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The Deep Deformation of Europe

Economic Conflict in the European Union

Elli Louka Elli Louka

Elli Louka Page 1

Elli Louka is the founder of Alphabetics (, a consulting company based in
Princeton, New Jersey, and has worked with countries and companies on international law issues. Louka
has been a Marie Curie Fellow, a Ford Foundation Fellow and Senior Fellow at Orville H. Schell, Jr. Center
for International Human Rights at Yale Law School. Publications include: Nuclear Weapons, Justice and
the Law; Water Law and Policy: Governance Without Frontiers and International Environmental Law:
Fairness, Effectiveness and World Order.
Elli Loukas books can be found at:

Front Cover: Map of Europe as a queen, printed by Sebastian Mnster in Basel, 1570.
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The euro crisis has deeply deformed Europe as it has taken the dimension of economic conflict between
creditor states and debtor states, the proverbial north against south. Despite a half-century long
struggle to transform Europe into a European Union (EU), the euro crisis has embroiled European states
in an asymmetric conflict through the instrument of economic power. The economic conflict has
tarnished EUs brand as the model of international cooperation. The EU has become, instead, one more
exemplification of the coercion dynamics that prevail in international politics. This deformation of the
European Union has generated a legitimacy crisis that has yet to be addressed by the current
institutions. European citizens who are confronted with an institution that they neither control nor
like are trapped in a forced Union.

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Table of Contents
1. The Tipping Point
2. Debt and Guilt: the Greek Sovereign Debt Crisis
3. Attack on Offshore Finance: the Cyprus Case
4. Origins
4.1. The Opaque Structure of Global Finance
4.2. The Bond Market against Weak Sovereigns
4.3. The Value of a Strong Currency with Frankfurt at Its Center
4.4. The Crippled Financial Integration of the EU
5. Institutions
5.1. European Council, Eurogroup, European Commission
5.2. The Mechanisms
5.3. Economic Surveillance and Sanctions
5.4. European Central Bank
5.4.1. Carbon Copy of the German Central Bank?
5.4.2. Opaque Operator The Target2 System
5.4.3. Buyer of Sovereign Bonds
5.4.4. Liquidity and Emergency Backer
5.5. National Courts
5.6. The IMF
6. Banking Union and Fiscal Union
7. No Exit No Voice
7.1. EU Legitimacy: a Citizens Perspective
7.2. EU Legitimacy: Creditor States versus Debtor States
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The man who desires to be rid of an evil knows what he wants; but the man who desires something
better than he has got is stone blind.

1. The Tipping Point
Romantics are people who, instead of resolving a conflict, imagine an alternative reality in which conflict
does not exist.
Political romantics in Europe
believed that the perpetual conflict among European
states could be stopped if Europe was transformed into a European Union (EU). Such metamorphosis
would stem from the spillover effect:
economic integration was to spill over to other policies and
gradually lead to a political union something akin to a United States of Europe. Despite these high
hopes, seventy years after World War II erupted, the euro crisis took on the dimension of conflict
between creditor states and debtor states. Europe has not been transformed into a Union. The
successive transformations
have only led, instead, to a deep deformation: an asymmetric conflict
through the instrument of economic power.
Political romantics who had visualized Europe as a United
States of Europe are now staring reality in the face: the European Union as an archetype of the coercion
dynamics in international politics.

In 1951 the EU is born out of the disaster of World War II. The United States is instrumental in the
incubation of the first European Communities as it sees in a United Europe a parapet against Soviet-

Goethes Elective Affinities: with an Introduction by Victoria C. Woodhull 18 (1872).
See Carl Schmitt, Political Romanticism (translation Guy Oakes, 1986).
See, e.g., Elli Louka: Water Law and Policy: Governance Without Frontiers (2008) (analyzing how water policy has
been oriented towards building a Europe without frontiers).
See Elli Louka, Conflicting Integration:the Environmental Law of the European Union 5 (2004).
See Treaty Establishing the European Economic Community (EEC Treaty or Treaty of Rome), Mar. 25, 1957,
reprinted in 298 U.T.S. 3. The EEC Treaty was followed by the Single European Act, Feb. 17, 1986; the Treaty on
European Union (Maastricht Treaty), Feb. 7, 1992; the Treaty of Amsterdam, Oct. 2, 1997; the Treaty of Nice, Feb.
26, 2001; the Treaty of Lisbon, Dec. 13, 2007. These treaties have been consolidated. See Consolidated Versions
of the Treaty on European Union (EU Treaty) and the Treaty on the Functioning of the European Union (TFEU), OJ C
326/1, 26.10.2012.
On the coercive use of economic power, see Myres S. McDougal, The Impact of International Law upon National
Law: A Policy-Oriented Perspective, 4 South Dakota Law Review 25, at 47-48 (1959).
See, e.g., W. Michael Reisman, Coercion and Self-Determination: Construing Article 2(4), 78 American Journal of
International Law 642 (1984).
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styled communism.
European states see in a United Europe an assurance that the coal and steel
production of Germany will not be used again to make war against them.
There is a consensus in
Europe that the industrial Goliath of Germany must be contained. Germany seizes the opportunity to
rebrand itself as a Community-oriented country.

In 1992, after forty years of economic integration, the Maastricht Treaty is adopted establishing a
monetary union.
In September 1992 the European Exchange Rate Mechanism (ERM), the foundation
of the monetary union, collapses when the UK is forced to exit the ERM. George Soros, a hedge fund
manager and a billionaire, makes one billion dollars by selling the British pound and he is labeled the
man who broke the Bank of England.
In 1997 the European Union agrees to adopt the Stability and
Growth Pact
under the insistence of Germany that financial discipline and sanctions must be imposed
on states that exceed a specific budget deficit ceiling. In January 1999 the euro is established. In 2001
Portugal exceeds the deficit ceiling imposed by the Stability Pact and is chastised by the European
Commission for that violation.
In November 2003 Germany
and France
violate the deficit ceiling.

Barry Eichengreen, The European Economy since 1945: Coordinated Capitalism and Beyond 9 (2007).
See Treaty Establishing the European Coal and Steel Community (ECSC), Apr. 18, 1951, reprinted in 261 U.N.T.S.
Eichengreen, supra note 8, at 164.
See supra note 5.
The Man Who Broke the Bank of England, BBC, Dec. 6, 1998 available online
See section 5.3.
See Commission Opinion on the existence of an excessive deficit in Portugal Application of Article 104(5) of the
Treaty Establishing the European Community, SEC(2002) 1117 final. See also Council Recommendation for a
Council Recommendation to Portugal with a view to bringing an end to the situation of an excessive government
deficit Application of Article 104(7) of the Treaty, SEC(2002) 1110 final.
See Recommendation for a Council Decision on the existence of an excessive deficit in Germany Application of
Article 104(6) of the Treaty establishing the European Community, SEC (2003) 9 final. See also Recommendation
for a Council Decision establishing, in accordance with Article 104(8) of the EC Treaty, that action taken by
Germany in response to the recommendations made by the Council pursuant to Article 104(7) of the Treaty is
proving inadequate, SEC (2003) 1316. For the excessive deficit procedures taken against Germany see
See, e.g., Recommendation for a Council Recommendation to France with a view to bringing an end to the
situation of an excessive government deficit, Application of Article 104(7) of the Treaty, SEC (2003) 516 final. For
the excessive deficit procedures taken against France see
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The European Commission brings a case against France and Germany, but eventually France and
Germany prevail.
Political interference so that the Stability Pact does not apply to the largest EU
countries strengthens beliefs that the pact is practically unenforceable.
The Stability Pact is relaxed in
reinforcing expectations that the rules included in it are malleable. In fact, the majority of EU
member states do not hesitate to engage in creative accounting and misreporting
in order to fudge
their real debt and deficit numbers. In 2005 the French public and the Dutch public reject the European
a treaty that, as its name suggests, embodies the ideal of a United States of Europe.
In June 2007 the global financial crisis hits with the first signs of the collapse of the United States
subprime mortgage market.
The crisis quickly spills over to Europe. The European Central Bank (ECB)
injects more than two hundred billion euros
into the banking system to improve liquidity. The United

See Council of the European Union, 2546th Council meeting, Economic and Financial Affairs, Press Release,
Nov. 15, 2003 available online
25_council_press_release_en.pdf; Council of the European Union, 2634th Council meeting, Economic and Financial
Affairs, Press Release, Jan. 18, 2005 available online
Cline Allard, et al., Toward a Fiscal Union for the Euro Area, IMF Staff Discussion Note, at 8 (2013) available
It was amended to allow states latitude in addressing economic bad times. Compare article 5 of Council
Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the
surveillance of economic policies, OJ L 209/1, 2.8.97 with article 5 Council Regulation No 1055/2005 of 27 June
2005 amending Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and
the surveillance and coordination of economic policies, OJ L 174/1, 7.7.2005.
See, e.g., Jrgen von Hagen et al., What Do Deficits Tell Us about Debt? Empirical Evidence on Creative
Accounting with Fiscal Rules in the EU, 30(12) Journal of Banking & Finance 3259 (2006). See also Timothy C. Irwin,
Accounting Devices and Fiscal Illusions, IMF Staff Discussion Note SDN/12/02, Mar. 28, 2012 available online
Treaty establishing a Constitution for Europe (TCE), OJ C 310/1 (2004).
For the events mentioned in this section the following sources have been used: Mauro F. Guilln, Global
Economic and Financial Crisis: A Timeline available online;
Christophe Gouardo, Euro Crisis Timeline available
df; Greek Crisis Timeline from Maastricht Treaty to ECB Bond Buying available online
All numbers are in euros unless otherwise specified.
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States Federal Reserve, the Bank of Canada and the Bank of Japan begin to intervene in the markets.
Two German banks announce that they face severe losses due to their investments in the subprime
mortgage market. In September 2007 Northern Rock, a British bank, asks for emergency assistance.
Depositors withdraw one billion British pounds from Northern Rock, the largest run on a British bank for
more than a century, but eventually the UK government declares that their savings are guaranteed. In
February 2008 the British government nationalizes Northern Rock.
In September 2008 Lehman Brothers, an investment banking firm, collapses, turning the financial crisis
into financial panic. The European banking and insurance company Fortis is partly nationalized because
it is too big and important, for the European banking sector, to fail. The Netherlands, Belgium and
Luxembourg agree to inject 11.2 billion into the bank. On September 30, Dexia, another bank, gets a
bailout when France, Belgium and Luxembourg agree to put in 6.4 billion to save the bank. The Irish
government decides to guarantee all deposits in Irish banks undertaking a burden of four hundred
and forty billion more than twice Irelands GDP. Germany announces a fifty billion plan to save one
of the countrys biggest banks, Hypo Real Estate. By October 2008 all three major banks of Iceland
collapse. A diplomatic row erupts between Iceland and Britain about the handling of the banking
collapse. At stake are hundreds of millions of British pounds that have been deposited in Icelandic banks
by British savers. Iceland expresses shock at the decision of the UK to invoke anti-terrorism legislation to
freeze Icelandic banks' assets in the UK.
The UK condemns Iceland for guaranteeing domestic deposits
but failing to guarantee British savers' deposits. Iceland eventually requests an International Monetary
Fund (IMF) stand-by arrangement
to help resolve the banking and currency crisis that has decimated
its economy.
On October 12, 2008, European leaders clarify that their action plan to address the financial crisis does
not involve a joint guarantee on bank debts and that each country should act alone, in coordination
with other countries, to provide guarantees for its banking sector.
The IMF, the EU and the World
Bank announce a massive rescue package for Hungary. In November 2008 a secret task force starts to
meet to devise an action plan in case a Hungary-style crisis hits a eurozone nation. Membership is
limited to senior policy makers from France, Germany, the European Commission, the ECB and the office

The international dispute, known as the Icesave dispute, started when the UK used anti-terrorism legislation
against Iceland to freeze the UK-based assets of Kaupthing, Iceland's biggest bank. Eventually the EFTA (European
Free Trade Association) Court cleared Iceland of all the charges against it. See Case E-16/11, EFTA Surveillance
Authority v. Iceland, Jan. 28, 2013 available online
A stand-by arrangement is a lending instrument of the IMF through which it provides financial assistance to
countries based on the condition that they adopt IMF-designated reforms.
Declaration on a Concerted European Action Plan of Euro Area Countries, Summit of the Euro Area Countries,
para. 8, Oct. 12, 2008 available online
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of Jean-Claude Juncker, the Luxembourg prime minister who heads the group of eurozone finance
ministers. The task force is secret because even a rumor that such a task force exists could trigger
speculation in the financial markets against the euro.

On November 4, 2008, as the economic crisis rages around the world, the EU finance ministers meet
ahead of the G-20 meeting in Washington (planned for November 15, 2008) to forge a common position
before that meeting. France offers a detailed ten-page plan, but runs into objections from Germany.
The German finance minister states that the French plan is too close to supra-national economic
governance at the EU level: It could be interpreted that we are aiming for a coordinated, overarching
economic policy [at the European level]. We would be very skeptical about that. We dont need a
European economic government.
In December 2008 Ireland puts together a ten billion fund to
recapitalize its banks.
In January 2009 Germany approves a stimulus package, the biggest in Europe, to overcome the
countrys economic woes. On January 14, 2009, the S&P, a rating corporation, cuts the rating on Greek
government bonds from A to A-. The rating company points to the countrys weak finances, as the
global economy is entering recession. On January 30, angry protesters around the world blame
governments for failing to confront the economic crisis. In February 2009 the European Commission
reports that six countries Ireland, Greece, Spain, France, Latvia and Malta have a budget deficit
that is more than that allowed by the Stability Pact.
The banking sectors of Central and Eastern Europe
get a 24.5 billion EU loan to help them ride out the economic crisis.

In March 2009 the US Federal Reserve announces a plan to buy 1.7 trillion dollars of government debt to
boost the US economy. In addition the United States announces a plan, under the Treasurys Troubled
Assets Relief Program, to buy up to one trillion dollars' worth of toxic assets to help repair US banks
balance sheets. In September 2009 the finance ministers of the worlds most powerful economies agree

Marcus Walker, On the Secret Committee to Save the Euro, a Dangerous Divide, Wall Street Journal, Sept. 24,
2010 available online
Stephen Castle, Europe Asks France to Rethink Fiscal Plan, NY Times, Nov. 4, 2008 available online
European Commission, Commission Assesses Stability and Convergence Programmes of Ireland, Greece, Spain,
France, Latvia and Malta; Presents Reports Under Excessive Deficit Procedure, Press Release, IP/09/274, Feb. 18,
2009 available online
European Bank of Reconstruction and Development (EBRD), IFI Initiative: EBRD, EIB and World Bank Group Join
Forces to Support Central and Eastern Europe, Press Release, Feb. 27, 2009 available online
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to a series of measures to regulate better the global banking system.
The OECD calls for new policies
to tackle high global unemployment.
In 2009 Spains unemployment has already climbed to eighteen

In August 2009 the IMF issues a country report on Greece that is mixed.
Stress tests conducted jointly
by the Bank of Greece and the IMF suggest that the Greek banking system has enough buffers to
weather the expected downturn.
The Greek economy, despite a bloated public sector, has shown
resilience nevertheless a recession is to be expected.
In October 2009 the Greek government
announces that the 2009 public deficit would be 12.5 percent of GDP a figure much larger than what
was reported before (3.7 percent of GDP).
The credibility of the Greek figures becomes a major issue
in the markets in 2009 even though the Eurostat, the EUs official statistics reporting agency, had issued
since 2004 publicly accessible reports about the accounting failings of Greece.
The IMF also had raised
concerns about severe shortcomings in the area of fiscal transparency in Greece.

Greece announces plans to bring its budget deficit within the limits of the Stability Pact by 2012 and it
adopts austerity measures to achieve that goal. In the meantime the yield on the ten-year Greek bond
reaches 6.25 percent, the eurozones highest. The European Union convenes an emergency meeting on
Greece. The ECB mentions that it will continue to accept Greek government bonds (now rated BBB-) as

See G-20 Communiqu, Meeting of Finance Ministers and Central Bank Governors, London, Sept. 4-5, 2009
available online
OECD, Unemployment in OECD Countries to Approach 10% in 2010, Says OECD, Press Release, June 23, 2009
available online
OECD, OECD Unemployment Rate Stable at 8.8% in December 2009, Press Release, at 3, Feb. 8, 2010 available
Greece: 2009 Article IV ConsultationIMF Country Report No. 09/244, Aug. 2009 available online [hereinafter IMF 2009 Report].
Id. at 16.
Id. at 33.
See European Commission, Report on Greek Government Deficit and Debt Statistics, at 3, COM(2010) 1 final.
See Report by Eurostat on the Revision of the Greek Government Deficit and Debt Figures, Nov. 22, 2004 (in this
report the Eurostat revised the Greek debt and deficit numbers from 1997 to 2003) available online [hereinafter Eurostat Greek
IMF, Greece: Report on Observance of Standards and Codes Fiscal Transparency Module, IMF Country Report
No. 06/49, Feb. 2006 available online
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collateral. On April 23, 2010, Greece asks the EU and the IMF for a forty-five billion loan, as yields on
government bonds reach 7.4 percent, launching Europes sovereign debt crisis. On May 2, 2010, the
eurozone and the IMF agree to provide Greece with a hundred and ten billion loan under the condition
that Greece will achieve thirty billion in budget cuts.
October 18, 2010 marks the tipping point in the euro crisis. This is the date when German chancellor
Merkel and French president Sarkozy issue a joint declaration in Deauville, France.
According to the
Franco-German declaration, private creditors would have to contribute to future sovereign bailouts.
The joint declaration unnerves bondholders who realize that they will suffer losses on government
bonds issued by weak periphery countries whose debts are deemed unsustainable.
The IMF has
blamed on this joint Franco-German declaration the widespread loss of confidence in the Greek
The 2010 Deauville Declaration and the time that elapses between the declaration and the
restructuring of the Greek debt push the country into a confidence destroying downward spiral.
December 2011 the yield on the ten-year Greek bond skyrockets to thirty-two percent, demonstrating
that investor confidence is in shambles. The outflows of capital that began in 2010 reach eighty-three
billion by the summer of 2012.

