debt was more than 110% of the GDP, and the deficit announced by the preceding administration of 3.7 per cent surpassed 12 per cent (Papandreou, 2010). Furthermore, the endemic corruption infiltrated public institutions meant that the national systems could not cushion the economy from economic and financial fallouts. Consequently, the chronic mismanagement in the Greek crisis

hindered the nation’s recovery alongside other European countries after the global crisis.

The Rise and Fall of Investments

In the first decade of the twenty-first century, private debt increased rapidly as local banks financed large portions of the population in various sectors, shifting the nation’s financial health. Households, mass retail, automobile and construction companies opted into locally-financed debt following the attractive conditions offered by the banks, while bank deposits grew at a slower rate. In 1998, Greece’s deposits in banks doubled the number of loans processed by banks but by 2008, the loans outweighed the reserves in the banks (Toussaint, 2017). On the other hand, the Greek private banks cut down on their investments in public administration. As a result, by the end of the first decade, most Greek national debt came from institutions in other countries, mainly in Europe. As such, the private credit bubble that grew with the government’s encouragement destabilized the financial situation before the global crisis as loans exceeded deposits.

Foreign Direct Investment in the period before and during the financial crisis included investments in the public sector and risky loans to private banks that would eventually weaken the local financial institution. Following the deregulation of the banking sector in Greece, the private banks started engaging in brave borrowing practices. For instance, banks utilized mostly short-term deposits while also attaining short-term loans from foreign banks (Gibson et al., 2012). Between 2002 and 2009, local banks in Greece increased their borrowing from international lenders by six and a half fold, to €78.6 billion (Toussaint, 2017). As a result, the local banks became vulnerable to tendencies of financial markets and customer withdrawals. Even so, the local banks continued to operate profitably in the short run, which attracted foreign investments, including French banks which acquired Greek banks.

However, after the American bank Lehman Bros. collapsed in the United States and the impact on European markets, interbank loans halted as confidence in the sector dissipated. Consequently, Greek banks were plunged due to their extensive dependence on foreign investments. For instance, the share value of Greek banks in the second half of 2008 plummeted to a level 20% below their 2007 quotations (Toussaint, 2017). The European Central Bank (ECB) offered strict guidelines for the Bank of Greece’s liquidities made available to the local banks. Now that the local banks could not look at foreign institutions for funding, the Greek government announced a €28 billion bail-out plan that included €3.5 billion for banks’ recapitalization (Toussaint, 2017). Additionally, the government assured depositors to prevent massive withdrawal of bank reserves which would cripple the local banking system. As the short-term benefits of the local Greek banks’ borrowing spree came to a halt, the banking system’s exposure to the international markets cost the nation a great deal in the global crisis.

The Aftermath of the 2008 Global Crisis

In a twist of events, the financial crisis brought an unprecedented effect on the economy of Greece that stretched to impact most sectors, including the tourism, trade, real estate, and shipping industries. As a result of the global recession, nearly 20% of the population was reported to be jobless by the end of 2008 (Vasiliadis, 2016). Property markets in Greece faced a continued drop in property sales linked to the banking crisis and the credit crunch. Since the banks faced liquidity restrictions, the funds available for property investment continued to fall in 2013 (Vlamis, 2014). As such, the fiscal stance of the Greek economy following the global crisis continued to impact the real estate industry and several others in the long term.

Tough economic times also impacted the political space in Greece as leaders came under pressure from the citizens suffering from unemployment with growing demonstrations against the government. The Greece Prime Minister, Costas Karamanlis, decided to call for an early election as he could not form any economic reforms through legislative action (Galenianos, 2014). However, his administration’s scandals prevented his re-election, as Papandreou became elected as prime minister in October 2009 (Galenianos, 2014). With a new government in place, the parliament allowed for economic reforms to be instituted, beginning with the 2010 budget announcement that was to be announced two weeks later. As such, the Greek crisis led to some crucial political changes starting with the installation of a new regime that would later lead to financial and economic reforms.

Restructuring of Greece’s Economy

The previous regimes’ mismanagement, tax evasion, and endemic corruption that affected Greece for many years came as a significant hindrance to the success of the prime minister’s political reforms. On the international markets, some scepticism still existed over foreign investments in Greece, which the government needed to regrow the economy out of the crisis. In one case, the new prime minister, Papandreou, scared EU leaders after admitting to false financial statements from the previous regime in Greece that covered up the severity of the fiscal deficits in the country (Papandreou, 2010). The government offered austerity measures intending to cut the fiscal deficit to 8.7% of GDP in 2010 (Papandreou, 2010). Nonetheless, Doubts over sovereign debts were ripe at that period after Dubai announced plans to delay the repayment of some of its bonds.

Come early 2010; the government introduced three deficit-reduction packages to cumulatively drop the deficit by five per cent, in line with the president’s structural reforms. The new policies included a “crisis levy imposed on profitable firms and an increased value-added tax, with additional taxes for fuel, tobacco, and alcohol (Galenianos, 2014). In the long run, the prime minister’s government implemented strategic reforms to the pension ad tax systems, with additional policies to encourage investment (Galenianos, 2014). One advantage of the Greek crisis seemed to be the opportunity to rebuild the nation’s economy and financial sectors with a deep understanding of the challenges that arise from mismanagement. Addressing the critical challenges due to a lack of competitiveness and high fiscal deficit is at the core of solving Greece’s long-term strategies and reforms.

Greece’s crisis emanated from unregulated banking practices, political mismanagement, and high fiscal deficits from a reliance on foreign banks that left the nation vulnerable to global financial risks, leading to long-term economic challenges following the global recession. Prime Minister George Papandreou admits that his government inherited state institutions suffering from chronic mismanagement and endemic corruption, which led to the state’s unpreparedness in the wake of the global crisis. Additionally, the borrowing culture had been skewed by private banks with the government’s aid for short-term returns that collapsed in the worldwide recession. While local and foreign investments were on the rise in the early part of the millennium’s first decade, the practices in the local banking systems ignored the risks of the international financial market. However, there is an excellent opportunity to restructure the political and economic sectors in the region with the new government based on the experience of the Greek crisis.

References

Galenianos, M. (2014). The Greek Crisis: Origins and Implications. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2505455

Gibson, H., Hall, S., & Tavlas, G. (2012). The Greek financial crisis: Growing imbalances and sovereign spreads. Journal Of International Money And Finance, 31(3), 498-516. https://doi.org/10.1016/j.jimonfin.2011.10.009

Papandreou, G. (2010). A new global financial architecture: Lessons from the Greek Crisis. Mediterranean Quarterly, 21(4), 1-6. https://doi.org/10.1215/10474552-2010-022

Toussaint, E. (2017). Banks are responsible for the crisis in Greece. Retrieved 30 April 2020, from http://www.cadtm.org/Banks-are-responsible-for-the.

Vasiliadis, L. (2016). The financial crisis and Greek banks’ internationalization. Global Business And Economics Review, 18(3/4), 247. https://doi.org/10.1504/gber.2016.076222

Vlamis, P. (2014). Greek fiscal crisis and repercussions for the property market. Journal Of Property Investment & Finance, 32(1), 21-34. https://doi.org/10.1108/jpif-08-2013-0052