Published July 10, 2023 by Jay Rappaport, Class of 2024 at Georgetown Law, IIEL Fellow.

Disclaimer: The views expressed in this article are my own and do not reflect the views of my employer/firm.

I. Introduction

The desire to limit the crises’ contagion and legal and political circumstances—constraints and opportunities—informed the official sector’s responses to the Great Financial Crisis (GFC) and Eurozone Crisis. Both crises posed great risks of contagion:[1] when one country’s economic troubles creates problems in other countries.[2] To limit the crises’ contagion, the official sector demonstrated immense shows of economic force, a willingness to support economies with great magnitude and speed.[3] Both crises presented legal and political obstacles and opportunities, which impacted how the official sector demonstrated economic shows of force and deployed policy.[4] These different legal and political factors help distinguish the official sector’s responses to the GFC and Eurozone Crisis. This brief analyzes each crisis, examining, first, the official sector’s show of economic force and, second, its deployment of policy.

II. Great Financial Crisis

II.A GFC: Show of Economic Force

To limit the GFC’s contagion, the official sector responded with an immense show of economic force that reflected the political and legal constraints and opportunities it faced. In April 2009, the Group of 20 (G-20) governments expanded the International Monetary Fund’s (IMF’s) resources from $250 billion to $1 trillion.[5] The GFC’s risk of contagion motivated this response. The G-20 president said the IMF needed $1 trillion to “impress the [global] markets,”[6] and the G-20’s communique announcing the expansion identified “ensuring that capital continues to flow to emerging market and developing countries” as its goal.[7] Because the GFC began in the United States (U.S.), an advanced economy,[8] supporting emerging market and developing countries’ access to capital constitutes mitigating contagion. That the IMF raised this money through borrowing rather than raising quotas[9] reflects political difficulty and legal opportunity. It was too politically difficult to decide the long-debated issue of how much quotas, countries’ contributions to the IMF, should increase[10] because increasing a country’s quota expands its voting power at the IMF and the amount it can withdraw from the Fund.[11] However, the IMF is legally able to borrow from member countries as well,[12] so the IMF borrowed from its members instead of raising quotas.[13] The method of borrowing also reflected political realities. “Donating to the IMF is politically toxic,”[14] and that was especially true during the GFC and Eurozone Crisis due to concern that the money would support wealthy countries.[15] Therefore, instead of referring to the money the countries gave the IMF as loans, the official sector labeled it bonds instead.[16] In contrast to a loan, a bond makes crude political sense: bonds indicate a country is diversifying its portfolio by investing in the IMF, which the public can easily understand.[17]

The IMF’s changes to the New Arrangements to Borrow (NAB) and establishment of the Flexible Credit Line (FCL) were immense shows of economic might and reflected the official sector’s desire to limit the GFC’s contagion within political constraints. The IMF “expand[ed] and enlarge[d] the [previous] NAB … [to] stem[] contagion risks.”[18] The IMF also increased the NAB’s “flexibility” to limit global risk[19] by creating an “activation period,” during which the IMF could continue to give a country additional financing without holding successive votes for each installment, as long as the funding stayed within the highest limit at least eighty-five percent of “participants” approved initially.[20] The IMF created the FCL to limit contagion too: the FCL would support countries on sound economic footing that nonetheless experienced economic “blowback” from the GFC.[21] The IMF intended and creditor governments supported the FCL to enable the IMF to aid countries without countries’ experiencing the “stigma associated with the traditional [IMF] lending instruments.”[22] Thus, in creating the FCL, the official sector circumvented a political limit, that “stigma.”[23] The FCL’s show of force worked numerous times: by having the FCL “approved” for them, Colombia, Mexico, and Poland preserved market access without even needing to draw on their FCL funds.[24]

II.B GFC: Deployment of Policy

To respond to the GFC, the official sector deployed economic policy according to political and legal constraints and opportunities it faced. Any use of the NAB would reflect political pressures the IMF faced from member countries as the IMF created several escapes from NAB funding commitments should creditor governments develop their own balance of payment difficulties.[25] Conversely, the lifting of political restraints also influenced the official sector’s use of policy. After the U.S. bailed out its automobile industry, the political concern that moral hazard would accompany corporate bailouts eased, allowing the official sector to support some corporate debt restructuring elsewhere.[26]