In November 21, 2010, Ireland formally requests financial assistance from the EU. The EU and the IMF
grant an eighty-five billion loan under strict conditionality.
The country has to cut public spending by
ten billion and raise taxes by five billion.
This steep austerity, many argue, could lead the country to a
deep recession. By helping Ireland, Germany and France achieve what was hard for them to accomplish
before. Ireland concedes to reconsider branding itself as a low-tax corporate jurisdiction and to

Franco-German Declaration, Statement for the France-Germany-Russia Summit, Deauville, Oct. 18, 2010
available online
Arturo C. Porzecanski, Borrowing and Debt: How Do Sovereigns Get into Trouble? in Sovereign Debt
Management 309, at 320 (Lee C. Buchheit et al., eds., 2014).
IMF, Greece: 2013 Article IV Consultation, IMF Country Report No. 13/154, at 6, June 2013 available online [hereinafter IMF Report 13/154].
See Porzecanski, supra note 41, at 321. See also European Commission, The Economic Adjustment Programme
for Greece, Fifth Review, Occasional Paper 87, at 16-18, Oct. 2011 [hereinafter European Commission Fifth
IMF Report 13/154, supra note 42, at 10.
For the details of the program, see European Commission, Economic Adjustment Programme for Ireland
available online
See Irelands Department of Finance, The National Recovery Plan 2011-2014, at 5-6 (2010) available online
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participate in the discussions for the adoption of a Common Consolidated Corporate Tax Base (CCCTB)
draft directive.
France and Germany have resented the low corporate tax rates of Ireland, which
entice foreign corporations to place their headquarters in that country.
In 2011 Portugal asks for an EU emergency loan. On May 16, 2011, the eurozone officially approves a
seventy-eight billion loan for Portugal,
which becomes the third eurozone country after Ireland and
Greece to receive emergency loans. On June 5, 2011, the rating company Moody's cuts Portugal's credit
rating to junk status. Moodys has cut Portugals credit rating since the 2010 downfall of Greece,
speculating that the financial meltdown is to spread to other weak European states with high public
debts and budget deficits. Despite the recessionary trends worldwide, the ECB raises its interest rate,
making it even harder for the periphery states to pay off their debt.
On July 22, 2011, Germany and
France negotiate bilaterally a deal that establishes a European Stability Mechanism and the outline for
the restructuring of the Greek debt that involves the participation of the private sector.
This bilateral
deal, which is presented as a fait accompli to the European Council, is one of the many expressions of
the reluctant bilateralism the main tool used to address the euro crisis. On June 26, 2012, Spain
requests financial assistance. An agreement (the Financial Assistance Facility Agreement FFA) with
the EU/IMF is reached on July 20, 2012 to provide funding for Spains banking sector. The loans will be
provided to the Fondo de Reestructuracin Ordenada Bancaria (FROB), the bank recapitalization fund of
the Spanish government, and then channeled to the troubled financial institutions.

On July 26, 2012, Mario Draghi, the president of the ECB, declares that the ECB is ready to do whatever
it takes to preserve the euro.
The subsequent program announced by the ECB of unlimited purchases

See European Commission Fifth Review, supra note 43, at 8.
See European Commission, Economic Adjustment Programme for Portugal available online
See Annalyn Censky, ECB Hikes Interest Rates, CNNMoney, July 7, 2011 available online; See also Paul Carrel, ECB Hikes
Rates, Ready to Move Again if Necessary, Reuters, Apr. 7, 2011 available online
Carsten Volkery, Saving the Euro: Sarkozy Gets His European Monetary Fund, Spiegel, July 22, 2011 available
See European Commission, Financial assistance for the recapitalisation of financial institutions in Spain available
ECB, Speech by Mario Draghi, President of the European Central Bank at the Global Investment Conference in
London, Press Release, July 26, 2012 available online
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of short-term sovereign debt (the open market transactions OMT)
discourages speculation about
the euro break-up and the yields on Spanish government bonds stay below six percent. On December 3,
2012, the Spanish government requests the disbursement of about 39.5 billion from the FFA.
November 2012 the IMF endorses the view that in some circumstances capital controls can be beneficial
for states.

On March 16, 2013, the EU and the IMF agree to grant Cyprus a ten billion loan, making it the fifth
country after Greece, Ireland, Portugal and Spain to receive emergency financing. The loan comes
under the condition of the restructuring of the Cypriot banking sector requiring bondholders and savers
to incur substantial losses. This is the coup that decimates the islands economic base. Cyprus enacts
capital controls to prevent the flight of capital, instituting in this way the de facto division of the euro
into the northern euro and the southern euro.

2. Debt and Guilt: the Greek Sovereign Debt Crisis
In German the moral concept Schuld (guilt) descends from the very material concept of Schulden
From time immemorial, debtors who are unable to pay off their debt are punished. Their
creditors devise methods of retribution, including taking away their freedom. Through the punishment
of the debtor, the creditor takes part in the rights of the masters.
He enjoys the elevated feeling of
being in a position to despise and maltreat someone as inferior.
Greece is in debt and, therefore,
guilty. It is time for the country to reform through austerity. Reform will be a kind of an aide
so that the fear of repercussions of debt accumulation will prevent the country from
borrowing excessively again.

See infra section 5.4.3.
See supra note 51.
IMF, The Liberalization and Management of Capital Flows: An Institutional View (2012) available online
Friedrich Nietzsche, On the Genealogy of Morality 37 (Keith Ansell-Pearson, ed., 2006) [emphasis in the original].
Id. at 41.
On punishment and reform, see id. at 54. See also The Other Moral Hazard, Economist, Sept. 29, 2012, at 61
(Mario Monti, Italys prime minister in 2012, stated that for Germany, economics is a branch of moral
philosophy. Countries must pay for sins of commission (budget deficits) and omission (poor bank supervision).
Only then can there perhaps be more European integration to avert problems in the future.).
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In 2010 most believed that the crisis would be contained and that the EU might emerge stronger from it.
The euro crisis was good for Germany as its exporters were benefitting from a weaker euro. Even better,
Germany was cracking the whip on the rest of the Eurozone
to fix their finances. It was believed,
though, that, because creditor states and debtor states shared the same currency, the credibility of that
currency would not be risked. Eventually what had not shattered Europe yet might make it stronger.

Greece entered the eurozone in 2001. A currency swap that was facilitated by Goldman Sachs, an
investment firm, which camouflaged the Greek debt, smoothed that entry. Greece and Goldman Sachs
were derided in 2012 for executing this derivative deal
even though the specifics of the deal were
widely publicized in 2003.
Moreover, these types of deals were just one of the techniques that
countries used to meet the Maastricht Treatys debt and deficit ceilings.
In fact, the EU member states
had knowingly incapacitated the Eurostat from scrutinizing such deals.
Up to 2009, many states
including Italy, Poland, Belgium and Germany took advantage of accounting loopholes built into the

Thomas Meaney, Greeces Crisis, Germanys Gain, Los Angeles Times, Mar. 15, 2010 available online
Nicholas Dunbar, Goldman Secret Greece Loan Shows Two Sinners as Client Unravels, Bloomberg, Mar. 5, 2012
available online
See Nick Dunbar, Revealed: Goldman Sachs Mega Deal for Greece, Risk Magazine, July 1, 2003
See European Parliament, Committee of Economic and Monetary Affairs, MEPs Hear Views of Leading Figures on
the Greek Fiscal Crisis, Press Release, Apr. 14, 2010 available online
[hereinafter European Parliament].
See Dunbar, supra note 63. The ESA95 is the EU manual on government deficit and debt published by the
European Commission and the Eurostat. The 2002 version of the manual was subject to fierce arguments between
government debt managers and statisticians. The published version of the ESA95 in 2002 reflected the victory of
government debt managers who insisted on having the freedom to use derivatives to adjust deficit ratios. See also
European Commission and Eurostat, ESA95 Manual on Government Deficit and Debt, at 202 (2002).
European Parliament, supra note 64.
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The eurozone member states and the ECB were at loggerheads over the handling of the Greek crisis. It
took till March 25, 2010 for the European Council to agree that Greece might need external help.
April 23, 2010, the Greek government concluded that it was unable to deal with the crisis by itself.
Under strict conditionality a hundred and ten billion loan was granted to Greece. The loan was funded
by Germany (27.9 percent), France (21 percent) and Italy (18.4 percent). The total loans granted to
Greece by eurozone states amounted to eighty billion the so-called Greek Loan Facility. The IMF
contributed thirty billion under a stand-by arrangement.
Greece had to find thirty billion in budget
cuts and additional taxes to qualify for the incremental disbursement of the loan. The loan conditions,
however, did not affect Greeces military spending. Greece was to keep spending on military equipment
it had ordered, before the crisis, from France and Germany what was called the informal
conditionality of the Greek Loan Facility.
Greece is a heavy spender on military equipment and it has
under-reported several times its military expenditures in order to present a smaller deficit to the EU

Greece was placed under close supervision to ensure that the emergency loans would be paid off.
Teams of inspectors from the European Commission, the IMF and the ECB, the so-called troika, visited
Greece regularly to ensure that it met the conditionality agreed to. It was the first time that the EU was
so closely involved in monitoring a state.
Germany insisted on the involvement of the IMF in the Greek
emergency loan as a counterweight against the European Commission, which Germany believed would
not be objective enough and strict enough to monitor Greeces implementation of conditionality. The
loans to Greece were granted not by the European Union, but by eurozone states, on a bilateral basis,
giving creditor countries substantial flexibility in handling their debtor (Greece). What these bilateral
loans really achieved was a change in the ownership of the debt. Before the official loans were granted,
Greece owed money to European banks, many of them German and French banks.
Greece could use

See Council of the European Union, Statement by the Heads of State and Government of the Euro Area, Press
Release, Mar. 25, 2010 available online
See European Commission, Financial assistance to Greece available online
Christopher Rhoads, The Submarine Deals that Helped Sink Greece, Wall Street Journal, July 10, 2010
Eurostat Greek Revision, supra note 38, at 3.
Kevin Featherstone, The Greek Sovereign Debt Crisis and EMU: A Failing State in a Skewed Regime, 49 Journal of
Common Market Studies 193, at 205 (2011).
French and German banks were particularly exposed to the residents of Greece, Ireland, Portugal and Spain. At
the end of 2009, they had $958 billion of combined exposures ($493 billion and $465 billion, respectively) to the
residents of these countries. See Stefan Avdjiev et al., Highlights of International Banking and Financial Market
Activity, BIS Quarterly Review, at 19, June 2010. Furthermore, the joint foreign claims of banks headquartered in
Elli Louka Page 15

the 2010 official loans to pay off its debts transferring the Greek debt from the balance sheet of
banks to the balance sheet of European governments. The loans were granted to Greece to spare the
financial system the repercussions of a Greek default estimated at two hundred billion.
In 2010 the
IMF officially declared that it had faith that the 2010 loans to Greece would be sufficient to stave off any
further crisis. Secret documents that were leaked in 2013 have revealed, though, that there was
internal dissension among the IMF members regarding the 2010 loans granted to Greece.
and many Middle Eastern, Asian and Latin American countries argued that the loans could not possibly
alleviate the debt burden of Greece since they included no debt restructuring such as forgiving debt
principal, reduction of the interest rate and extension of the payment schedule to make the service of
the debt easier.
The loans were, instead, about the transfer of the Greek debt from the private sector
to the public sector. In Germany the 2010 loans to Greece were viewed as a French victory and a
German defeat. In the German press, the eurozone was derogatorily referred to as a mutual bailout
association, a transfer union. Because the eurozone was a transfer Union the ECB obviously would lose
its independence, the euro would become a soft currency and inflation would surge. Many Germans
wanted to scrap the euro and switch back to the deutschmark.

Before its entry into the eurozone, the markets viewed Greece as a convergence play. The bond market
demonstrated a high preference for Greek government bonds because of the high yields they offered
compared with the low risk assigned to a country that was converging
to adopt the euro. When the
euro was established the implicit assumption was that the eurozone partners would bail each other out

the eurozone on the public sectors of Greece, Ireland, Portugal and Spain were 254 billion dollars. Once again,
most of those claims belonged to French ($106 billion) and German ($68 billion) banks. These two banking systems
had sizeable exposures to the public sectors of Spain ($48 billion and $33 billion, respectively), Greece ($31 billion
and $23 billion, respectively) and Portugal ($21 billion and $10 billion, respectively). Id. at 21.
Ronald Janssen, Greece and the IMF: Who Exactly Is Being Saved? Center for Economic and Policy Research, at 6,
July 2010 available online
Thomas Catan, Past Rifts over Greece Cloud Talks on Rescue, Wall Street Journal, Oct. 7, 2013 available online
Wolfgang Proissl, Why Germany Fell Out of Love with Europe, at 32, Bruegel Essay and Lecture Series, July 1,
2010 available online
The European Commission publishes reports called convergence reports on whether a country meets the
requirements to join the euro. In 2000 the European Commission concluded that Greece met the convergence
criteria to join the euro. It is worth noting that on December 17, 1999, the Council had just abrogated its previous
decision on the existence of an excessive deficit in Greece. See European Commission, Proposal for a Council
Decision in accordance with article 122(2) of the Treaty for the adoption by Greece of the single currency on
1.1.2001, COM(2000) 274 final.
Elli Louka Page 16

in times of trouble, in other words, that the eurozone was ruled by a system of joint and several

In 2011 it was evident that Greece would need more financial assistance.
The Greek prime minister
decided to put the loan conditionality demanded by creditor states to a public referendum. The
referendum never took place after an implicit Franco-German blackmail that such a referendum would
jeopardize the chances of Greece getting a new loan and even its EU membership.
The Greek prime
minister came under intense pressure and eventually resigned. A caretaker government was installed
under the leadership of a former vice president of the ECB.
By 2012 the EU Council of Ministers officially concluded that private sector involvement (PSI), in addition
to government loans, was necessary to allow for the write-off of more than fifty percent of the Greek
debt. The PSI was presented as voluntary, but in essence, it was the default of Greece. The Greek press
reported that the government was prepared to introduce a new law to force private creditors to accept
the exchange of their bonds for new, discounted bonds. By choosing default the eurozone admitted
that investors had to bear the losses for failing to differentiate between the risk profiles of the eurozone
countries. Since Greeces official creditors (the IMF, the ECB, eurozone governments) were excluded
from the PSI, the remaining creditors had to incur even larger losses.
The PSI deal inflicted damage on the European sovereign debt market (a market estimated at 8.4
because it demolished the prevailing perception that the bonds of eurozone sovereigns would
not default. Now a default risk was attached to them and their ultimate value was dependent on the
decisions of governments, the ECB, the EU and the IMF. No wonder investors hankered after a higher

Jean Tirole, The Euro Crisis, Some Reflexions on Institutional Reform, Banque de France Financial Stability
Review, No. 16, at 225, Apr. 2012 available online
See Draft Greece Debt Sustainability Analysis, Oct. 21, 2011 (leaked to the media) available online
According to revelations by the former French finance minister, Franois Baroin, the blackmail was rather explicit
during the 2011 Cannes summit of G-20. During that meeting the French president told the Greek prime minister:
'"On te le dit clairement, si tu fais ce rfrendum, il n'y aura pas de plan de sauvetage. Papandrou fait mine de
ne pas comprendre. Avec un regard d'acier, Merkel lui redit la mme chose de faon trs ferme. C'est une guerre
psychologique. (translation: Were telling you straight out, if you do the referendum there will be no salvation
plan. Papandreou pretends not to understand. With a cold look Merkel reiterates the same thing very firmly. It is
a psychological war. ) See Eric Mandonnet, "Black Swan," le secret d'Etat rvl par Franois Baroin, L'Expansion,
Oct. 30, 2012 available online
Peter Boone et al., The European Crisis Deepens, Peterson Institute for International Economics, Policy Brief 12-
4, at 3, 2012 available online
Elli Louka Page 17

return for holding bonds of the periphery countries that were labeled high risk.
Furthermore, each
time the official creditors bought bonds or provided loans to the weakened periphery the private debt
holders became subordinated because the official creditors claimed a preferential status. Because
private bondholders were subordinated to the official creditors, holding euro-periphery bonds became
like holding junior claims on troubled economies.

Greece had a hard time implementing the conditionality demanded by its creditors. In February 2012
Greece was to receive a loan installment under the initial emergency loan, but no such installment was
forthcoming unless further budget cuts were enacted. Without the emergency financing, it would have
been impossible for Greece to make payments of 14.5 billion on the debt it had already incurred. The
appointed prime minister Papademos, in his address to the nation, warned that failure to pass the
austerity bill would lead the country to disorderly default. He warned that Greece was nearing ground

The eurozone governments and the IMF wanted unambiguous commitments that Greece would abide
by the strict loan conditionality no matter who was elected in the upcoming elections of April 2012.
They demanded signed commitment letters from the political parties that they would support economic
austerity if they won the elections. This was seen as direct interference in Greeces politics and an
undermining of Greek democracy and sovereignty. The finance minister of Germany proposed that it
would be better to postpone the Greek elections altogether and set up a small technocratic cabinet to
run Greece for a couple of years.
Germany was willing to help, according to its finance minister, but it
could not put its money into a bottomless pit.
That statement got an angry response from the Greek
president who had fought against the German occupation during World War II.
Eventually, after two
rounds of elections, a fragile coalition was built in which the pro-austerity parties held a slim majority.
The extreme right and left, however, won an unprecedented number of votes, and consequently more
parliamentary seats, instituting a voluble opposition to austerity. The outcome of the 2012 Greek
elections was the result of public outrage at what was conceived as foreign-implanted austerity.

Greece Bailout: PM Lucas Papademos Gives Final Warning, BBC News, Feb. 11, 2012
Greece and the Euro: Flaming February, Economist, Feb. 18, 2012, at 53.
Greek Protesters Fight with Police as Parliament Agrees Cuts Deal, Guardian, Feb. 12, 2012 available online
The World from Berlin: Greek President's Wrath Is Exaggerated but Ominous, Spiegel, Feb. 17, 2012 available
Elli Louka Page 18

All through the Greek sovereign debt crisis, the German press and politicians were painting the Greeks
as the archetypical lazy southerners or rich tax evaders. According to the German popular verdict, if
Greece could not pay back its debt it should sell its real estate, for instance, the Greek islands and
Some speculated that social chaos would erupt in Greece but that an international
protection force, like that sent to Bosnia and Kosovo, might not be necessary.
Many claimed that the
Greeks must learn lessons from the massive failure of their state and must accept the surrender of their
This public reaction in Germany is demonstrative of the remarkable absence of solidarity
among of the peoples of the states that make what has been called the European Union. Germans could
not identify with their conception of slothful and tax-evading Greeks.
As long as there was such a negative media blitz on Greece any attempt to restore a sense of stability in
its economy was condemned to failure.
In 2010 the exit of Greece from the euro was unthinkable. In
2012 speculation about the Grexit was rampant. The ECB and the European Commission were
reportedly working on emergency scenarios in case Greece would not make it. Greece was facing one of
the worst economic recessions in its history and many economists were arguing that the austerity
package demanded as a sine qua non for the emergency loans would drag Greece even deeper into
The mood on the streets was ugly. One day protests turned violent as protesters threw
Molotov bombs torching more than forty buildings.
The austerity package for Greece worsened
unemployment, which reached twenty-two percent. More than fifty percent of the unemployed were
among the young. At the same time, Greece was experiencing a slow-motion bank run as more and

Nicole Itano, Germans to Debt-Ridden Greeks: Sell the Acropolis. And a Few Islands, Christian Science Monitor,
Mar. 4, 2010 available online
Melissa Eddy, A War of Words over the Euro Crisis, NY Times, May 18, 2012 available online
The World from Berlin: Germanys Power Is Causing Fear in Europe, Spiegel, Feb. 1, 2012 available online
Andreas Antoniades, At the Eye of the Cyclone: The Greek Crisis in Global Media, Athens Centre for International
Political Economy (2012) available online
Anthony Faiola, In Greece, Fears that Austerity Is Killing the Economy, Washington Post, Jan. 10, 2012 available
Harry Papachristou, Greek Lawmakers Approve Austerity Bill as Athens Burns, Reuters, Feb. 12, 2012 available
Elli Louka Page 19

more depositors pulled out their cash in anticipation of the Greek exit from the euro. In March 2012
cumulative outflows of deposits from Greek banks climbed to seventy-three billion.
The ECB was
financing the bank run by lending the banks enough euros to keep them in operation. By 2012 Greece
was characterized as a heavily indebted poor country (HIPC). Some argued that the EU must adopt
something similar to the 1996 HIPC initiative based on which lenders agreed to reduce the debt of the
most heavily indebted poor countries if they implemented reforms. The debt relief could be achieved by
cutting interest rates and pushing out maturities to fifty years.
In June 2013 Greece became the first
developed country to be downgraded to emerging-market status.
Greece had just been upgraded to
developed-market status in 2001 when it entered the eurozone.
This 2013 downgrade was the great
downfall of a country that was growing at an annual rate of 4.2 percent between 2000 and 2007 as
foreign capital swamped the country.
Many Greeks started to view their country as the protectorate of foreign powers. Anti-German
sentiments were prevalent, reinforced by the fact that Greece was a victim of German occupation and
atrocities during World War II. Some felt that this economic war was worse than World War II because
their government, instead of resisting, was following German orders.
In the 2012 elections the voters
abandoned the mainstream parties and opted to vote for the extremists. It was the first time, after the
restoration of democracy in 1974, that the extreme left and the extreme right got so many votes in a
Greek election. This reaction was predictable, as voters perceived that the Greek mainstream political
establishment was cudgeled into endorsing austerity policies. Anti-German sentiments were fueled all
over Europe when Volker Kauder, a German parliamentary, epitomized the new German power by
claiming: Now Europe is speaking German.
Germany was winning World War III, the money war.

Delphine Cavalier, Focus 2: Greek Banks Holding Their Breath, BNP Paribas Economic Research, June 1, 2012
available online http://economic-
Greeces Debt Burden: How to End the Agony, Economist, Nov. 10, 2012, at 12.
Tom Stoukas, Greece First Developed Market Cut to Emerging at MSCI, Bloomberg, June 12, 2013 available
Greek Parliament Passes Austerity Plan after Riots Rage, NY Times, Feb. 12, 2012 available online
'Now Europe Is Speaking German:' Merkel Ally Demands that Britain 'Contribute' to EU Success, Spiegel, Nov. 15,
2011 available online
Elli Louka Page 20

Some labeled the imposition of German policies on Europe the Merkelization of Europe.
Germans did not like to be called Nazis, but the Greek newspapers continued to caricature the German
chancellor Merkel as the new Adolph Hitler and the European Union as a covert operation that brought
about the Fourth Reich.
In 2010 eurozone governments granted loans to Greece on a bilateral basis to enable it to fulfill its
obligations to private creditors. In 2012 the new loans to Greece were to be channeled through the
European Financial Stability Facility (EFSF), which started to operate in August 2010. The EFSF is a
corporation in which shareholders are the eurozone countries and its special purpose is to issue bonds
or other debt instruments in the capital markets. The money it raises this way it lends to Greece and
other troubled eurozone countries. The EFSF is backed by guarantee commitments from all the
eurozone states and has a total lending capacity of four hundred and forty billion.

Since there is no international bankruptcy law for states when a state is insolvent the power of creditors
over the debtor state determines the outcomes. Greece was negotiating with sixteen hard-nosed
governments and many nervous creditors. Obtaining an agreement among the creditors and between
the creditors and the eurozone governments was a torturous exercise, which became even more
onerous due to the lack of transparency and disclosure.
In 2012 Greece lay helpless on the ground,
being snapped and snarled at by the other two players,
the creditor states and the bondholders.
Obviously, Greece could not transform itself overnight into a highly industrialized country like Germany.
The only advantage that Greece had was that the majority of the bonds it had issued were covered by
Greek law. The Greek government could pass a law, therefore, to restructure these bonds unilaterally.
The bondholders knew that they could not physically invade Greece and impound its assets. But they
could freeze further lending to Greece. They could sue Greece in other countries in order to obtain
judgments against it, making other lenders unwilling to grant any loans to Greece. The bondholders
could threaten Europe-core by claiming that losses of the private sector on the Greek debt would lead to
a strike on lending and further contagion to other countries in Europe-periphery.

See, e.g., SA Aiyar, Is Germany Trying to Win World War III?, Times of India, Feb. 12, 2012 available online
Paul Hockenos, The Merkelization of Europe, Foreign Policy, May 14, 2012 available online
For more details on the EFSF see section 5.2.
How the Greek Debt Reorganisation of 2012 Changed the Rules of Sovereign Insolvency, Allen & Overy Global
Law Intelligence Unit, at 20, Sept. 2012 available online
Id. at 11.
Elli Louka Page 21

The eurozone was a potent negotiator. Theoretically the ECB could print all the money needed to buy
the Greek bonds. Such a move, however, was blocked by the German Central Bank, which was fearful
of inflation. Furthermore, the eurozone was the only player who could guarantee some repayment of
the Greek debt. The eurozone could ensure stringent control of expenditures and the collection of taxes
in Greece. Even better, if Greece failed to pay, the new bonds offered for the restructuring of the Greek
debt were EFSF bonds issued under foreign law and guaranteed by the eurozone states. Greece or the
eurozone would have to pay up eventually.
The loans granted to Greece amounted to 164.5 billion till the end of 2014. Of this amount, the
eurozone was to contribute 144.7 billion to be provided through the EFSF, while the IMF was to
contribute 19.8 billion. The IMF contribution was part of a twenty-eight billion deal under the Extended
Fund Facility that the IMF put in place for Greece for four years.
The official sector loans were
supplemented by the PSI. On February 24, 2012, Greece invited the bondholders to exchange the
government bonds for new rescheduled bonds. The total eligible amount of bonds was 205.6 billion.
The offer did not extend to the bonds held by the ECB and the eurozone national central banks, enabling
them to be paid in full at the due date of the bonds they already held. The day before the offer, on
February 23, 2012, Greece adopted a law that allowed the country to insert a collective action clause

in the existing bonds governed by Greek law. Eventually, out of 205.6 billion in bonds eligible for the
exchange offer, approximately one hundred ninety-seven billion, or 95.7 percent were exchanged.

The terms of the bond exchange were spelled out in a memorandum.
To this memorandum were
attached the commitment letters of the two major Greek political parties that they would abide by the
memorandum if they were elected to government.
The bondholders were offered to exchange their old bonds for new bonds with a nominal value of 31.5
percent of the value of old bonds.
In addition, fifteen percent of the old bonds nominal value was to
be paid to the bondholders through cash-like, short-term notes issued by the EFSF (making the overall
discount on the original nominal value of bonds 53.5 percent). Accrued interest on the old bonds was to

European Commission, Financial assistance to Greece available online [hereinafter Financial Assistance to
A collective action clause allows a supermajority of bondholders to agree to a debt restructuring that is legally
binding on all bondholders, even those who vote against the restructuring.
See Financial Assistance to Greece, supra note 105.
Memorandum of Understanding Between the European Commission Acting on Behalf of the Euro Area Member
States, and the Hellenic Republic, Mar. 1, 2012 available online [hereinafter
Memorandum on Greek Bond Exchange] .
Elli Louka Page 22

be paid to the bondholders in the form of six-month EFSF notes.
The coupon on the new bonds was
two percent per year (till 2015); three percent per year (till 2020); and 4.3 percent per year (after
An additional GDP-linked coupon capped at one percent was to be added if the Greek
economy performed better than what was estimated by official projections.
Greece could borrow
from the EFSF twenty-three billion to compensate the Greek banks for their losses in the PSI
if the
funds available to the Hellenic Financial Stability Fund (HFSF)
were not sufficient to preserve financial
The specifics of the PSI were crystallized in a number of multilateral agreements between the EFSF, on
the one hand, and Greece and the Bank of Greece on the other. The Private Sector Involvement
Liability Management Facility (PSI LM) was to provide a thirty billion loan to Greece the value of the
EFSF cash-like notes that the EFSF issued for Greece.
A loan of thirty-five billion was provided to
Greece through the ECB Credit Enhancement Facility to enable Greece to buy back the old bonds at the
discounted value.
A Bond Interest Facility of 5.5 billion was put in place to allow Greece to pay
interest on its existing debt.

The Hellenic Financial Stability Fund (HFSF) is a bank rescue fund. It was founded in July 2010 as a private legal
entity. It has administrative and financial autonomy from the state. It was created by the Greek government to
recapitalize the Greek banking sector and resolve unsound banks. See Greek Law 3864/2010 (adopted July 21,
2010) as amended by Greek Law 4051/2012 (adopted Feb. 29, 2012). The 2012 EU/IMF loan to Greece injected
fifty billion into the HFSF through the EFSF. By 2013 the HFSF owned majority stakes in Greece's top four banks
National, Piraeus, Alpha and Eurobank. See Hellenic Financial Stability Fund, Annual Financial Report for the
period from 01/01/2012 to 31/12/2012, Aug. 2013. In 2013, under pressure by the troika, the chairman of the
HFSF was of Dutch nationality. However, he resigned soon thereafter.
See Memorandum on Greek Bond Exchange, supra note 108. See also Financial Assistance Facility Agreement
between EFSF, the Hellenic Republic and the Bank of Greece Private Sector Involvement Liability Management
Facility Agreement, Mar. 1, 2012 available online
[hereinafter PSI LM].

See Memorandum on Greek Bond Exchange, id. See also Financial Assistance Facility Agreement between the
EFSF, the Hellenic Republic and the Bank of Greece, Mar. 1, 2012 available online
content/uploads/2012/02/8-bridge-loan.pdf [hereinafter ECB Credit Enhancement Facility Agreement].
See Memorandum on Greek Bond Exchange, id. See also Financial Assistance Facility Agreement between the
EFSF, the Hellenic Republic and the Bank of Greece (Bond Interest Facility), Mar. 1, 2012 available online
Elli Louka Page 23

Furthermore, a co-financing agreement was signed between Greece, the Wilmington Trust, the EFSF and
the Bank of Greece (as a common paying agent). Based on this agreement, the Wilmington Trust (a
private company based in London) was to act as the trustee for the bondholders and the Bank of Greece
was to function as an agent for the payments made by Greece to the bondholders and the EFSF.
Bank of Greece, as the common paying agent, was to hold in trust for the creditors the amounts paid by
Greece in servicing its debt.
The co-financing agreement treated Greeces debt service to the
bondholders and its debt service to the EFSF equally. In the event of shortfall in payments the common
paying agent committed to distribute the amount it received from the Greek government pro rata
between the EFSF and the bondholders.
This way Greece could not default on its bondholders
without defaulting on the EFSF at the same time.
All these agreements
have a common clause according to which: the law that governs the agreements
is English law and the courts of Luxembourg have exclusive jurisdiction over any issues that arise from
the agreements. Furthermore, Greece and the Bank of Greece irrevocably and unconditionally waive
all immunity from legal proceedings and from execution and enforcement against their assets to the
extent not prohibited by mandatory law.
According to the opinion of the legal advisor to the Greek
Ministry of Finance attached to the agreements: neither Greece nor the Bank of Greece nor any of
their respective property is immune on the grounds of sovereignty or otherwise from jurisdiction,
attachment whether before or after judgment or execution in respect of any action or proceeding
relating to the Agreements.
With the stroke of a pen, thus, Greece wiped out even the semblance of
its sovereignty. For the Greek Central Bank, the waiver of immunity
means that its foreign reserves
[hereinafter Bond Interest Facility].
See Co-financing Agreement between the Hellenic Republic, the Bank of Greece (acting as Bond Paying Agent),
the EFSF, the Wilmington Trust London Limited (acting as Bond Trustee) and the Bank of Greece (acting as
Common Paying Agent), Mar. 1, 2012 available online
Art. 7.4, id.
Art. 6, id.
See supra notes 115-118.
See, e.g., art. 13, PSI LM, supra note 115.
See, e.g., Annex 4: Form of Legal Opinion, ECB Credit Enhancement Facility, supra note 116.
For an article critical of waiving the sovereign immunity of central banks, see Note, Too Sovereign to Be Sued:
Immunity of Central Banks in Times of Financial Crisis, 124 Harvard Law Review 550, at 567 (2010) (arguing that the
international reserves of central banks that are beyond the reach of creditors could allow a country to deal with
default more successfully). The Bank of International Settlements (BIS) the central bank of central banks
presents itself as the type of bank whose extensive immunities make it possible to protect bank assets held with
Elli Louka Page 24

and gold can be attached, especially if held abroad, making it more difficult for Greece to revert to the
drachma, the original Greek currency, in case the country decides to leave the euro. At the time of
writing, the Greek Central Banks foreign reserves and gold were estimated at about 7.3 billion
an amount unlikely to satisfy all of Greeces creditors.
Three Memoranda
between Greece and the EU/ECB/IMF troika spell out the specific reforms that
Greece must adopt, including privatization and tax reform, for receiving the installments of emergency
loans granted to it. Unless the reforms adopted by Greece are deemed adequate by its creditors the
emergency financing will be suspended. Greece cannot propose or implement measures that may
infringe on the free movement of capital. It cannot introduce any voting or acquisition caps in assets it
plans to privatize. It cannot establish any disproportionate and non-justifiable veto rights or any other
form of special rights in privatized companies.
In order to comply with the privatization demands,
the government had to repeal the special rights granted to the state in the process of privatization.

Greece had to repeal the Law on Strategic Companies (art. 11, law 3631/ 2008)
and to transfer to the

the BIS from measures of compulsory execution and sequestration. See BIS as a Bank for Central banks available
See United States Central Intelligence Agency (CIA), The World Factbook available online
The 2010 Memoranda have been amended periodically to reflect the progress made by Greece in implementing
the loan conditionality. They include: the Memorandum of Economic and Financial Policies (MEFP), the
Memorandum of Understanding on Specific Economic Policy Conditionality (MOU) and the Technical
Memorandum of Understanding (TMU). The Memoranda as amended are reprinted in European Commission, The
Second Economic Adjustment Programme for Greece, First Review, Occasional Paper 123, Annex 3, Dec. 2012
available online
[hereinafter Economic Adjustment Programme for Greece].
Id. at 75.
Id. In 2008 Greece changed the rules on investment in Greek strategic companies to ensure state control on
companies that were to be privatized, the so-called Public Benefit State Companies (i.e., certain public utilities).
While Greece was willing to let private investors acquire shares of such companies it was reluctant to allow private
shareholders to increase their stake to an extent that they would control such companies. See Thomas
Papadopoulos, Greek Legislation on Strategic Investments: the Next Golden Share Case before the European
Court of Justice?, 6 European Company Law 264 (2009). See also Case C-244/11, Action under Article 258 TFEU for
failure to fulfill obligations, European Commission v. Hellenic Republic, Nov. 8, 2012 available online
&dir=&occ=first&part=1&cid=253074. The European Court of Justice struck down Greeces restrictions on the
privatization of public utilities because they lacked precision and granted too much discretion to the state. A more
precise Belgian law on strategic companies was upheld by the Court.
Elli Louka Page 25

Hellenic Republic Asset Development Fund (HRADF),
structured as a private company and monitored
by the troika, a number of state assets including motorways, ports and public utilities.
Some have
described the Greek privatization program as the perfect example of privatization under duress.

The privatization of Greek state assets demanded by creditor states as a sine qua non for granting the
emergency loans to Greece provides a snapshot of the geopolitical struggle behind the Greek debt crisis.
By 2012 the privatization of the DEPA, the Greek gas utility, and the DEFSA, the Greek gas pipeline, were
dragging. Two Russian companies, Gazprom and Sintez, came up with the highest offers. The United
States and the European Union, though, voiced disapproval and the HRADF urged all the bidders to seek
Western firms as collaborators.
European competition officials, already investigating Gazprom for
breaching competition rules in eastern Europe, made it clear to the Russian energy giant that it would
be closely scrutinized if it grabbed DEPA.
The EU was uncomfortable at having a company
understood to be an extension of the Russian state beefing up its holdings in an EU country.

According to documents released by Wikileaks, an anti-secrecy NGO, Germany wanted to shift the Greek
privatization program to an agency that would be independent from the Greek government and on
which Germany would have an influence.
Eventually, the privatization was handled by the HRADF
structured as a private entity under surveillance by the troika.
Stratfor, an influential private

The Fund is a socit anonyme (public limited liability corporation) in which the Hellenic Republic is the sole
shareholder with a share capital of thirty million. Any asset transferred to the fund by the state is to be sold,
developed or liquidated. The return of any asset back to the state is not allowed. The decisions of the board of
directors take into account the opinions of the council of experts, which are not binding. The council of experts is
composed of seven persons. Four persons are appointed by the board of directors and three by the troika. The first
three experts appointed by the troika were from Germany, Spain and Slovakia. See
See Memorandum of Understanding on Specific Economic Policy Conditionality, in Economic Adjustment
Programme for Greece, supra note 126, at 189.
Jared A. Blacker, Privatization under Duress: The Privatization of the Greek Economy, in 30 Perspectives on
Business and Economics Greece: The Epic Battle for Economic Recovery 3 (2012).
Greece: Is the Grexit off the Table? Economist, Feb. 9, 2013, at 53.
Renewed Greek Troubles: Darkness at Midnight, Economist, June 15, 2013, at 74.
Re: Analysis for Edit Russia/Greece/Germany/Eurozone Greece: Why Privatization Matters?, email id-
5262440, Wikileaks: The Global Intelligence Files, released Mar. 2, 2013 available online
greece.html [hereinafter Greek Privatization].
See supra note 130.
Elli Louka Page 26

consulting company, predicted a scramble for Greece. Germany was looking to get Greek assets at fire
sale prices. The Deutsch Telecom, which had already acquired a ten percent stake in the Hellenic
Telecommunications company, was interested in Greek assets.
For China, Greece was a strategic
point of entry into Central and Eastern Europe and it could use the Greek ports of Piraeus and
Thessaloniki to bring its goods to the Balkans. Chinas Ocean Shipping (COSCO) made an investment in
Piraeus in June 2010, leasing two container terminals for thirty-five years at the price of five billion
dollars. COSCO was interested when the Greek government announced plans to privatize its entire
seventy-five percent stake in the Piraeus port authority.
Russia was interested in Greek energy assets.
The question was whether Germany would stand in the way of China and Russia.