Legal constraints and opportunities also impacted how the official sector implemented economic policy. The IMF may legally provide financing to member countries experiencing “balance of payments problems” only if the country is making adjustments necessary to address them.[27] To adhere to this commitment when a country’s balance of payments deteriorates after receiving an FCL, the IMF developed ex ante conditionality: the IMF would require countries have a “strong track record of policy performance” to receive an FCL.[28] This would give the IMF sufficient confidence that the country would continue to “address its balance of payments pressures.”[29] The IMF also invoked its legal capability to issue special drawing rights (SDR’s) to its member countries.[30] At least partially to limit the GFC’s contagion, the IMF advocated for increasing SDR allocations,[31] and small countries’ governments used their albeit small amount of SDR’s to help insulate themselves from the GFC.[32]

III. Eurozone Crisis

III.A Eurozone: Show of Economic Force

The official sector responded to the Eurozone Crisis first by marshalling immense shows of economic force to limit the crisis’ contagion within legal and political constraints it faced. In response to Greece’s crisis, the IMF and European Commission (EC) built a “wall of money” to help preserve market access, extending Greece a “EUR 110 billion credit line” in May 2010.[33] The IMF even lowered its own threshold for the probability of debt sustainability required for a country to receive IMF financing.[34] Initially, the official sector decided to lend Greece funds instead of counseling Greece to restructure its debt because the European Union (EU), IMF, and European Central Bank (ECB), “feared that a Greek debt restructuring would lead to contagion for banks, financial markets and institutions, and other Eurozone sovereigns” (emphasis added).[35] The EC and ECB—rather than Greek national authorities—supported Greece due to a legal constraint: by entering the Eurozone, countries surrender their monetary policy to Eurozone institutions.[36]

The ECB too demonstrated a prodigious show of economic force in order to limit contagion and respond to political constraints. The IMF and EC’s “wall of money” did not restore market confidence because the market did not trust the EC to oversee the Greek bailout as it considered the EC overly politicized.[37] The failure to restore market confidence stoked the official sector’s fear of contagion: concern spread that not only Portugal, Ireland, and Greece were in trouble but also France and Italy, which would be both too big to fail or save.[38] The ECB responded to these political and contagion concerns with its own show of great economic force. When the ECB announced that it would purchase Greek bonds on the secondary market, then-ECB President Mario Draghi publicly “promise[d] to ‘do whatever it takes.’”[39] Simply announcing the program—with Draghi’s dramatic guarantee—inspired sufficient confidence for capital markets to return.[40]

III.B Eurozone: Deployment of Policy

The official sector deployed economic policy to limit the Eurozone crisis’ contagion using legal opportunities but within political and legal constraints. Many in the official sector wanted Greece to remain in the Eurozone because of the political integration the Eurozone represented.[41] The ECB supported Greece’s sovereign bonds to mitigate contagion: the ECB aimed to lower interest rates that were excessively high “in part” because of “the demand for excessive risk premia for the bonds … to guard against the risk of a break-up of the euro area.”[42] How the ECB supported Greece’s sovereign bonds reflected legal constraints the ECB faced. The EU Treaty “prohibit[s]… monetary financing of the euro area Member States.”[43] To circumvent this legal hurdle, the ECB purchased Greece’s sovereign bonds on the secondary market.[44] The European Union Court of Justice would later accept that because the ECB bought the bonds on the secondary market—not from the Greek government directly—it avoided violating the EU Treaty’s prohibition against monetary financing.[45] The court also reasoned that the ECB could lower Greece’s interest rates and “maintain price stability” only through buying the bonds,[46] and the ECB was responsible for these objectives due to the Eurozone’s single currency.[47]