Finland, in order to participate in the 2012 Greek bailout, asked for collateral from the Greek
government over the objections of other eurozone members. Obviously, if every state asked for
collateral the whole deal would collapse. The banks of Greece agreed to provide collateral to Finland in
the form of cash and high-rated assets.
The details of the collateral deal remained secret until mid-
2013 when the Finnish supreme administrative court asked the government to release them to the
In April 2013 Finland received the first installment of collateral payments. Finland was paid
three hundred and eleven million by Greece. The total payments to Finland are nine hundred twenty-
five million to be paid gradually as Greece gets financing from the EFSF. In other words, Greece has
been receiving loans from the EFSF, and its successor the European Stability Mechanism, some of which
are used to pay for the Finnish collateral. The Finnish insistence on collateral was instrumental in
appeasing the domestic political establishment that was hostile to the idea of assisting Greece.
real economic advantages to Finland from the collateral arrangement are questionable.

Greek Privatization, supra note 136.
Greek Banks to Satisfy Finnish Collateral Demand Resources, Reuters, Feb. 15, 2012 available online
See website of Finnish Ministry of Finance
The sovereign debt crisis was seen as a moral crisis in Finland. The media often used terms countries that lived
carelessly on borrowed money, moral decay, countries that handled their accounts badly. See Paul Jonker-
Hoffrn, Finland: a Tough Nordic Accountant that is Caught up by Reality, LSE Blog Euro Crisis in the Press, June 22,
2013 available online
See [OS] FINLAND/GREECE/EU/ECON Finland Hails Collateral Deal but Experts Call it a 'Farce,' email id-
4962177, Wikileaks, Global Intelligence Files, released Mar. 18 2013, available online
Elli Louka Page 27

The Greek debt restructuring was facilitated by the creditors committee, which acted as the negotiating
representative of bondholders. This committee was put together by a private association, the Institute
of International Finance (IIF).
The creditor committee was self-appointed and derived its legitimacy
from the fact that it was accepted by the creditor states, Greece and the bondholders. The 2012
default of Greece has been the biggest sovereign default in modern times. It involved a developed
country and the second largest currency in the world, making it a milestone in financial history. The
Greek sovereign debt was about four hundred billion. By comparison, Argentinas debt was a tiny
eighty-one billion dollars. It has been estimated that the 2012 Greek debt restructuring provided debt
relief for Greece in the amount of ninety-eight billion to a hundred and six billion, or about fifty-one to
fifty-five percent of the 2012 Greek GDP.

After the 2012 debt restructuring, the economic surveillance of Greece by the troika became draconian.
The European Commission strengthened the task force for Greece, which had to have a permanent
presence on the ground in Greece.
The head of the task force was a German national, Horst
whom the media called German Governor of Greece. Greece was to isolate its debt
service payments into a segregated account and to ensure that a legal framework was in place so that
the debt servicing payments had priority over any other payments. A provision to this effect was to be
incorporated into the Greek Constitution.

In 2013 Germany declared that the loans given by Germany to Greece for the bailout must be paid in full
with interest.
The Greek government, on the other hand, has been asking Germany to pay for the
damage inflicted on Greece by Germany during World War II.
The Greek finance ministry has been

The Steering Committee members included the following companies: Allianz (Germany); Commerzbank
(Germany); Deutsch Bank (Germany); LBB BW (Germany); BNP Paribas (France); CNP Assurances (France); ING
(France); National Bank of Greece; and Alpha Eurobank (Greece). See Private Creditor-Investor Group on Greece
Forms Steering Committee to Pursue Bond Negotiations, IIF Press Release, Nov. 28, 2011 available online
Jeromin Zettelmeyer et al., The Greek Debt Restructuring: An Autopsy, at 24, Working Paper 13-8, Peterson
Institute for International Economics, 2013 available online
European Commission, Q&A on the Task Force for Greece and Its Second Quarterly Report, Press Release,
MEMO/12/184, Mar. 15, 2012 available online
Council of the European Union, Eurogroup Statement, Press Release, Feb. 21, 2012 available online
Phillip Inman, Greece Is Right to Expose German Loans Hypocrisy, Guardian, Apr. 26, 2013 available online
For an assessment of the damages incurred by Greece during the World War II German occupation, see
Apostolos Vetsopoulos, The Economic Dimensions of the Marshall Plan in Greece, 1947-1952: The Origins of the
Elli Louka Page 28

examining the possibilities of asking Germany to pay for the infrastructure damage perpetuated by the
German army during the period of German occupation of Greece and for a loan that Germany
demanded from Greece in support of Germanys World War II effort.
Despite the passage of time, the
memories of World War II are fresh in Greece as there are still survivors who fought in that war. Greece
joined Italy in the International Court of Justice in an effort to empower its citizens to obtain some
reparations from Germany for the German atrocities committed in Greece during World War II.

In May 2013 the IMF released an assessment of its own and the EU handling of the Greek financial crisis.
The IMF noted that the restructuring of the Greek debt encountered notable failures, including the loss
of market confidence, a thirty percent reduction in bank deposits and a severe recession.
recommended that the troika must find a way to streamline its process and criticized the eurozone
leaders for not tackling the Greek debt decisively at the outset of the crisis and for sending inconsistent
signals to the markets, creating uncertainty about the eurozones capacity to resolve the crisis. The
delayed debt restructuring, according to the IMF, provided a window for private creditors to reduce
exposures and shift debt into official hands.
The IMF criticized the European Commission for putting
too much emphasis on compliance with the EU regulations rather than on the growth of the periphery
The ECB lacked experience in bank supervision.
Furthermore, there were marked
differences of view within the Troika.
The program documentation was subject to varying degrees of
and this aggravated coordination problems. According to the IMF, the Greek debt crisis
brought to the fore the shortcomings of the euro area architecture. Without exchange rate flexibility

Greek Economic Miracle (Doctoral Thesis, University of London, 2002) available online .
See Suzanne Daley, As Germans Push Austerity, Greeks Press Nazi-Era Claims, NY Times, Oct. 5, 2013 available
See Jurisdictional Immunities of the State, Germany v. Italy: Greece Intervening, Judgment, Feb. 3, 2012
available online (Germany claimed that because it enjoyed
sovereign immunity it could not be sued in Italian courts. The ICJ agreed with Germany).
IMF, Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-by Arrangement, IMF Country
Report No. 13/156, at 1, June 2013 available online
Id. at 28.
Id. at 31.
Elli Louka Page 29

and without an independent monetary policy, the eurozone left its member states vulnerable to debt
crises that spread to the banking system and then to the real economy.

In 2013 the Greek current account deficit was shrinking, but this was happening mainly because of the
severe recession, the contraction of the economy and the increase in unemployment.
The political
situation seemed stable but it remained fragile because political and social tensions were high due to
the deep recession and high levels of unemployment especially among the young.
Since the Greek
banks were preoccupied with paying back the loans granted to them by the ECB, they were reducing the
credit available to the economy, intensifying the recession.
In short, the Greek debt burden was
unsustainable without additional debt relief.

While the periphery was facing a severe recession and unemployment, many core states were
benefitting from the euro crisis. Germany, as a big stakeholder in the euro, was bearing substantial risks
in case the euro collapsed. As long as the euro remained the currency of the eurozone, however,
Germany reaped many benefits. The predicament of Europe-periphery spurred capital flight from the
debtor states to the creditor states. All through the crisis, the banks of creditor states were perceived as
safe havens for capital. As the debtor states deteriorated, German government bonds became safe
havens forcing German bond yields into negative territory. The ten-year German bond was offering rates
less than the rate of inflation. Investors were willing to incur costs to keep their money safe in Germany.

3. Attack on Offshore Finance: the Cyprus Case
The ECB statement of March 21, 2013 was a bombshell for Cyprus. The ECB set for Cyprus March 25,
2013 as the deadline for agreeing with the EU/IMF on the conditionality attached to an emergency loan
granted to it. The ECB threatened to cut off financing to the Cypriot banks if such an agreement was not

Id. at 34.
IMF, Greece: Third Review under the Extended Arrangement under the Extended Fund Facility, at 5, IMF
Country Report No. 13/153, June 2013 available online [hereinafter IMF Third Review]. According to the
IMF, the recession has been one of the deepest peacetime recessions in industrialized economies. The economy
contracted by twenty-two percent between 2008 and 2012 and unemployment rose by twenty-seven percent.
Youth unemployment exceeded sixty percent.
By April 2013 the banks had repaid forty billion of ECB financing, see id. at 7.
Id. at 23.
Elli Louka Page 30

The warning came after Cyprus rejected the first EU/IMF proposal for the restructuring of its
banking sector that demanded, as a condition for granting emergency financing, the decimation of the
deposits of even insured savers.
With Cyprus sovereign bonds ineligible as collateral for ECB financing,
due to their low credit rating, the Cypriot Central Bank was providing commercial banks with ECB
emergency liquidity assistance (ELA).
The Cypriot banks, which faced severe losses after participating
in the PSI that reduced Greeces debt,
were reliant on this ELA. By the end of January 2013, they had
used around 9.1 billion of ELA financing.

The Cypriot banking crisis reached an acute stage in 2013. Creditor countries threatened to expel
Cyprus from the eurozone given the bad condition of its finances.
Under the threats of ejection and
financial isolation, an agreement was eventually reached that was historic for the evolution of the euro.
The agreement, in effect, broke up the euro into the northern euro and the southern euro. The northern
euro can be moved anywhere across the world while the southern euro is confined within the borders of
a small island.
The agreement bailed in the creditors of Cyprus two biggest banks, but spared, unlike the proposed
first agreement, insured depositors. The terms of the agreement were:

ECB, Governing Council Decision on Emergency Liquidity Assistance Requested by the Central Bank of Cyprus,
Press Release, Mar. 21, 2012 available online
Cyprus Rejects Eurogroups Savings Levy and Bailout Deal, Euronews, Mar. 19, 2013 available online
See infra section 5.4.4.
European Commission, The Economic Adjustment Programme for Cyprus, Occasional Paper 149, May 2012, at
15, 31 available online [hereinafter
Economic Adjustment Programme for Cyprus]. In September 2012 Cypriot banks direct loans to the Greek
economy amounted to nineteen billion, which was the equivalent of about one hundred and eleven percent of
Cypriot GDP. The Greek government debt held by Cypriot banks reached 4.7 billion in June 2011. Following their
participation in the Greek PSI, three domestic banks had to apply a seventy-four percent discount to the nominal
value of the Greek government bonds they held.
The countrys banks were able to draw only three hundred and seventy-six million from the regular ECB liquidity
operations because the ECB had stopped accepting Cypriot sovereign bonds as collateral starting June 2012. See
Paul Carrell, ECB Sets Monday Deadline for Cyprus Bailout Deal, Reuters, Mar. 21, 2013 available online
Graeme Wearden, German Politicians Threaten to Block Cyprus Bailout, Guardian, Jan. 9, 2013 available online
Elli Louka Page 31

1. The provision of a ten billion loan from the IMF and the eurozone countries (one billion was
contributed by the IMF and nine billion by the eurozone countries);
2. The closing down of Laiki, the second biggest bank of the island. The bad loans it had made were
dumped into a bad bank. Laikis bondholders were wiped out. Shareholders and junior
bondholders were wiped out, first, followed by senior bondholders and uninsured depositors.

Uninsured deposits at the bank (deposits above 100,000 per depositor) were estimated to be
4.2 billion. What remained of Laiki, including insured depositors, went to the Bank of Cyprus.

3. The recapitalization of the Bank of Cyprus by writing down bonds and turning uninsured
deposits into equity. These uninsured deposits, estimated at close to ten billion, were to be
frozen pending a determination of the loss that they would have to incur a loss to be
calculated by taking into account the banks recapitalization needs. Losses of uninsured
depositors were subject to an immediate bail-in of 37.5 percent that materialized through a
deposit-to-share swap (i.e., instead of getting their deposits back, depositors received shares of
the bank). Another 22.5 percent of uninsured deposits were frozen to make sure that the capital
needs of the bank were covered.

4. The privatization of state assets.
For sale were a number of state-owned enterprises and
semi-governmental organizations, including Cyprus Airways, the electricity authority, the
telecom utility and the ports.

To avert capital flight, Cyprus had imposed capital controls since March 16, 2013.
By July 2013 the
capital controls were still in place and it was already an open secret that Cyprus had made a hidden,

Economic Adjustment Programme for Cyprus, supra note 168, at 42.
The loan was provided through the European Stability Mechanism, see Financial Assistance Facility Agreement
between European Stability Mechanism and the Republic of Cyprus and Central Bank of Cyprus, May 8, 2013
available online
See Memorandum of Understanding on Specific Economic Policy Conditionality, in Economic Adjustment
Programme for Cyprus, supra note 168, at 66.
Id. at 43.
Elli Louka Page 32

silent exit from the euro.
If the euro held in Cypriot banks were de facto less useful than the euro
held in other banks, these two types of euro would be priced differently.
In 2013 the ECB sent an ultimatum to the Cypriot Central Bank, which manages 13.9 metric tons of gold,
warning that any sale of the gold must cover first the emergency assistance granted by the ECB to the
Cypriot banks. The Dutch finance minister mentioned that selling the gold was an option for the Cypriot
authorities, but that this was a decision to be made independently by the Cypriot Central Bank. On April
9, 2013, an assessment by the European Commission mentioned that Cyprus was committed to selling
four hundred thousand of excess gold reserves.
The question was whether the Cypriot gold would be
sold to Russia, China, Germany or the ECB, which was asking for the sale (at the depressed prices that
were prevalent in mid-2013).
Creditor countries were gloating for achieving the bail-in of failed banks by uninsured depositors and
bondholders and fending off the bailout by governments and, hence, taxpayers. The Eurogroup, the
group of eurozone finance ministers, instead of depicting the Cyprus deal as a special case, claimed that
the bail-in of creditors, including uninsured depositors, was to become the template for the
recapitalization of failed banks. The Eurogroup stated in public what, since the beginning of the euro
crisis, creditor nations had been whispering in private: they were fed up with lending money to
peripheral countries and their banks.
The Cyprus crisis erupted on June 25, 2012 when Cyprus requested an EU/IMF loan.
At that time,
however, Cyprus decided not to be tangled in the EU/IMF conditionality by getting a loan from Russia,

betting correctly that Russia would be willing to help given that some of Cyprus banks biggest
depositors were of Russian nationality. In 2013 Russia decided not to provide additional help to Cyprus,

Andrew Higgins, Currency Controls in Cyprus Increase Worry about Euro System, NY Times, July 9, 2013
available online
Draghi Says Any Cyprus Gold Sale Must Cover Emergency-Loan Loss, Bloomberg, Apr. 12, 2013 available online
loss.html. The foreign reserves and gold of Cyprus are minimal estimated at 1.3 billion dollars in 2011. See CIA,
The World Factbook
Economic Adjustment Programme for Cyprus, supra note 168, at 37.
Cyprus has been shut out of the financial markets since mid-2011 as yields on its bonds skyrocketed. In 2011
Cyprus was able to secure a 2.5 billion loan from Russia at 4.5 percent interest rate. Id. at 35.
Elli Louka Page 33

as Cyprus was not worth the risk of jeopardizing relationships with Germany.
It took two years from
the moment Cyprus was cut off from the capital markets
to conclude the EU/IMF deal.
Cyprus was vilified in the media for being a tax shelter for Russian mafia money. The recapitalization of
the banking system by the depositors of Cypriot banks was viewed, therefore, as a way to penalize
Russian corruption. Some of the money deposited in Cyprus might have been the result of corruption.
Most of the money, though, was deposited there by the Russian capitalist class. That class feels
uncomfortable with depositing its money at home because of the unpredictability of the Russian
Therefore, it tends to amass its fortune abroad and many Russian businesses are
registered as British, Dutch, Swiss, or, till 2013, Cypriot.
For instance, Russias steel oligarchs
controlled their companies through Cypriot holding companies.
Many state-owned companies, which
are the pillars of the Russian economy and are traded in the global stock markets, had Cyprus accounts
including the oil company Rosneft, and the banks Sberbank and VTB.
The Russian elite deposited its
money in Cyprus because Cyprus is an EU country with rules and regulations and, therefore, not only a
tax haven but also a legal paradise where confiscation of private assets by the state was unthinkable.
After the EU raid on their Cypriot accounts
Russians moved their money to other European havens
including the Dutch Antilles, British Virgin Islands, Malta and Luxembourg.
At the same time the
uninsured depositors, who would have to swap their blocked deposits for shares in the bank of Cyprus,

Jim Armitage: Need to Keep Germany Sweet Pulls the Plug on Russia's Cyprus Rescue, Independent, Mar. 23,
2013 available online
In 2011 Cyprus suffered a triple-point downgrade by Fitch and one-point downgrade by S&P on the grounds of
the large exposure of Cypriot banks to Greek government bonds. See Economic Adjustment Programme for
Cyprus, supra note 168, at 37.
Putin, the president of Russia, sees the oligarchs who control the oil and gas industry in Russia as opportunists
who took advantage of the chaos, which followed the collapse of the state in the 1990s, to get rich. He has strived
to transform them into mere managers of his ascending empire. See Alena V. Ledeneva, Can Russia Modernise?
Sistema, Power Networks and Informal Governance (2013).
See Ben Judah, Did Putin Sink Cyprus? NY Times, Apr. 2, 2012 available online
Elli Louka Page 34

would end up owning that bank. According to some estimates, about sixty percent of the shares of that
bank would eventually be held by foreigners, primarily Russians.

According to the troika, bank deposits in Cyprus were inflating the banking sector to unsustainable
levels deposits about eight times the GDP of the island. The figure, however, was much smaller than
that of Luxembourg
and quite close to that of Malta and Ireland. The troika was telling Cyprus that its
business model was unsustainable. Their recommendation was that Cyprus banks should shrink by fifty
to sixty percent in the next five years.
While Cyprus was getting a dressing down by the EU/IMF,
Frankfurt in Germany, Zurich in Switzerland, Delaware in the United States, Austria and the United
Kingdom are still active offshore financial centers. Cyprus made a political decision to become an
offshore financial center following in the steps of many developed states. Business services and
tourism development make sense for a small island economy with no manufacturing tradition. Because
of the bail-in of creditors most of the capital that sought Cyprus as an offshore financial center flew to
other offshores.
At the forefront of the battle against the alleged tainted Russian deposits in Cyprus was the German
finance ministry, which had received a confidential report by the German foreign intelligence agency.
That agency claimed that the island was a haven for money laundering.
The battle against alleged
money laundering in Cyprus was bizarrely shouldered by a state that has yet to put its own house in
order. In 2013 the Tax Justice Network, a non-governmental organization, rated Germany in the top ten
of countries that turn a blind eye to financial secrecy.
The Financial Action Task Force (FATF), an
intergovernmental institution, in a 2010 report stated that many indicators suggest that Germany is
susceptible to money laundering. Substantial proceeds of crime are generated in Germany estimated at

Andrew Higgins, Cyprus Banks Bailout Hands Ownership to Russian Plutocrats, NY Times, Aug. 21, 2013
available online
Economic Adjustment Programme for Cyprus, supra note 168, at 11-12. The assets of the banking sector
amounted to seven hundred and eighteen percent of Cyprus 2012 GDP. By comparison, Luxembourgs banking
sector is two thousand one hundred and fifteen percent of Luxembourgs 2012 GDP.
Christopher Pissarides, Cyprus Finds not all Nations are Equal, Financial Times, Mar. 27, 2013 available online
German Intelligence Report: Aid to Cyprus Could Benefit Russian Oligarchs, Spiegel, Nov. 5, 2012 available
The financial secrecy index produced by the Tax Justice Network is based on fifteen indicators that include
transparency of company ownership and a countrys offshore financial sector. Switzerland is rated as the number
one secrecy jurisdiction while the United States takes sixth place. See
Elli Louka Page 35

forty to sixty billion per year.
Lawyers, accountants, tax agents and company service providers are
subject to strict professional secrecy obligations which contribute to a low level of reporting of
suspicious transactions and complicate cooperation with investigative authorities.
arrangements (treuhand) are common legal arrangements in Germany, but the disclosure obligations
that are in place for trusts are insufficient to ensure transparency about the real owner who benefits
from them.
Germany does not have comprehensive public statistics about the number of money
laundering convictions in the country. The government usually delegates the supervision of
implementation of anti-money laundering rules to private auditing firms that may have conflicts of
In 2013 Germany effectively blocked EU efforts to require transparency of beneficial
ownership of companies across Europe.
Germany has been criticized for signing a tax deal with
Switzerland according to which German holders of Swiss accounts could preserve their anonymity and
their secret Swiss accounts provided that Switzerland would be able to withhold a tax to be submitted to
But it is not only Germany that tries to entice capital. As the business model of Cyprus is
being demolished, Switzerland and the UK remain enormous, secretive financial jurisdictions in which
many dictators have chosen to safeguard stolen assets.
In fact, the UKs financial sector success is
based on the willingness of the state to host an opaque, tax evading capital market.
Given the
permissive circumstances of financial secrecy in these developed EU economies, it is not surprising that

See FATF/OECD and IMF, Anti-Money Laundering and Combating the Financing of Terrorism, Mutual Evaluation
Report of Germany, at 9 (2010) available online http://www.fatf-
Id. at 13.
Id. at 14.
See Financial Secrecy Index: Narrative Report on Germany, Tax Justice Network, Nov. 7, 2013 available online
Tanguy Verhoosel, Total Impasse on Savings Taxation, Europolitics, May 15, 2012 available online
The UK, Germany and Austria have signed the so-called Rubik bilateral tax agreements with Switzerland.
According to Project Rubik devised by the Swiss Bankers Association, a flat-rate tax on a client's assets in Swiss
banks will be applied but the clients name is not to be revealed to others, honoring the Swiss tradition of banking
secrecy. See Project RUBIK available online
per&Itemid=40. The German-Swiss agreement was not eventually ratified but it could be revived.
The UK and Switzerland have refused requests for assistance in locating assets of former dictators. See
Recovering Stolen Assets: Making a Hash of Finding the Cash, Economist, May 11, 2013, at 63.
International Finance: Money Will Find a Way, Economist, July 6, 2013, at 14.
Elli Louka Page 36

Cyprus viewed the effective shutdown of its financial sector as the coercive elimination of its
competitive advantage for the benefit of other EU countries.
Given the capital controls imposed in 2013, it is hard to imagine that the banks of Cyprus would soon
attract new depositors. This is harmful not only to the banks, but also to the Cypriot law firms,
accountants and other service providers. The service sector of the Cypriot economy accounted for
twenty percent of the GDP and it was the trade surplus in services that partially offset the increasing
trade deficit in goods.
Finance, insurance and other businesses closely related to the financial sector
accounted for fifty percent of the economy and employment throughout 2012.
Since the financial
sector has been shut down by the EU/IMF decision, the countrys prospects look dim. It was unclear at
the time of writing whether investment in the energy sector was to materialize or whether tourism
could be revamped. The economic adjustment for Cyprus devised by the EU/IMF has been based on the
shaky assumption that the islands proper place in the world is that of a tourism magnet or potentially
an energy hub.
As a result, the financial sector, the bread and butter of the island, was wiped out.

The Cyprus debt crisis has shed the illusions of many political romantics. The crisis has provided a useful
reminder of how a big country can force a small one to change its development model overnight from a
model focused on financial services to a scheme centered on yet-to-be-proven energy resources and
Cypriot depositors were entrapped in that asymmetric economic conflict and were dealt with
as the unfortunate collateral damage.
The ECB and the European Commission have concluded:
The bail-in of uninsured depositors will cause a loss of wealth, which will reduce private
consumption and business investment. This, compounded by the impact of fiscal consolidation
already undertaken and new measures agreed, will result in a sharp fall in domestic demand. Little

Economic Adjustment Programme for Cyprus, supra note 168, at 10.
Id. at 14.
Id. at 40, 53.
See id. at 42.
The Memorandum of Understanding on Specific Economic Policy Conditionality adopted in 2013 has no
provisions on how Cyprus could revitalize its financial services sector so that it remains an international finance
center. See Memorandum of Understanding on Specific Economic Policy Conditionality, id. at 66.
See Peter Coy, A Cypriot Nobelist Is Appalled by the Proposed Bailout Bank Tax, Bloomberg Business Week,
Mar. 19, 2013 available online
Elli Louka Page 37

reprieve can be expected from exports amid uncertain external conditions and a shrinking financial
service sector.

4. Origins
4.1. The Opaque Structure of Global Finance
The financial panic of 2008 was not different from the panics of 1893 or 1907 in terms of economic
fatalities, but the resulting economic crisis has not been the easiest one to explain. Structured
investment vehicles, credit derivatives, securitization and the repo market may be routine terms for
financial engineers but sound exotic to the general public. Shadow finance is based on customized
contracts between buyers and sellers in the over-the-counter (OTC) market. The OTC market is a less
regulated market than other securities markets. Trades are bilateral, are only reported at the aggregate
level and there is not much information on the risk exposure of institutions involved. The entire
operation of the derivatives market is handled by a private trade association, the members of which are
banks, the International Swaps and Derivatives Association (ISDA). Most transactions in the derivative
market are handled by fifteen dealers, the so-called G15 banks.
The complexity and customization of
derivative contracts make such contracts hard to decipher even for state authorities that are supposed
to regulate them.
In 2011 the US Financial Crisis Inquiry Commission concluded that derivative
contracts not cleared centrally contributed to the crisis because of the uncontrolled leverage, the lack of
transparency, the insufficient capital and collateral requirements, market concentration and
In 2010 the size of the global shadow banking system, the non-bank credit activity, was
about forty-six trillion.

Assessment of the Public Debt Sustainability of Cyprus by ECB and the European Commission, in Economic
Adjustment Programme for Cyprus, supra note 168, at 114.
They are: Bank of America, Barclays, BNP Paribas, Citigroup, Credit Swiss, Deutsche Bank, Goldman Sachs, HSBC,
JP Morgan Chase, Morgan Stanley, Nomura, Royal Bank of Scotland, Socit Gnrale, USB and Wells Fargo. See
European Commission, European Financial Stability and Integration Report 2012, at 92, n. 119, Apr. 2013
[hereinafter Stability and Integration Report].
See Financial Stability Board, Global Shadow Banking Monitoring Report 2012, Nov. 18, 2012 available online
The Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report: Final Report of the National
Commission on the Causes of the Financial and Economic Crisis in the United States, at xxiv, Jan. 2011 available
European Commission, Green Paper: Shadow Banking, at 4 COM(2012) 102 final [hereinafter EC Shadow
Elli Louka Page 38

The European Commission has concluded that the shadow banking performs important functions of the
financial system. It creates additional sources of financing and offers investors alternatives to bank
deposits. However, these benefits come with substantial risks, including those related to the disorderly
failure of shadow banking entities.
The European Commission has blamed the 2008 financial
meltdown on the abuse of Special Purpose Vehicles (SPVs), which were widely used by credit institutions
to present a sanitized version of their balance sheet.
But, despite this blame showered on shadow
banking, and on the SPVs in particular, it was an SPV that eurozone states put quickly together to which
they transferred the liabilities they incurred, due to their exposure to the weakened periphery, from
their national accounts.
Overall SPVs have been used not only by the private sector but also by
governments to conceal their liabilities when it is convenient for them. Governments have used SPVs to
shift liabilities from the national accounts to entities that, for reporting purposes, are not counted as
part of government.
For example, in 2010 the German government asked the Eurostat to classify
Erste Abwicklungsanstalt (EAA), colloquially called 'bad bank
and created to remove toxic assets from
the German financial institutions balance sheet, as an entity outside the government. That demand
was denied by the Eurostat.
In general EU states have used derivatives and other financial
engineering to rig up their national accounts in order to qualify for entry into the eurozone or to
increase their credit score.

Much before the euro crisis, economists warned that the future of the euro was threatened not only by
the persistence of high budgetary imbalances, but also by the lack of transparency with which the

Id. at 2.
Id. at 4-5.
See infra section 5.2.
Irwin, supra note 20, at 11.
[T]he Bad Bank Act in Germany, passed in July 2009, provided private banks relieve [sic] on holdings of illiquid
assets by allowing them to transfer assets to a special entity and receive government-guaranteed bonds issued by
this special entity in exchange. While direct fiscal costs for Germany amount to just above 1 percent of GDP, total
guarantees (including those associated with the Bad Bank and financial institutions' debt) reached about 6
percent. See Luc Laeven et al., Resolution of Banking Crises: The Good, the Bad, and the Ugly, at 15, IMF Working
Paper, June 2010 available online See also Irwin,
supra note 20, at 12.
Eurostat, Sector Classification of the Erste Abwicklungsanstalt, Letter to Hans Bernhard Beus, July 19, 2010
available online
Irwin, supra note 20, at 6-8.
Elli Louka Page 39

process of reduction in these imbalances [was] carried out.
The use of derivatives to obfuscate debt
obligations became notorious in 2010 during the Greek debt crisis.
However, the use of derivatives by
sovereign borrowers to window-dress their public accounts was not isolated to Greece.

Poland, Belgium and Germany have used derivatives to fudge their debt figures.
The Eurostat
tolerated the non-disclosure of derivative activity carried out by sovereign borrowers.
There was no
legal or accounting framework to record derivative transactions in national accounts. Furthermore,
some governments, including Greece and Germany, securitized their future revenues (e.g., taxes) and
sold these securities to investors in order to exhibit higher revenues.
It has been argued convincingly
that the Maastricht Treaty, by putting pressure on states to reduce debt and deficits, indirectly pushed
states to use derivatives or other financial engineering to underreport deficit and debt numbers.

In the case of Greece, the ECB declined to disclose internal documents,
which showed how Greece
used derivatives to conceal government debt, because such disclosure could increase the risk of market

Gustavo Piga, Derivatives and Public Debt Management, at 143 (International Securities Markets Association
and Council on Foreign Relations, 2001) available online
See supra notes 62-63.
Piga, supra note 220, at 143.
See also Sarfraz Thind, Italys Use of Derivatives for EMU Access under Scrutiny, Risk Magazine, Jan. 2002
available online
After it was publicized that Italy had used derivatives to facilitate its entry into the monetary union, Romano Prodi,
the Italian prime minister at the time, wrote to the press to point out that the Eurostat had approved Italys use of
the derivative deal.
European Parliament, supra note 64.
Piga, supra note 220, at 143.
Irwin, supra note 20, at 8.
Piga, supra note 220, at 143.
The first document is titled The impact on government deficit and debt from off-market swaps: the Greek
case. The second document reviews the Titlos securities that were used by the National Bank of Greece, the
countrys biggest lender, as collateral for securing credit from the ECB. The underlying asset that backed the
securities was an interest-rate swap between the Greek bank and the government. See Elisa Martinuzzi, ECB
Rejects Request for Greek Swap Files, Citing `Acute' Risks, Bloomberg, Nov. 5, 2010 available online
Elli Louka Page 40

instability. The European general court agreed with that decision of the ECB.
It is unclear how
withholding these documents from the public, especially given that the nature of the documents is
has helped to stabilize the euro. As a matter of principle, the public should be informed on
how its government is using financial innovation for the purposes of deception. The secrecy tolerated
by the ECB exacerbates perceptions that opaque markets work arm-in-arm with non-transparent
governments and opaque international institutions.
The 2008 financial crisis exposed the ties that bind together corporations with sovereigns.
In the
midst of the financial crisis the United States seized the mortgage market by nationalizing Fannie Mae
and Freddie Mac, two enterprises of hybrid type (government-sponsored enterprises GSE) created
by the state and managed by private interests. Furthermore, between 2008 and 2009, the US
government invested eighty billion dollars in two automakers based on the motto what is good for GM
really is good for America.
The Hypo Real Estate was bailed out by the German Central Bank and was
eventually nationalized.
In the aftermath of the 2008 panic, developed countries have identified
certain private companies as systemically important for the financial system. Systemically Important
Financial Institutions (SIFIs) are often large and complex corporations or financial conglomerates.
Because they are important for the smooth functioning of the markets, states are dependent on the
SIFIs to keep their economy growing. The SIFIs, in turn, are dependent on states to support them and
provide them with advantages that would help them beat foreign competitors. During the financial
crisis, though, SIFIs were involved in gross manipulation of the financial markets. Large financial
conglomerates have been implicated in the manipulation of the LIBOR,
the currency exchange
the commodities markets
and the energy markets.
This extensive manipulation has

Case T-590/10, Gabi Thesing et Bloomberg Finance LP v. European Central Bank, Nov. 29, 2012 available online
See supra note 228.
See also Marianna Mazzurato, The Entrepreneurial State: Debunking Public vs. Private Sector Myths (2013).
The Goliaths, Economist, June 22, 2013, at 79.
Hypo Real Estate Is Nationalised with Squeeze Out, Reuters, Oct. 13, 2009 available online
The LIBOR Scandal, Fixed Harmony, Economist, Dec. 7, 2013, at 79.
EU Commission Looking into Possible Forex Manipulation, Reuters, Dec. 5, 2013 available online
See United States Senate Subcommittee on Financial Institutions and Consumer Protection, Hearing on
Examining Financial Holding Companies: Should Banks Control Power Plants, Warehouses and Oil Refineries?,
Testimony by Tim Weiner, July 23, 2013 available online
Elli Louka Page 41

shaken peoples faith in the integrity of Western capitalism, making it evident that the proverbial
invisible hand has been swapped for the few, naked and colluded hands.

The regulation of the global financial system is controlled by major developed countries that dominate
the global financial institutions and host powerful private entities that perform state functions. This is
not a new phenomenon. States have tried to control the international economic space by supporting
their companies overseas, even by concocting coups and overthrowing established governments.

The United States has used its private internet companies, the merchant sovereigns,
to spy on other
states and foreign companies.
Through overt state capitalism (Russia, China) or through public-
private close-knit partnerships, states have vied to command the global economic space. Today one has
a hard time distinguishing between state capitalism and the liberal capitalism proposed by the West.
The most widely used payments system worldwide SWIFT (Society for Worldwide Interbank Financial
Telecommunication) is an industry-owned limited liability cooperative society set up under Belgian law
and controlled by its member banks.
The SWIFT looks like a technocratic financial body, but this
private society is the economic equivalent of Special Forces. The economic sanctions imposed on Iran
for not cooperating with the International Atomic Energy Agency on its nuclear program have been
imposed through SWIFT. On March 17, 2012, SWIFT disconnected from its international network all
Brian Wingfield, JPMorgan Accused of Energy-Market Manipulation by U.S. Agency, Bloomberg, July 29, 2013
available online
Despite the severe manipulation of the markets by financial firms, it does not seem that their reputation
measured by their market valuation has suffered much. See also Jonathan Macey, The Death of the Corporate
Reputation (2013).
See Arindrajit Dube et al., Coups, Corporations and Classified Information, NBER Working Paper No. 16952,
2001 (the paper estimates how the removal from power of foreign
governments engineered by the CIA affected the stock price of companies well-connected with the CIA that were
to benefit from regime change).
Lawrence Lessing, Code: Version 2.0, at 377 (2006).
Gabrielle Coppol, Snowden Documents Show U.S. Spied on Petrobras, Globo TV Reports, Bloomberg, Sept. 8,
2013 available online
Committee on Payment and Settlement Systems (CPSS), Payment and settlement systems in selected countries:
Red book, at 455 (Bank of International Settlements, Apr. 2003) available online
Elli Louka Page 42

Iranian banks that were subject to EU sanctions.
Immediately after September 11, 2001, the United
States established the Terrorist Finance Tracking Program aimed at obtaining data from SWIFT. The
program was operating secretly till 2006 when information about the program was revealed in the

Even the European Financial Stability Facility (EFSF), established to make conditional loans to financially
weak eurozone countries, is a private corporation.
The EFSF is a limited liability company whose
shareholders are the eurozone states, and it is established as an SPV, an organizational structure that
received much bad publicity during the financial crisis.
It is registered in Luxembourg, a European
offshore financial center. By choosing a private instrument and not an EU institution, creditor states
assumed total control over the loans to distressed peripheral states, something they could not easily
achieve within the existing EU framework. Furthermore, they shifted the liabilities, due to exposure to
the periphery, off their balance sheets. Any decision on disbursing EFSF funds must be made
unanimously by the eurozone states and the opinions of those that provide most of the funds matter
the most. The EU cannot penalize its members without qualified majority, but a private bank can
certainly discipline its debtors. As a commentator astutely observed: After 60 years of integration,
Germany is hoping that a self-leveraged, off-balance sheet, private but German-led Luxembourg-based
entity will not only be the EU's saving grace, but will deliver Germany what three generations of war
could not.