That the official sector eventually supported restructuring Greece’s debt reflected its desire to contain contagion, and how it conducted the restructuring reveals legal opportunities and constraints it faced. “By the summer of 2011,” the official sector decided to support “a Greek debt restructuring” because they believed it was “inevitable”[48] and, “[i]n the eyes of the IMF at least,” necessary “to place that debt stock on a sustainable basis.”[49] Concern over the contagion a Greek default would unleash likely motivated the official sector to endorse a Greek restructuring because contagion concerns had dissuaded the official sector from restructuring initially.[50] To restructure Greek debt, the official sector used a legal opportunity. “[A]ppoximately 93% of outstanding GGBs [Greek government bonds] were governed by Greek law.”[51] The Greek government used this “‘local law’ advantage” to pass a law that “retrofitted a collective action mechanism to … the debt stock … governed by Greek law.”[52] The collective action clauses (CAC’s) aggregated voting across bond issuances, which again the Greek government could do because of the “local law advantage.”[53] On February 24, 2012, the bondholders triggered the CAC’s and provided Greece debt relief.[54] However, the Greek government’s adding CAC’s rather than legislating haircuts directly allowed this debt relief to comport with the European Convention’s legal constraint regarding the “protection of property” for bondholders who had voted against restructuring.[55] By voting to accept the restructuring with sufficient majorities to trigger the CAC,[56] the bondholders provided the haircut on their own bonds, allowing the Greek government to avoid illegally confiscating property.[57] Greece also had thirty-six bond issuances governed by foreign law, but only seventeen issuances were restructured.[58] Because these bonds were governed under foreign law, they had CAC’s originally.[59] To restructure these foreign law bond issuances, the bondholders “activat[ed] … the bonds’ CACs,”[60] exercising CACs’ legal opportunity. However, the official sector did not restructure more foreign law bond issuances because of their CACs’ legal limit: they did not aggregate voting across issuances.[61]

The official sector also responded to the Eurozone Crisis by rectifying a legal constraint in the Eurozone bank regulatory system. The Eurozone Crisis demonstrated that national bank regulators were insufficient to regulate the Eurozone’s “single financial market.”[62] The official sector responded accordingly by giving the ECB bank supervisory authority.[63]

IV. Conclusion

The official sector sought to limit the GFC’s and Eurozone Crisis’ contagion, and legal and political constraints and opportunities informed the nature of its responses. To prevent these crises from spreading, policymakers needed to both demonstrate great shows of economic force and deploy both the promised and additional other policies. Both the communication of policy and its use were essential.

I would like to extend special thanks to Professor Sean Hagan for sharing his numerous insights during class lectures, directing me to many sources upon which this paper relies, and providing me with critical feedback throughout the semester.

Sources:

[1] IMF Press Release, NAB Participants Agree to Expand Fund’s Borrowing Arrangement to up to US$600 Billion, 1 (Nov. 24, 2009) [hereinafter IMF Press Release on New Arrangements to Borrow] (discussing the Great Financial Crisis’ risk of contagion); Lee Buchheit, The Greek Debt Restructuring of 2012, in European Central Bank Legal Conference 2016, 46, 47 (European Central Bank: Eurosystem, ed., 2016) [hereinafter Buchheit, The Greek Debt Restructuring] (discussing the risk of contagion Greece’s debt crisis presented); e.g., Sean Hagan, Visiting Professor of Law, Georgetown University Law Center, Lecture in Resolution of International Financial Crises: The Great Financial Crisis – Building the International Firewall & The Eurozone Crisis, (March 2022) [hereinafter Hagan lectures].

[2] E.g., Hagan lectures, supra note 1; see, e.g., Buchheit, The Greek Debt Restructuring, supra note 1, at 47.

[3] E.g., IMF Press Release on New Arrangements to Borrow, supra note 1, at 1 (expanding the IMF’s NAB and increasing its “flexibility” in response to the GFC); see, e.g., Buchheit, The Greek Debt Restructuring, supra note 1, at 47 (discussing how the official sector made much funding available to Greece at the onset of its crisis).

[4] E.g., Sean Hagan, Reforming the IMF, in International Monetary and Financial Law: The Global Crisis, 40, 59-60 (Mario Giovanoli & Diego Devos, eds., 2010) (discussing how the ex ante conditionality of the IMF’s Flexible Credit Line allows the program to comport with legal requirements on IMF financing); see, e.g., Hagan lectures, supra note 1 (discussing the Eurozone’s legal architecture that has a single currency for all member countries).

[5] G-20 Communique, Declaration on Delivering Resources Through the International Financial Institutions – London, at 1 (Apr. 2, 2009) https://www.banque-france.fr/sites/default/files/media/2016/10/21/london-declaration2_2009-04-02.pdf [hereinafter G-20 Communique]; e.g., Hagan lectures, supra note 1.

[6] E.g., Hagan lectures, supra note 1.

[7] G-20 Communique at 1, supra note 5, at 1.

[8] E.g., Hagan lectures, supra note 1.

[9] E.g., id.; see generally IMF Press Release on New Arrangements to Borrow, supra note 1, at 2.

[10] Hagan lectures, supra note 1 (discussing the long-standing complaint that the quotas had not kept pace with the development of Brazil, Russia, India, and China (BRIC’s) and other emerging market economies); see Articles of Agreement of the IMF art. 3, §2 (discussing the general “[a]djustment of quotas” process).