Hundreds of trade associations of banks, brokers and security dealers that promote the interests of their
industry lobby the governments that regulate the global financial system.
Often the ambition of
these associations is not only to lobby, but also to play a governmental or intergovernmental role in the
allocation of capital. The Institute of International Finance (IIF), for example, played an important role in

SWIFT, SWIFT Instructed to Disconnect Sanctioned Iranian Banks Following EU Council Decision, Press Release,
Mar. 15, 2012 available online
Eric Lichtblau, Bank Data Is Sifted by U.S. in Secret to Block Terror, NY Times, June 23, 2006 available online
See infra section 5.2.
See supra note 214.
Re: Weekly for Precomment, Email-ID 1364773, Wikileaks Global Intelligence Files, released Oct. 18, 2013
available online
Such associations include: the International Capital Markets Association (ICMA), the International Council of
Securities Association, the World Gold Council, the World Federation of Exchanges, the International Swaps and
Derivatives Association (ISDA).
Elli Louka Page 43

negotiating the 2012 Greek debt restructuring.
Members of the IIF include most of the worlds largest
commercial banks and investment banks as well as a growing number of insurance companies,
sovereign wealth funds, hedge funds and export credit agencies. It was the ISDA that determined that
the Greek debt restructuring constituted a credit event triggering payouts under the credit default
swaps (CDS). Moreover, the ISDA determined the level of compensation that was due under the CDS
because of the Greek default.
The Pacific Investment Management Company (PIMCO), one of the
largest bond investors headquartered in the United States but owned by Allianz, a German financial
services firm, performed the analysis of the banking sector of Cyprus in February 2013
just before the
EU/IMF intervention that terminated the use of Cyprus as an offshore banking center.
In the wake of the financial crisis, governments have tried to impose controls on capital by punishing tax
evasion and forcefully repatriating their tax base. The United States took aggressive steps to make
Switzerland reveal secret accounts held by United States residents what Switzerland has dubbed
financial imperialism.
The EU has followed hesitantly in the US footsteps by taking on easy targets
such as Cyprus, but leaving unscathed bigger financial centers such as London and Frankfurt. It seems
that capital always finds a way to escape regulatory oversight despite the restrictions placed by
governments. This is because of the back door that these same governments leave open intentionally in
their myriad financial regulations.
States have established global financial institutions to provide, at the minimum, a forum for negotiating
the regulation of capital. Some of these institutions were conceived initially as private entities and then
were transformed into public organizations. Despite that transformation they have retained their
private underpinnings. The Bank of International Settlements (BIS), started as a private bank in 1929,
was transformed into an international organization later.
Despite its grounding in public international

See generally Institute of International Finance, IFF Response to the Global Financial Crisis: 2007-2012 available
Greece CDS Holders Paid off in Line with Unprotected Bondholders, FTSE Global Markets, Apr. 16, 2012
available online
See PIMCO, Independent Due Diligence of the Banking System of Cyprus, Feb. 2013 available online
See, e.g., Daniel J. Mitchell, A Swiss Response to American Fiscal Imperialism, Cato Institute, Feb . 13, 2012
available online
BIS, BIS Completes Redistribution of Shares, Press Release, June 1, 2005 available online (it was in 2005 that the BIS completed the withdrawal of privately held
shares and their redistribution to central banks).
Elli Louka Page 44

law the bank preserves its structure as a private institution.
The BIS is affiliated with a number of
transnational committees
and inter-governmental bodies.
These transnational regulatory bodies
made up of middle-level government officials have been characterized as flexible networks that monitor
and support the financial system.
Others, though, have criticized these networks as secretive clubs of
developed countries,
the embodiment of financial imperialism.
Indeed many transnational
financial regulatory bodies are dominated by the countries that serve as the nodes of the financial
system powerful developed countries.
These bodies assert a huge amount of power all over the
world because the rules they promulgate are used by the IMF and the World Bank to make lending
decisions. A state that does not adhere to the rules promulgated by these bodies or the rules issued by
the IMF and the World Bank must be willing to lock itself out of the global financial system.
The IMF was unable to foresee the extent and spread of the 2008 financial crisis. A significant degree of
intellectual capture makes it difficult for the IMF to assess advanced economies risks and
vulnerabilities differently from the country authorities.
There is a significant degree of groupthink
and insularity among IMF staff, Management, and, to a lesser extent, even at the Board.

See arts. 1, 2 and 11, Statutes of the Bank for International Settlements, Jan. 20, 1930 amended June 27, 2005.
The bank is a limited liability company. All sixty central banks vote at the annual General Meeting of the BIS. Their
voting power is proportionate to the number of BIS shares they own and the central banks of G-10 countries own
most shares.
Such as the Basel Committee on Banking Supervision, the Committee on the Global Financial System, the
Committee on Payment and Settlement Systems (CPSS) and the Markets Committee.
The BIS hosts the secretariats of a number of transnational regulatory bodies such as: the Financial Stability
Board, the International Association of Insurance Supervisors (IAIS), the International Association of Deposit
Insurers and the International Organization of Securities Commissions (IOSCO). The Basel Committee on Banking
Supervision, the IAIS and the IOSCO work together as the Forum on Financial Conglomerates. The CPSS and the
IOSCO have published together the principles for the financial market infrastructure.
See, e.g., Anne-Marie Slaughter, A New World Order 36-61 (2004).
See, e.g., Stephen Troope, Emerging Patterns of Governance and International Law, in The Role of Law in
International Politics 96-97 (Michael Byers, ed., 2000).
See, e.g., Lawrence Tshuma, Hierarchies and Government Versus Networks and Governance: Competing
Regulatory Paradigms in Global Economic Regulation, 9 Social & Legal Studies 115, at 126 (2000).
For an insightful analysis see Jacob Katz Cogan, Representation and Power in International Organization: The
Operational Constitution and Its Critics, 103 American Journal of International Law 209 (2009).
Ruben Lamdany, Ten Years of Independent Evaluation at the IMF: What Does It Add Up To? 1, at 11, in
Independent Evaluation Office of the IMF: the First Decade (Ruben Lamdany et al., eds., 2012).
Elli Louka Page 45

shortcoming of the IMF is that it does not treat all member states equally. Instead, it accords
preferential treatment to the advanced developed economies. Greater evenhandedness is needed in
the IMFs application of policies.
Even among non-borrowing countries the IMF is stricter with low-
income and emerging market economies than it is with advanced economies.
There are often
significant differences in the IMF advice to countries. Sometimes these differences seem to reflect the
relative weight of each country at the Board and in the ownership of the IMF.

4.2. The Bond Market against Weak Sovereigns
Governments issue bonds to borrow money from the capital markets. Because states cannot really run
out of money, as they have the power to tax or cut down expenditures or even the capacity to
nationalize/privatize industries, they are considered reliable borrowers.
Therefore, the sovereign
bond market sets the long-term interest rates in the economy of a state. When bond prices fall interest
rates rise with painful consequences for borrowers. How the sovereign bond market behaves can be
seen clearly in the case of the Greek crisis. When the bond market started to worry about the Greek
economy the price of Greek bonds plummeted and the interest rates rose dramatically. Since Greek
bonds were deemed risky, the bond market asked for more interest in order to keep holding Greek
bonds. When the Greek government bonds were rated junk by the rating companies, the Greek state
faced tremendous liabilities and it essentially defaulted.
States are apprehensive of the bond market because it passes daily judgment on the credibility of their
fiscal and monetary policy. For states that borrow in the bond market even a small increase in the
interest rate adds to the budget deficit. There is a vicious circle between a states deficit and the bond
yield the higher the yield, the more the deficit; the more the deficit the less the markets faith in a
sovereign leading to bond sell-off and further yield increases. When under attack by the bond market, a
state faces two unattractive options:
(1) Defaulting on its bonds, fulfilling the bond markets worst nightmare; or
(2) Cutting the deficit by cutting expenses or increasing taxes.
The bond market started as a means to facilitate borrowing by governments, but it has ended up
dictating government policy.
Pension funds and other savings institutions that are required to hold a

The bond market rates not so much the ability but the willingness of a sovereign to pay off its debt. See Rawi
Adbelal, Capital Rules: The Construction of Global Finance 162 (2007).
Niall Ferguson, The Ascent of Money 69 (2008).
Elli Louka Page 46

percentage of their assets in the form of government securities invest in government bonds.
As the
proportion of retirees increases, the percentage of people who live off fixed income increases. In other
words, since many people are dependent on the bond market for their livelihood, the bond market has
gained the power to shape governments policies.
Also, the bigger the bond market the more
susceptible it is to panicky behavior and contagion.
In the past, governments who defaulted on their debt risked economic sanctions, the imposition of
foreign control over their finances and even military intervention. Between 1870 and 1913, a country
that defaulted ran the risk of gunboats blockading its ports and creditor nations seizing fiscal control.

Only countries that surrendered their fiscal sovereignty for an extended period of time were able to
issue new debt in the London capital market. Britain, France and Germany, the creditor nations, did not
hesitate to pursue aggressively the interests of private bondholders. Creditors also were organized to
lobby governments to protect their interests. The Corporation of Foreign Bondholders (CFB) was formed
by the British creditors in 1868. The CFB published information on sovereign debt and tax revenues to
discourage investment in countries that could not pay back their debts.
In 1898, soon after its
independence, Greece came under the creditors control after it defaulted. In that case Germany was a
major player in arranging for the protection of foreign bondholders. By all appearances the protection
of foreign bondholders was guaranteed by a Greek law but, in fact, Germany dictated the terms of debt
Committees of foreign bondholders backed by the military power of leading creditor
nations (UK, France and Germany) administered customs collection and controlled the finances of
Greece, Serbia, Egypt, Turkey, Latvia, Morocco, Santo Domingo and Tunis after their default.
Calvo and Drago doctrines
enunciated the Latin American resistance to the US role as a collector of
debts owed to European creditors by Latin American countries. Commentators urged the United States

Id. at 117-18.
See Stephen D. Krasner, Sovereignty: Organized Hypocrisy 127-51 (1999).
See Paolo Mauro et al., The Corporation of Foreign Bondholders, IMF Working Paper, May 2003 available online
Kris James Mitchener et al., Supersanctions and Sovereign Debt Repayment, 29 Journal of International Money
and Finance 19 (2010).
Krasner, supra note 270.
Amos S. Hershey, The Calvo and Drago Doctrines,1 American Journal of International Law 26, at 45 (1907) (The
Drago doctrine forbids the forcible collection of public debt. The Calvo doctrine absolutely condemns diplomatic
and armed intervention for the pursuit of all private claims of financial interest).
Elli Louka Page 47

not to become the debt collecting agency of European creditors and not to establish a protectorate
over the states of Latin America.

In the 1980s the role of the debt-collecting agency was assumed by the IMF and the tool that it used was
the structural adjustment program that was part of the so-called Washington consensus.
Washington consensus is a term used to describe a number of policies debtor countries had to adopt in
order to be granted some facilitation in paying off their debts. Debtor countries had to raise taxes and
open their markets to foreign goods and services to get some financial assistance from the IMF.
Indebted states had to introduce a number of reforms such as securing property rights, the privatization
of state-run industries, the deregulation of the markets and the removal of barriers to trade and foreign
direct investment.
Because United States companies were to benefit the most from the Washington
consensus, some economists accused the United States of economic imperialism under the cover of the

The United States' approach to financial globalization relies on delegation to two private firms
Moodys and Standard & Poors (S&P).
These private rating companies are the big players in the
sovereign bond market since they have become the reputational intermediaries in that market.
United States Securities and Exchange Commission, a government agency, calls them Nationally
Recognized Statistical Rating Organizations (NRSROs). These are private companies, but they are
treated as official appraisers of companies and countries an ostensible display of the privatization of
public authority.
The credit ratings are a requirement in a large number of financial regulations in the
United States and the EU. Because their ratings are required by regulation, the rating companies have

The reputation of rating companies was tarnished during the 2008 financial crisis when it became
obvious that they behaved more as companies obsessed with making profits rather than with providing

Ferguson, supra note 267, at 309.
Id. at 310-12.
Adbelal, supra note 266, at 161-62.
Timothy J. Sinclair, Credit Rating Agencies and the Global Financial Crisis, 12 Economic Sociology 4, at 5, Nov.
2010 available online
Adbelal, supra note 266, at 173.
Id. at 172.
Elli Louka Page 48

objective ratings of financial products.
Some claimed that the companies were uncritical transmitters
of the prevailing economic orthodoxy.
In the beginning of 2012, the S&P rating company cut the
ratings of Italy, Spain, Portugal, France, Austria, Malta, Slovenia and Slovakia.
When France was
toppled from its AAA status, leaving Germany as the only top-rated country with a stable outlook in the
eurozone, the balance of power in Europe was disrupted. France could not position itself anymore as
Germanys equal. That equality used to be the cornerstone of European integration. Given the
instrumental role that rating companies have played in the sovereign debt crisis in Europe, the EU has
pushed back against them
and has started to regulate them strictly.

The bond market has incontestable power, but only over weak states. The bond market is apprehensive
of strong sovereigns who can issue hard currency. The relationship between the central bank of a state
and the bond market is intricate. But the central bank must have clout it must be able to print strong
currency. The central banks of nations that have tamed inflation, often central banks of developed
nations, enjoy a good reputation in the markets. The markets are affected by the policies that these
central banks choose to follow. The United States Federal Reserve, which prints the reserve currency of
the world, has an enviable amount of power almost impossible for any other central bank to duplicate.
To minimize their foreign exchange risk central banks of all states prefer to have in their foreign reserves

In 2013 the United States Justice Department used the Financial Institutions Reform, Recovery and Enforcement
Act (FIRREA) to charge the rating companies with fraud. See US Department of Justice, Department of Justice Sues
Standard & Poors for Fraud in Rating Mortgage-Backed Securities in the Years Leading Up to the Financial Crisis,
Press Release, Feb. 5, 2013 available online On
November 5, 2012, an Australian court held the S&P jointly liable with a bank, ABN AMRO, for losses suffered by
local councils that had invested in credit derivatives. The court ruled that since the issuers of financial products
pay for ratings and investors rely on the information the rating companies provide, the rating companies could be
held liable. See paras. 2919, 2922, Bathurst Regional Council v. Local Government Financial Services Pty Ltd (No
5), Federal Court of Australia, (2012) FCA 1200, Nov. 5, 2012 available online
=%22[/Judgments/] .%22.
For the role of rating companies as transmitters of the prevailing economic orthodoxy, see Adbelal, supra note
266, at 178.
David Gauthier-Villars, Europe Hit by Downgrades, Wall Street Journal, Jan. 14, 2012 available online
See European Securities and Markets Authority (ESMA), Credit Rating Agencies Sovereign ratings
investigation: ESMAs assessment of governance, conflicts of interest, resourcing adequacy and confidentiality
controls, Dec. 2, 2013 available online
See, e.g., Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013
amending Regulation (EC) No 1060/2009 on credit rating agencies, OJ L 146/1, 31.5.2013.
Elli Louka Page 49

the reserve currency of the world, the United States dollar. The European Central Bank, which prints the
euro considered a strong currency also yields influence on the financial markets. When the ECB
declared that it would do whatever it takes to save the euro, the bond yields of peripheral eurozone
countries fell and stabilized.
4.3. The Value of a Strong Currency with Frankfurt at Its Center
The United States Federal Reserve plays a central role in the governance of the global financial system
because it manages the US dollar, the reserve currency of the world. By having the worlds reserve
currency, the United States has been spared balance-of-payments crises.
The United States, for
instance, buys goods from China by paying China in US dollars. China then uses the US dollars to invest
in Treasuries (US government bonds) because such bonds are considered a riskless investment. This
way the money the United States pays to import goods comes back to the United States by those who
want to invest in US government bonds.
Between 1991 and 2001, the United States experienced
large capital inflows that financed the new internet companies. Then the dotcom crash happened and
capital inflows evaporated. The vacuum was filled by foreign central banks who invested primarily in US
The remarkable premium assigned to dollar denominated assets is due to the fact that the
United States exerts catalyzing influence on the formulation of global monetary policy.

This privileged position the United States can remain as long as it keeps issuing the worlds reserve
currency. If another currency becomes the dominant currency or a rival dominant currency, the United
States' situation will change significantly. If the US Federal Reserve does not manage the worlds
reserve currency, if it becomes a mortal central bank like all the others,
its hold on the global
economy will be loosened. When the Federal Reserve pursues expansionary policies, investors will be
quick to dump the dollar and switch their assets to an alternative reserve currency (e.g., the euro).
present, two thirds of the world trade is conducted in US dollars and two thirds of banks currency
reserves are in US dollars.
The countries that supply the worlds energy have the unusual clout to decide whether the dollar, the
euro or any other currency (e.g., the yen) would be the worlds reserve currency. Since oil and gas are

Jacques Ruef, The Monetary Sin of the West 17-18 (1972).
Benn Steil et al., Money, Markets and Sovereignty 103 (2009).
Id. at 210.
See, e.g., Marcel Fratzscher et al., On the International Spillovers of US Quantitative Easing, ECB Working Paper
Series, No 1557 (2013) available online
Steil, supra note 289, at 231.
Id. at 230-31.
Elli Louka Page 50

the worlds primary energy resources and they are bought and sold in dollars, all countries have an
interest in holding dollars to pay for them. Countries need dollars to protect their currency in case of a
speculative attack against it. If there is a speculative attack on a countrys currency, and as a result the
country is forced to devaluate, then for that country the price of oil will increase. Countries hold dollars
in their reserves to be able to buy back their currency when it is under speculative attack, averting in this
way a forced devaluation.
The power exercised by printing the worlds reserve currency is noticed by other countries. The euro
has vied to share that power with the dollar. If the euro becomes the dominant reserve currency
countries will dump the US dollar and accumulate euros. If the euro becomes the dominant reserve
currency the world will stop subsidizing the American consumption and will subsidize the European
consumption instead. However, switching from the dollar to the euro is difficult. China and the Gulf
states are holding huge amounts of dollars. If they attempt to diversify their holdings by holding more
euros (selling the dollars and buying euros), this will put downward pressure on the dollar and drive
down the purchasing value of their own currency reserves.

The economic power of the United States is all the more visible when compared with that of developing
states. The currencies of many countries are valueless material. When people have lacked faith in what
their government asks them to hold as money, they have concocted legal and illegal schemes to transact
in foreign currencies. The central banks of these weak states, which have the misfortune to manage
currency that is not convertible, have the following choice:
(1) Allow transactions in the international currency in the domestic market, which pretty much
disables the central bank from making monetary policy; or
(2) Do not allow transactions in the strong currency and witness the flight of capital to offshore
financial centers.

The deutschmark was the sole strong currency in the European Union before the introduction of the
euro. The euro started as a French idea. French president Mitterrand considered the deutschmark
Germanys atom bomb and wanted to neutralize it in a common currency. But it was the German
chancellor Kohl who viewed the euro as the deutschmark in disguise. The German Central Bank has
been the sole economic sovereign in Europe. Before the introduction of the euro the bank frequently
refused to cut interest rates to accommodate weaker currencies in the European region.

Id. at 219.
Id. at 132.
France turned embarrassingly to Germany in 1969, 1979 and 1987, asking it to revalue the deutschmark so that
the French impeding devaluation would look less severe and could be presented to voters as a mere currency
rebalancing. See Eichengreen, supra note 8, at 191, 239.
Elli Louka Page 51

By focusing on low inflation the German Central Bank has fought to ensure that the deutschmark and its
successor, the euro, do not become valueless currency. This has been especially important since the
euro is a new currency competing for a role as an alternative reserve currency. Germany has
understood that the bond markets can be moved only by a strong sovereign. When the peripheral
countries went into an economic tailspin, their euros flew to Germany to find a safe haven there.
Germany had the power to impose even negative interest rates on investors who were ogling its bonds
as a safe asset. As a consequence, Germanys borrowing costs plummeted while the borrowing costs of
the periphery skyrocketed. This is how the bond market understands who, in Europe, is sovereign.
Some have argued that Germany behaves like a geo-economic power. Germany defines its interests in
economic terms. From 1997 to 2007, the German surplus in the eurozone went from twenty-eight
billion to one hundred and nine billion.
The economy has been reliant on exports to grow. Persistent
trade surpluses are one of the hallmarks of geo-economic powers.
If Germany is a geo-economic
power, though, it is not alone. All great powers are geo-economic powers that know how to use the
economic instrument to their advantage.
The tools with which Germany has chosen to exercise its
geo-economic power have had tremendous implications for the half-a-century old EU project. During
the euro crisis no package for Greece was possible without Germany and, consequently, the votes of the
German parliament became relevant for all states in the eurozone.
As the German constitutional
court has assumed extraterritorial jurisdiction over the EU economic policy,
the EU seems to have
become nothing more than a faade for the assertion of economic power.

Competition in Europe takes place not only between private actors, but also between states. Since EU
member states have their own financial centers, economic competition between these centers is
In 2013 Frankfurts financial industry was predicting that the ECB would obtain a swap deal
to trade in Chinas yuan currency four times larger than that obtained by the Bank of England.

Hans Kundnani, Germany as a Geo-economic Power, 34(3)The Washington Quarterly 31, at 36 (2011) available
See, e.g., Michael J. Hogan, Informal Entente: the Private Structure of Cooperation in Anglo-American Economic
Diplomacy, 1918-1928 (1991).
See Proissl, supra note 76, at 41.
See infra section 5.5.
See also Special Report: Germany, Europes Reluctant Hegemon, Economist, June 15, 2013. See also supra note
Speech by Lorenzo Bini Smaghi, Regulation and Supervisory Architecture: Is the EU on the Right Path?, 2009
ECON meeting with national parliaments (Feb. 12, 2009) available online
Elli Louka Page 52

Policymakers from China were meeting with policymakers and industrialists in Germany to discuss how
to establish Frankfurt as an offshore yuan-trading center. Germany is Chinas biggest trading partner in
Europe. It is expected that by 2015, Chinas cross-border business will be settled in yuan, making yuan
the third most traded currency after the US dollar and the euro. According to some, Frankfurt has a
competitive advantage over London and Paris because it is the home of the euro and continental
Europe. Paris would probably be very interested in becoming a trading hub. But theyve missed the
boat, as Frankfurt already has the ECB, as well as a record of stable development during recent crises.
Frankfurt will emerge as a winner in the euro area.

The neo-imperialist ambitions of the euro project have never been hidden. Some economists have even
speculated that the euro may replace the dollar as the worlds reserve currency.
Union officials
described the introduction of the euro as the beginning of a bi-polar world in which one of the poles is
the dollar and the other the euro.
The international debt crisis has dented such ambitions. The
international use of the euro slipped in 2012 because of the debt crisis in Europe, but the US dollar held
its position as the worlds reserve currency. The euros share among the currency reserves of central
banks fell to 23.9 percent in 2012 from 25.1 percent in 2011. The dollars share remained virtually
stable at 61.9 percent.

4.4. The Crippled Financial Integration of the EU
The EU creditor states have claimed that the causes of the euro crisis lie in the fiscal irresponsibility of
debtor states. According to this view, deficits and debt in the periphery were so large that once the
great recession hit investors lost confidence in the ability of the periphery countries to remain solvent.
As they tried to get rid of the bonds of these countries, they triggered the crisis. The bond market is the
true martinet when it comes to sovereigns. Markets will eventually punish states with budget deficits
and foreign debt by triggering capital outflows.

Quote attributed to Horst Loechel, professor of economics at the Frankfurt School of Finance & Management.
See Angela Cullen, Yuan Offshore Trade Race Picks Up with Frankfurt Bid: Currencies, Bloomberg, July 3, 2013
available online
See Menzie Chinn et al., Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?,
NBER Working Paper No. 11510, Aug. 2005 available online (predicting that
the euro may surpass the dollar as leading international reserve currency by 2022). But see David McHugh, Debt
Crisis Shrinks International Use of Euro, Associated Press, July 2, 2013 available online
Assertion of Romano Prodi, former European Commission president. See Bradley A. Thayer, The Case for the
American Empire 1, 33, in American Empire: A Debate (Christopher Layne et al., eds., 2006).
ECB, The International Role of the Euro, at 19 (2013) available online
Elli Louka Page 53

But arguing that the debt crisis was caused by the debts and deficits of debtor states is tautological. In
the case of Greece, the poster child for the euro crisis, none of the fundamentals of the Greek economy
changed much from the moment Greece entered the eurozone till the time the Greek crisis erupted. On
the other hand, short-term capital flows to Greece reached thirty-five billion in 2008
from the nine
billion they were in 2002.
Greece was compelled to liberalize the flows of capital as a prerequisite for
its entry into the monetary union. In May 1994 the Greek government adopted a law allowing short-
term capital to move freely in and out of the country, fulfilling in this way the requirement for joining
the monetary union.

The idea that capital should be free to cross borders became prevalent in the EU in the late 1980s.
Before that, the predominant view was that short-term capital movements could have destabilizing
effects on a states economy and infringe on the exercise of independent monetary policy. Therefore,
the decision of how much capital should be moved, and when, was left to the discretion of national
governments. What is labeled financial repression today,
in those days was commonsense financial
The United States and the United Kingdom were the trailblazers for the liberalization of
capital flows followed by Japan and Germany. France eventually converted to the ideology of freedom
of capital as a quid pro quo for Germanys concession to the monetary union.
Germany and the UK
had to wheedle other states, such as Italy and Greece, into catching up with them in liberalizing capital.
The periphery states objected to the liberalization of capital. They knew, however, that they had no
chance of making a dent in the rare consensus among the big three France, Germany and the UK.

The European Union adopted a number of directives that transformed the EU economic space from a
restricting-of-capital space
to a competing-for-capital space.
By freeing capital movements and

IMF 2009 Report, supra note 34, at 37.
IMF, Greece: 2004 Article IV Consultation, IMF Country Report No. 05/43, at 28, Feb. 2005.
Anastasios P. Pappas, The Short-term Determinants of Capital Flows for a Small Open Economy: the Case of
Greece, 15 Review of Development Economics 699 (2011).
See, e.g., Carmen M. Reinhart et al., Financial Repression Redux, Finance & Development, June 2011 available
Adbelal, supra note 266, at 48-49.
Id. at 9-10.
Id. at 71-72.
See Council Directive of 21 March 1972 on regulating international capital flows and neutralizing their
undesirable effects on the domestic liquidity, OJ L 91/13, 18.4.72. A 1988 directive repealed the 1972 directive
but still allowed for controls on short-term capital movements a compromise between Germany and weaker
states that were reluctant to liberalize the movements of capital. See art. 3, Council Directive of 24 June 1988 for
the implementation of article 67 of the Treaty, OJ L 178/5, 8.7.88.
Elli Louka Page 54

fixing exchange rates through the monetary union, the central banks of EU states effectively
surrendered their monetary autonomy to the German Central Bank
a bank renowned for its
obsession with low inflation. At the same time, the removal of capital controls increased the mobility of
countries tax base, which now sought states with the lowest taxes on capital. The incentives given to
capital to move to states with the lowest taxes strengthened the resolve of France and Germany to
recapture their evading tax base through tax harmonization
and, when that was not successful,

through a naked economic war on the financial centers that were weakened due to the 2008 economic
crisis (i.e., Ireland and Cyprus).
With the adoption of the Maastricht Treaty, which established the economic and monetary union
(EMU), capital has been free to cross national frontiers in the EU along with goods, services and people
whose freedom of movement had been guaranteed in previous treaties. Free capital movements have
been embedded, in this fashion, in the constitutional
structure of the EU.
Smaller states asked to be
given more time to adjust their economies to this new freedom of capital but shied away from
demanding permanent exceptions.
The countries of eastern and central Europe that joined the EU in
2004 were eager to showcase their liberal credentials and readily legalized free capital flows.
countries understood that endorsing the freedom of capital provided the certification they needed to
get in the EU exclusive club.
The embedding of this economic ideology in the constitutional structure
of the EU eventually became a sort of sclerosis. The EU drew no lessons from the Asian financial crisis
of the late 1990s that could have helped tame the ideological hyperbole. That crisis led many
international institutions to revise their policies on free capital movements and propose cautious

For a historical analysis of this transition, see Adbelal, supra note 266, at 68-70.
Id. at 75.
See supra note 47.
See Fabio Wasserfallen, Political and Economic Integration in the EU: The Case of Failed Tax Harmonization, 51
Journal of Common Market Studies 1 (2013).
The treaties are constitutional since it is more difficult to amend them than regular EU legislation.
See art. 63, TFEU, supra note 5.
Adbelal, supra note 266, at 73.
Id. at 83.
Elli Louka Page 55

controls on the freedom of capital.
Following blindly the rules spelled out in its constitutional
the EU paved the way for its own economic crisis.
Capital inflows may undermine the economic and political stability of states when there is a sudden
reversal in the capital flow. Several countries are particularly vulnerable to a sudden reversal of capital
flows, the so-called capital freeze.
Debtor states suffered from such a freeze in 2010 when the
financial crisis hit and the bond markets started to reconsider the fundamentals of weaker economies.
The reversal of capital flows was dramatic in 2012 when there was intense speculation that Greece and
then other peripheral countries would default and possibly exit the euro. Before 2009 the markets were
happy to ignore the flaws in the fundamentals of the Greek economy and warnings by the Eurostat, as
recent as 2004, that Greece was misstating its accounts.

The IMF has reversed its prior position
and now endorses capital controls as a way to insulate
countries from financial instability. According to the IMF, capital flows can create benefits but also
carry risks, which can be magnified by the lack of financial and institutional infrastructure. Capital flow
liberalization is less risky when countries have already reached certain milestones of financial and
institutional development. The liberalization of capital flows must be well planned, timed and

The IMF, for example, see id. at 197.
The European Court of Justice supported the freedom of capital in a number of rulings, see, e.g., Case C-483/99,
Commission v. France, (2002)ECR I-4785; Case C-367/98, Commission v. Portugal, (2002) ECR I-4756. See also Case
C-244/11, Action under Article 258 TFEU for failure to fulfill obligations, European Commission v. Hellenic Republic,
Nov. 8, 2012 available online
&dir=&occ=first&part=1&cid=253074. Commentators have been critical of the ECJs persistence in upholding the
primacy of the EU law over national labor laws. See, e.g., Christian Joerges, The Lisbon Judgment, Germanys
Sozialstaat, the ECJs Labour-Law Jurisprudence, and the Reconceptualisation of European Law as a New Type of
Conflicts Law 27, in The German Constitutional Courts Lisbon Ruling: Legal and Political-Science Perspectives,
Discussion Paper 1/2010, Center of European Law and Politics (ZERP), University of Bremen (Andreas Fischer-
Lescano et al., eds., 2010).
The Economist has developed the capital freeze index, which measures the vulnerability of emerging markets
to a sudden stop in capital flows. See The Capital-Freeze Index: Stop Signs, Economist, Sept. 7, 2013, at 70.
See supra note 38.
In September 1997 the IMF formally proposed an amendment to its charter endorsing the liberalization of the
capital account, calling such liberalization an essential element of an efficient international monetary system in
this age of globalization. See Communiqu of the Interim Committee of the Board of Governors of the
International Monetary Fund, Press Release Number 97/44, Sept. 21, 1997 available online
Elli Louka Page 56

sequenced in order to ensure that benefits outweigh the costs.
Capital flocked to Greece as the
country was eager to borrow at low interest rates that became available to it after its accession to the
euro. The excessive borrowing fueled a fiscal largesse. Channeled through transfers, subsidies, and
investments, fiscal expansion lifted private income and consumption which in turn boosted tax revenues
and masked the true size of the underlying fiscal gap.
The lower interest rates stimulated also a
private sector borrowing spree.
The 2008 global financial crisis led to a retrenchment of cross-
border flows and unmasked Greeces underlying fiscal and structural imbalances.

The design of the euro not only caused but was also meant to cause the flows of capital from the core to
the periphery. One of the goals of the euro was to achieve greater financial integration among EU
member states. It was hoped that the common currency would make it easier for investors to find good
investment opportunities in the eurozone because they would no longer have to worry about exchange
rate risk. The euro made it easier for capital to flow from countries with abundant capital (and relatively
low returns on investment) to countries that were capital-poor and, thus, offered higher returns on
investment. This was considered key for the economic convergence, namely the economic catching up
of the South with the North of the EU.
Before the introduction of the euro, peripheral countries used to devalue their currencies in order to
stay competitive with Germany. As a result German exports were expensive and hard to sell to the
periphery. The euro solution, from the perspective of Germany, aimed at facilitating trade with the
peripheral economies of Europe through the abolition of sovereign currencies so that these countries
would not be able to use devaluation to stem the tide of German imports. In exchange the periphery
was supposed to gain from a strong currency and low interest rates. The scheme worked to some
extent: German goods became cheaper. Due to low interest rates, consumers could afford to borrow to
buy German goods. When the economic crisis occurred, the excessive borrowing appeared as a high
government deficit or as a banking crisis. In countries where the banks financed the standard of living of
citizens, for example Ireland and Spain, a banking crisis erupted. In Greece, where the government
borrowed to act as an employer of last resort, the crisis emerged as high deficit and government debt.
As a commentator succinctly put it, PIIGS bubbles pulled Germany out of balance sheet recession. The
economic booms (bubbles) sparked in other euro-zone nations by the ECB rate cuts saved Germany. In
effect, they allowed Germany to export its way out of the balance sheet recession.
By 2007 Germany

IMF, The Liberalization and Management of Capital Flows: An Institutional View, at 35 (2012) available online
IMF Report 13/154, supra note 42, at 4.
Richard C. Koo, Learning Wrong Lessons from the Crisis in Greece, at 8, Nomura Research Institute, Japan, May
20, 2011 available online
Elli Louka Page 57

had the worlds largest trade surplus thanks to the countries daintily called PIIGS (Portugal, Ireland, Italy,
Greece, Spain).

Given the fact that the periphery had lost monetary sovereignty,
the ECB should have watched for
large capital outflows from the core to the periphery and the nature of these outflows short-term
portfolio investments, the so-called hot money, and not long-term direct investment in the economies
of the periphery. The lack of ECB prudential supervision resulted in a large aggregation of risk in the
periphery. While in good times the benefits of free flows of capital were shared by both the core and
the periphery, in bad times the risks of the capital flows were borne exclusively by the periphery
The country on the receiving end of capital outflows risks serious financial crisis when
these outflows freeze.
On the other hand, the country that is the source of capital flows bears no
similar risk. In other words, the periphery of the eurozone bore the systemic risk inherent in the
common currency area while the benefits were shared by both the core and the periphery.

Some have claimed that the monetary union included a no-bailout clause
that surprisingly the
markets failed to take into account when pricing the debt of the periphery. It seems that since few
preventive mechanisms were in place to deal with a potential financial crisis in the eurozone, the
markets assumed that if a country faced financial difficulties the contagion to other countries would be
so substantial that the eurozone would bailout that distressed country to avoid a total economic
meltdown. The markets assumed also that the EU leaders were truthful when, time and again, they
asserted that the European Union was a political project designed to unite Europe.
The markets were
more convinced by the actions of the ECB, which treated the sovereign debt of all eurozone countries in
a similar fashion when it was offered as collateral for ECB credit. The markets concluded, therefore, that
the no-bailout clause was an empty threat inapplicable in practice.

On how countries lose monetary independence, see, e.g., Hlne Rey, Dilemma not Trilemma: The Global
Financial Cycle and Monetary Policy Independence, Aug. 2013, paper presented at the 2013 Economic Policy
Symposium of the Federal Reserve Bank of Kansas City available online
See Kash Mansori, Why Greece, Spain and Ireland Arent to Blame for Europes Woes, The New Republic, Oct.
11, 2011 available online
See supra note 327.
Mansori, supra note 337.
See art. 125, TFEU, supra note 5.
See Hans Albin Larsson, National Policy in Disguise: A Historical Interpretation of the EMU 143, at 159, 164, in
The Price of the Euro (Jonas Ljungberg, ed., 2004).
Elli Louka Page 58

The periphery wishes that the core states shared its losses. Monetary easing, or mutualization of risk by
issuing joint and several liability Eurobonds could alleviate some of the pain of the South.
This has
been unacceptable to core states. As long as the ECB is crippled by the informal veto of the German
Central Bank
and a common lender of last resort is not in sight the debtor states will continue
displaying the symptoms of developing countries that have borrowed in a currency that they cannot

In 2013 the ECB published a report on the financial integration in Europe,
which, from its content,
should have been titled Financial Disintegration in Europe. According to the ECB, the fragmentation of
financial markets has increased because of fears that the euro could break up.
The eurozone has
been divided into distressed and non-distressed countries.
This division has led to the flow of capital
to non-distressed countries, which are considered safe havens.
As a result, the borrowing costs of
safe-haven countries have plummeted while the borrowing costs of distressed countries have
Many banks located in distressed countries suffer a stigma, despite their health, while
those located in safe havens experience strong demand for their assets.
Loan growth between 2004
and 2008 was stronger in the distressed states but in 2012 the reverse was true, a development
consistent with the boost-bust cycle.
This was due to the ECBs flawed interest rate policy that
preceded the financial crisis.