[11] E.g., Hagan lectures, supra note 1; see generally Articles of Agreement of the IMF art. 3, §2.

[12] Articles of Agreement of the IMF art. 7, §1.

[13] E.g., Hagan lectures, supra note 1; see IMF Press Release on New Arrangements to Borrow, supra note 1, at 2 (listing the member countries from which the IMF borrowed).

[14] Hagan lectures, supra note 1.

[15] Id. (describing how, for example, the general counsel of the People’s Bank of China said that it would be very politically difficult for China to help bail out Eurozone countries with three times the GDP/ capita as China).

[16] E.g., id.

[17] Id.

[18] E.g., IMF Press Release on New Arrangements to Borrow, supra note 1, at 1.

[19] Id. (“The additional flexibility introduced into the NAB is designed to make it an effective tool of crisis management as a backstop for the international monetary system”).

[20] IMF, New Arrangements to Borrow, in Selected Decisions and Selected Documents of the IMF, para. 5a-5b (July 16, 2009) https://www.imf.org/en/publications/selected-decisions/description?decision=11428-(97%2F6); Hagan lectures, supra note 1.

[21] Hagan, Reforming the IMF, supra note 4, at 60; Hagan; see IMF, Decision Establishing the Flexible Credit Line, in Selected Decisions and Selected Documents of the IMF, Thirty-Ninth Issue, para. 1-2 (Mar. 24, 2009, as amended Dec. 6, 2017) (establishing the FCL and announcing that “FCL arrangement[s] shall be approved” for member countries with “strong economic fundamentals and institutional policy frameworks” among other indica).

[22] Hagan, Reforming the IMF, supra note 4, at 60 (describing the IMF’s desire); G-20 Communique, supra note 5 (describing G-20 countries’ support of the FCL to “address stigma concerns”).

[23] E.g., Hagan, Reforming the IMF, supra note 4, at 60.

[24] Id. at 62; Hagan lectures, supra note 1; see Poland to Ask IMF for 20.5 billion Flexible Credit Line, DW Akademie (Apr. 15, 2009) https://www.dw.com/en/poland-to-ask-imf-for-205-billion-flexible-credit-line/a-4178606.

[25] IMF, New Arrangements to Borrow, supra note 20, at para. 6b (describing that if a country develops its own balance of payment problem, then it would be excused from contributing to the NAB); id. at para. 11e (announcing that if a country had lent money to the IMF and developed a balance of payment issue itself then it could be repaid early); Hagan lectures, supra note 1.

[26] See Sean Hagan, Debt Restructuring and Economic Recovery, in Sovereign Debt Management, 359, 364-65 (Rosa M. Lastra & Lee Buchheit, eds., 2014); see also Hagan lectures, supra note 1.

[27] Articles of Agreement of the IMF art. 5, §3; e.g., Hagan, Reforming the IMF, supra note 4, at 59; e.g., Hagan lectures, supra note 1.

[28] IMF, Decision Establishing the Flexible Credit Line, supra note 21, at para. 2-3; Hagan, Reforming the IMF, supra note 4, at 60; Hagan lectures, supra note 1.

[29] Hagan, Reforming the IMF, supra note 4, at 60; Hagan lectures, supra note 1.

[30] See, e.g., Articles of Agreement of the IMF art. 18, §1-2; see also Hagan lectures, supra note 1.

[31] See IMF, Allocation of Special Drawing Rights for the Ninth Basic Period: Draft Executive Board Decision and Managing Director Report to the Board of Governors, Attachment, para. 6 (Jul. 16, 2009) https://www.imf.org/external/np/pp/eng/2009/071609.pdf.

[32] Hagan lectures, supra note 1.

[33] Buchheit, The Greek Debt Restructuring, supra note 1, at 47; Hagan lectures, supra note 1.

[34] Hagan lectures, supra note 1 (discussing how the IMF lowered its required threshold from a “high probability” of debt sustainability—installed in its Crisis Resolution Framework—to merely a “50-50” chance).

[35] Hal S. Scott & Anna Gelpern, International Finance: Transactions, Policy, and Regulation 417 (22nd ed. 2018) (describing the ECB and IMF); Buchheit, The Greek Debt Restructuring, supra note 1, at 47 (describing the ECB, EU, and IMF); see Hagan lectures, supra note 1 (discussing how the desire to limit contagion to the rest of the Eurozone contributed to the official sector’s decision to delay restructuring).

[36] See, e.g., Hagan lectures, supra note 1.

[37] E.g., id; see id. (noting also that the market thought that there would be insufficient funding even with the IMF involved).

[38] E.g., id.

[39] Scott & Gelpern, supra note 35, at 419; e.g., Hagan lectures, supra note 1.

[40] Scott & Gelpern, supra note 35, at 419; e.g., Hagan lectures, supra note 1; see Eur. Ct. of Justice, The OMT Programme announced by the ECB in Sept. 2012 is compatible with EU Law, at 1, (June 16, 2015) https://curia.europa.eu/jcms/upload/docs/application/pdf/2015-06/cp150070en.pdf (“The ECB has asserted that simply making the announcement about the OMT programme was sufficient to achieve the effect sought, namely to restore the monetary policy transmission mechanism and singleness of monetary policy”).

[41] E.g., Hagan lectures, supra note 1 (describing this desire among, for example, members of the Greek government and EU).

[42] Eur. Ct. of Justice, supra note 40, at 1.

[43] E.g., Hagan (citing Article 123 of the EU Treaty); see Eur. Ct. of Justice, supra note 40, at 1.

[44] Eur. Ct. of Justice, supra note 40, at 1; e.g., Hagan lectures, supra note 1.

[45] Eur. Ct. of Justice, supra note 40, at 3; e.g., Hagan lectures, supra note 1.

[46] Eur. Ct. of Justice, supra note 40, at 2; e.g., Hagan lectures, supra note 1.

[47] E.g., Hagan lectures, supra note 1.

[48] Buchheit, The Greek Debt Restructuring, supra note 1, at 47.

[49] Id. at 48; see Scott & Gelpern, supra note 35, at 418 (“Some proponents [of restructuring Greek debt] pointed out that the alternative—perpetual bailouts—would have been worse than any downside to restructuring”).

[50] Buchheit, The Greek Debt Restructuring, supra note 1, at 47; Scott & Gelpern, supra note 35, at 417.

[51] E.g., Buchheit, The Greek Debt Restructuring, supra note 1, at 49.

[52] Id.; Hagan lectures, supra note 1.

[53] Buchheit, The Greek Debt Restructuring, supra note 1, at 49; e.g., Hagan lectures, supra note 1.

[54] Buchheit, The Greek Debt Restructuring, supra note 1, at 49.

[55] Eur. Ct. of Human Rights, Mamatas and Others v. Greece, application nos. 63066/14, 64297/14 and 66106/14, Press Release, at 1, 3-4 (2016) https://hudoc.echr.coe.int/eng-press#{%22itemid%22:[%22003-5444603-6823781%22]}; Hagan lectures, supra note 1.

[56] Buchheit, The Greek Debt Restructuring, supra note 1, at 49 (noting that “enough [bond]holders [voted] to trigger the collective action mechanism” and the CAC required support from “holders of … at least two-thirds of the principal amount … of the Greek law-governed GGB’s,” where “holders of at least 50%” voted “either in favour or against”); Hagan lectures, supra note 1.

[57] Eur. Ct. of Human Rights, Mamatas and Others v. Greece, Press Release, supra note 55, at 1, 3-4; Hagan lectures, supra note 1.

[58] E.g., Hagan lectures, supra note 1; see Hagan lectures, supra note 1 (noting Greece had $19 billion in foreign law bonds); see Scott & Gelpern, supra note 35, at 419 (noting that Greece had “EUR 29 billion of bonds … issued under foreign (predominantly English) law or by state owned enterprises backed by government guarantees”).

[59] E.g., Hagan lectures, supra note 1; see Scott & Gelpern, supra note 35, at 419.

[60] Scott & Gelpern, supra note 35, at 419; see Hagan lectures, supra note 1.

[61] E.g., Hagan lectures, supra note 1; see Scott & Gelpern, supra note 35, at 419 (noting that “Greece ultimately chose not to default” and paid completely the non-restructured bond issuances, the holders of which “reportedly” included “an investment fund that had held out in prior sovereign debt restructurings”).

[62] E.g., Hagan, The Eurozone Crisis: Defining a Path to Recovery, 63 Ks. L. Rev., 1067, 1073 (2015); Hagan lectures, supra note 1.

[63] E.g., Hagan lectures, supra note 1 (describing how the official sector amended the ECB statute to give the ECB bank supervisory authority); see Hagan, The Eurozone Crisis: Defining a Path to Recovery, supra note 62, at 1073-74 (advocating for this change).