See infra section 6.
See infra section 5.4.1.
Peter Boone et al., Policy Brief: Europe on the Brink, at 3, Peterson Institute of International Economics, July
2011 available online
ECB, Financial Integration in Europe (2013 ) available online [hereinafter Financial
Id. at 9.
Id. at 19.
In addition to Germany and the Netherlands, safe havens were considered countries outside the eurozone, such
as Switzerland and Denmark.
Financial Integration, supra note 345, at 27.
Id. at 68.
Id. at 32.
According to the ECB, regional booms [were ]facilitated by interest rateswhich with insight proved excessively
low for domestic conditions prevalent then in deficit countries. See id. at 98.
Elli Louka Page 59

5. Institutions
The euro crisis has tarnished the reputation of the EU, which many Europeans view as a shadow state,

an undemocratic and illegitimate establishment. This shadow state is founded on a number of
international treaties that many Europeans have never heard of complemented by a number of
regulations code-named two-pack, six-pack' and Fiscal Compact.
These complex treaties and
regulations and the unelected institutions that administer them have been imposing economic policies
on states that are locked in the debt trap. The European Council, the shadow government in which the
state with the deep pockets prevails, and the troika of EU/ECB/IMF which conducts economic
surveillance and imposes sanctions rule over the supposed sovereigns that make the EU.
5.1. European Council, Eurogroup, European Commission
The European Council consists of the heads of state of EU member states. These are the masters of the
treaties, as the German constitutional court has affirmed,
the kings who are comparable to the kings
of the early ninetieth-century constitutions.
There is nothing in the legal structure of the European
Council that advantages one government over another. However, because of the inherently unequal
relationship between creditors and debtors, the euro crisis has transformed the Council from a Council
of ostensibly equals to a Council where the views of creditor states reign. Initially the German
chancellor Merkel led the European Council with the support of her French counterpart Sarkozy.
Germany wanted to stand side by side with France to avoid impressions that it was dominating Europe.
Some dubbed this the Merkozy show. But France and Germany have frequently worked bilaterally to
present their joint positions to the European Council as a fait accomplit.
During the euro crisis, the
German chancellor campaigned for the French presidents reelection, which some characterized as an
intervention in the internal affairs of France while others understood it as the emergence of pan-
European politics. When Sarkozy was not re-elected, there were fears that the new French president

The characterization is attributed to Thomas Mayer, chief economist of Deutsche Bank. See Andreas Becker,
European 'Shadow State' Faces Growing Resistance, Deutsche Welle, Apr. 6, 2013 available online
See infra section 5.3.
See paras. 231, 235, English translation of the judgment of the German constitutional court on the Lisbon Treaty
available online
Jrgen Habermas, The Crisis of the European Union: A Response 44 (2011).
Eichengreen, supra note 8, at 187.
Elli Louka Page 60

would try to create a Mediterranean coalition against Germany.
The downgrade of France by the
rating companies led many to view the German chancellor as the de facto president of the EU and the

The euro crisis was addressed at the bilateral (Germany-France) level or at the EU intergovernmental
level. The first euro summit was held in October 2008 and it was through a series of summits from
2008 to 2013 that the eurozone governments tried to grapple with the crisis.
The Treaty on Stability,
Coordination and Governance in the Economic and Monetary Union, the so-called Fiscal Compact,

which entered into force in January 2013, requires now a minimum of two euro summits per year.
When liquidity is an issue in an economy, it is the responsibility of the central bank to provide liquidity
based on the chosen monetary policy. But when solvency becomes the issue, it is the responsibility of
the treasury to get the economy out of trouble. While there is a European Central Bank, there is no
European Treasury. Actually, this lack of a central European Treasury has been pointed out, since the
beginnings of the euro, as one of its major weaknesses. Because of the absence of a central European
Treasury, the national treasuries of the eurozone states must coordinate their actions through the
Council of the European Union often called Council of Ministers.
The Council of the European
Union (Council) should not be confused with the European Council mentioned above. The Council is the
EU body comprised of representatives of member states. Usually these representatives are ministers
with responsibility in a specific area. The finance ministers meet once a month in the Council, which
handles economic and financial affairs, called Ecofin Council. The Eurogroup is the subgroup of Ecofin
the group of finance ministers of the eurozone. The Eurogroup does the preparatory work for the euro
summit meetings of the European Council and ensures the implementation of decisions made in these

For those who still aspire to European unity for every crisis the best response is more European
integration. The European Commission has been credited for facilitating that integration. During the
euro crisis, the European Commission functioned as part of the troika, an enforcer of the treaties and

On the possibilities of a Mediterranean Union, see Communication of the Commission to the European
Parliament and the Council, Barcelona Process: Union for the Mediterranean, COM(2008) 319 final.
See Proissl, supra note 76, at 8.
See infra note 464.
See, e.g., Memorandum of Understanding on Cooperation between the Financial Supervisory Authorities,
Central Banks and Finance Ministries of the European Union on Cross-Border Financial Stability, June 1, 2008,
See also Protocol No. 14 to TFEU, supra note 5.
Elli Louka Page 61

the contracts signed between creditor states and debtor states. It consistently beat the drum of
economic and fiscal integration, as the perennial little lone drummer who believes that her beat will
bring more unity.
The European Commission is a hybrid body: a civil service responsible for the everyday affairs of the EU;
a government with the exclusive right to propose legislation; and a regulator and enforcer of the EU
Since the Commission is not an elected body, this creates questions about its legitimacy and the
legitimacy of the European project it champions. Nevertheless, through the Fiscal Compact and other
legislation, the eurozone countries have charged the Commission with monitoring national deficits and
The Commission can demand budget changes and recommend sanctions for states that
violate the fiscal rules.
The commissioner for monetary affairs is now the states economic examiner.
Because of this deep intrusion of the Commission into the fiscal affairs of governments, questions about
its legitimacy have multiplied. Voters can oust governments because they do not agree with their
economic policies, but they cannot do anything about those who really dictate national economic
policies the officialdom in Brussels.
One cannot blame the European Commission for the perpetuation of the euro crisis since, during the
crisis, it was often reduced to a rubber stamp of the Councils decisions. As mentioned, during the euro
crisis, decision-making moved to the European Council with negotiations held behind closed doors
among creditor nations or just between France and Germany. Because of the power politics that
prevailed in the European Council, the peripheral countries started to view the Commission as the
institution that could help restore the balance of power in the EU. Creditor states eventually realized
that the Commission should act as the arbiter for the enforcement of contracts and legislation adopted
due to the euro crisis. There have been proposals to strengthen the legitimacy of the Commission by
holding elections to elect the Commissions president. This would give a mandate to the Commission to
assume a more political role and to delegate technocratic matters to the numerous European agencies.
However, the Commission has made its reputation by projecting itself as an objective, technocratic body
not influenced by politics. Even if this is a myth, it is a myth that the Commission wants to salvage from
the mayhem of the euro crisis.

Louka, supra note 4, at 27.
See infra section 5.3.
Elli Louka Page 62

5.2. The Mechanisms
The European Financial Stabilization Mechanism (EFSM) is a sixty billion balance of payments facility
created in 2010 and available to countries facing financial difficulties. The mechanism was created by a
Council Regulation
based on the Treaty on the Functioning of the European Union:
Where a Member State is in difficulties or is seriously threatened with severe difficulties caused
by natural disasters or exceptional occurrences beyond its control, the Council, on a proposal
from the Commission, may grant, under certain conditions, Union financial assistance to the
Member State concerned.

The EU regulation that establishes the EFSM states that the deepening of the financial crisis has led to
severe deterioration of the borrowing conditions of several member states beyond what can be
explained by economic fundamentals. In order to address this exceptional situation beyond the control
of the Member States, it appears necessary to put in place immediately a Union stabilization mechanism
to preserve financial stability in the European Union.

The European Commission uses the EFSM to raise money (up to sixty billion) in the capital markets
issuing bonds backed by an implicit EU budget guarantee.
The Commission then lends the money to
the state in trouble. The ECB acts as the intermediary for the administration of the loan between the
European Commission and the states central bank. The beneficiary state pays all interest and loan
principal. In case the beneficiary state defaults on its payment, the implicit EU budget guarantee means
EU funds will be used to pay creditors. Granting EFSM loans requires the qualified majority voting of
the Council.
The borrowing nation must be subjected to economic conditionality and supervised by
the European Commission. The Commission allows for the incremental release of financing if it
determines that the country is meeting the conditionality requirements.
The ECB pressured Greece,

Council Regulation (EU) No 407/2010 of 11 May 2010 establishing a European Financial Stabilisation
Mechanism, OJ L 118/1, 12.5.2010. A similar mechanism was adopted in 2002 to assist non-eurozone member
states. See Council Regulation (EC) No 332/2002 of 18 February 2002 establishing a facility providing medium-
term financial assistance for Member States balances of payments, OJ L 53/1, 23.2.2002.
See art. 122(2), TFEU, supra note 5.
Preamble (4)-(5), Regulation No 407/2010, supra note 367.
Art. 6(3), id.
See art. 2(2), id.
Art. 3(2), id.
Art. 4, id.
Elli Louka Page 63

Ireland and Portugal to seek bilateral loans from the EFSM rather than use the Target2 system
finance their balance of payments shortfalls. The financial assistance to Ireland and Portugal for a total
amount of 48.5 billion (up to 22.5 billion for Ireland and up to 26 billion for Portugal) was channeled
through EFSM.
The European Financial Stability Facility (EFSF) is a company, an SPV, with a lending capacity of four
hundred and forty billion that was established outside the EU system by eurozone member states to
deal with the sovereign debt crisis on a temporary basis.
Initially the sole shareholder of the EFSF was
Luxembourg in order to expedite its creation,
but later shareholders became all eurozone states.

Greece, Ireland and Portugal, the debtor states, stepped out from shareholder contributions. In
addition to the incorporation of the EFSF in Luxembourg, an agreement was signed between the EFSF
and the eurozone member states setting out the specifics of the functioning of the EFSF.
This is a
peculiar agreement since a corporation (whose shareholders are states) enters into an agreement with
the same states. Some have doubted the legality of such an arrangement
while others have viewed it
as a brilliant combination of EU law and private international law.
This convoluted establishment of

For the Target2 system, see infra section 5.4.2.
It was established on June 7, 2010, in Luxembourg. The decision to establish the company was taken on May 9,
2010, at an intergovernmental meeting of eurozone member states within the Council of the EU. See Decision of
the representatives of the governments of the euro area member states meeting within the Council of the
European Union, ECOFIN, Note of the General Secretariat of the Council No. 9614/10, May 9, 2010 available online For the articles of incorporation of the
company see European Financial Stability Facility, Socit Anonyme, Memorial Journal Officiel du Grand-Duch de
Luxembourg C-No. 1189, at 57026, June 8, 2010 [hereinafter EFSF articles of incorporation].
Council of the European Union, Terms of reference of the Eurogroup, European Financial Stability Facility, June
7, 2010
EFSF, European Financial Stability Facility presentation, Oct. 2011 available online
EFSF Framework Agreement between Belgium, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus,
Luxembourg, Malta, Netherlands, Austria, Portugal, Slovenia, Slovakia, Finland and the European Financial
Stability Facility, July 7, 2010 available online [hereinafter EFSF
Framework Agreement].
See, e.g., Giuseppe Bianco, The New Financial Stability Mechanisms and their (Poor) Consistency with EU Law,
European University Institute Working Paper, RSCAS 2012/44 (2012) available online
See, e.g., Bruno De Witte, Using International Law in the Euro Crisis: Causes and Consequences, Centre for
European Studies University of Oslo, Working Paper No. 4, June 2013 available online
Elli Louka Page 64

the EFSF creates uncertainties about the applicable law. According to the articles of incorporation of the
EFSF, Luxembourg law applies.
Based on the agreement between the EFSF and the eurozone,
however, English law is the applicable law.
The European Court of Justice (ECJ) has exclusive
jurisdiction over disputes between eurozone states, but Luxembourg courts have jurisdiction over
disputes between the EFSF and a state.
Overall the roles assigned to the European Commission, the
Eurogroup and the ECJ in the EFSF agreement are problematic since these are EU institutions while the
EFSF is an SPV.

The SPV structure gives more leeway to states as decisions are made by the board of directors of the
SPV (i.e., eurozone states) rather than EU organs. Germany fought to establish the EFSF as an SPV under
Luxembourg law, having as a CEO a German national in order to control it better. The EFSF provides
financial assistance based on conditionality. It obtains financing in the capital markets by issuing bonds
backed by irrevocable and unconditional guarantees of the euro-area member states.
guarantees total seven hundred and eighty billion that give the EFSF a lending capacity of four hundred
and forty billion.
The EFSF makes available to states in financial trouble the money it raises through
the markets. Financial Facility Agreements are negotiated between the EFSF and the states that ask for
assistance. Those states have to sign an MOU with the European Commission that acts on behalf of the
eurozone. The MOU lays out the stringent conditionality that states must abide with to get financing.

A number of bureaucratic controls are in place to ensure that a state that asks for assistance qualifies for
such assistance.

The EFSF has considerable ammunition. It may intervene in the primary and secondary bond markets,
act on the basis of a precautionary program or finance the recapitalization of financial institutions
through loans to governments. The German Finance Agency has acted as the issuing agent of the EFSF
See art. 24, EFSF articles of incorporation, supra note 375.
Art. 16(1), EFSF Framework Agreement, supra note 378.
See art. 16(2), id.
See Bianco, supra note 379, at 8.
Preamble (4), EFSF Framework Agreement, supra note 378.
Preamble (2), id.
Art. 2(1)(a), id.
Elli Louka Page 65

The German Finance Agency is a company owned by the Federal Republic of Germany and
deals exclusively with the financing of the German government.
In 2012 the EFSF issued bonds to
raise money it subsequently lent to Greece. To lure investors, the bonds were guaranteed, severally in
pro rata proportions, by all eurozone countries except for the debtor country (Greece). This is in
contrast to what happened with the 2010 assistance to Greece, which consisted of bilateral loans
granted by eurozone states. Since these were loans, and not just guarantees, they added to the
liabilities of creditor states and could affect their credit ratings.
The fact that the EFSF is an SPV has created bad publicity. According to critics, the EFSF is a tool that
has enabled creditor states to shift their liabilities off their national accounts in a manner reminiscent of
the financial engineering held responsible for the financial crisis.
The CEO of the EFSF tried to address
the criticism making obvious his own concern about the flimsiness of EFSFs institutional
The credit rating companies have applied methodologies used for collateralized debt
obligations to rate the EFSF debt issuance.
To them, the EFSF looks like a collateralized debt
obligation since you take a bunch of dodgy, less than AAA sovereigns and try to put together a product
that gets an AAA rating.

After June 30, 2013, the EFSF could not undertake new loan commitments. However, it continues to
manage the repayment of any outstanding debt. It will close down once all outstanding debt is
Given that some of the Greek bonds mature in 2042, the EFSF will not be closed down
formally till that day.
The European Stability Mechanism (ESM) is the eurozone seven hundred billion fund of which five
hundred billion are available to be loaned to states and banks that face economic problems.
has succeeded the EFSF but it is not a limited liability corporation like the EFSF. Still it has been

European Financial Stability Facility FAQs available online
Website of German Finance Agency
See supra note 214.
Rodrigo Olivares-Caminal, The EU Architecture to Avert a Sovereign Debt Crisis, OECD Journal: Financial Market
Trends, at 17, 2011.
Id. n. 67.
European Financial Stability Facility FAQs, supra note 389, at 4.
Treaty Establishing the European Stability Mechanism, Feb. 2, 2012 available online [hereinafter ESM Treaty].
Elli Louka Page 66

established outside the EU framework as an international organization headquartered in Luxembourg.
The creation of the ESM required a modification of the TFEU that before the financial crisis did not
contain any provisions on the establishment of mechanisms to safeguard the stability of the euro area
as a whole.
The treaty that establishes the ESM makes it clear that the ESM will assume the tasks
currently fulfilled by the EFSF and the EFSM.
This means that an international organization has
assumed the tasks previously performed by a limited liability corporation and an EU mechanism. It is
odd, to say the least, that an international organization is to perform tasks that should have been
performed under an EU umbrella. The ESM links to EU institutions when a eurozone state asks for
The ESM treaty seems to have established some basis for this link between the ESM and
the EU but the link is weak.

Financial assistance through the ESM is available to eurozone states on the condition of their ratification
of the Fiscal Compact.
Loans, intervention in the primary or secondary bond market and
precautionary lines of credit are types of financial assistance provided by the ESM. An MOU enumerates
the conditions and surveillance procedures a state must submit to in order to get assistance.

The TFEU was amended on Mach 25, 2011, by a unanimous European Council Decision to allow for the adoption
of a financial stability mechanism in the eurozone. More specifically, article 136 of the TFEU was amended by
adding a paragraph: The Member States whose currency is the euro may establish a stability mechanism to be
activated if indispensible to safeguard the stability of the euro as a whole. The granting of any financial assistance
under the mechanism will be made subject to strict conditionality. See European Council Decision of 25 March
2011 amending Article 136 of the Treaty on the Functioning of the European Union with regard to a stability
mechanism for Member States whose currency is the euro, OJ L 91/1, 6.4.2011 [hereinafter Decision to Amend
Article 136]. The treaty amendment entered into force on May 1, 2013; see European Parliament, Article 136
TFEU, ESM, Fiscal Stability Treaty: Ratification Requirements and Present Situation in the Member States June 2013
(2013). The TFEU amendment and the ESM Treaty were challenged at the European Court of Justice. See Case C-
370/12, Thomas Pringle v. Government of Ireland, Nov. 27, 2012.
Preamble (1), ESM Treaty, supra note 396.
Art. 13 (1)-(4), ESM Treaty, id. A state that needs stability support must address that request to the chairperson
of the ESM board of governors. On receipt of that request the chairperson entrusts the European Commission and
the ECB with a number of tasks: (1) to assess the existence of a risk to the financial stability of the euro area as a
whole or of its member states; (2) to assess (together with the IMF) whether the public debt of the state that
requests assistance is sustainable; and (3) to assess the actual and potential financial needs of that state. Upon the
receipt of the assessment the board of governors may decide to grant stability support to the state in the form of a
financial assistance facility. The European Commission then negotiates an MOU that includes strict conditionality
provisions for granting financial assistance. The European Commission signs the MOU on behalf of the ESM.
Preamble (10), ESM Treaty, id.
See infra section 5.3.
Art. 13(3), ESM Treaty, supra note 396.
Elli Louka Page 67

ESM has a capital of seven hundred billion which is divided into seven million shares, each share having
a nominal value of a hundred thousand.
The shares are available for subscription to the state parties
of the ESM based on their share of paid-in-capital contribution to the ECB.
Based on the contribution
key of the ESM, Germany has the highest number of shares (1,900,248) followed by France (1,427,013)
and Italy (1,253,959).
Eighty billion are already in the coffers of the ESM and the rest six hundred and
twenty billion are callable capital.
If a state party fails to meet the required payment under a capital
call, the ESM board of governors has to ensure that the state concerned settles its debt with the ESM
within a reasonable period of time.

The ESM board of governors consists of the ministers of finance of eurozone states. Certain decisions of
the board require unanimity. These include the provision of assistance to a eurozone state; the type of
assistance; conditions and terms of such assistance; calling in authorized unpaid capital; changing the
authorized capital stock and adapting the maximum lending volume.
In a number of areas the board
of governors makes decisions by qualified majority.
Qualified majority is defined in the ESM treaty as
eighty percent of the vote cast with voting rights equal to the number of shares allocated to each
Since Germany holds about twenty-seven percent of ESM shares it can block decisions of the
rest of the states when a qualified majority is required.

The ESM contains a secrecy clause. Former and current members of the board of governors and the
board of directors cannot disclose information that is subject to professional secrecy even after their
duties have ceased.
The purpose of this clause is to avoid leaks to the financial markets that could be
detrimental to the stability of the euro. This secrecy clause was modified by the German constitutional

Art. 8(1), id.
See Annex I and II, id. Contributions to the ECB have been determined based on the population and the GDP of
each state.
Art. 8(2), id.
Art. 25(2), id.
Art. 5(6), id.
Art. 5(7), id.
Art. 4(5), id.
Art. 5(7), id.
Art. 34, id.
Elli Louka Page 68

court, which ruled that the secrecy clause could not be held against the right of German parliament to
be informed on ESM matters.

The ESM has been granted a number of immunities. The privileges and immunities of international
organizations are part of customary international law
and many courts grant international
organizations absolute immunity. Critics claim, though, that a right balance must be established
between shielding international organizations from frivolous litigation that prevents them from
performing their duties and the right of citizens or states to have access to courts when there is a
dispute between them and an international organization. Granting extensive immunities to an
international organization, such as the ESM, in which a single state has decisive influence, adds to
perceptions of unfairness.
Eurozone states have agreed that the ESM should be allowed to recapitalize banks directly.
But the
funds allocated to that end have been capped at sixty billion.
This is a small amount given the scale of
the banking sector in Europe and bank losses that may still remain unrecognized. In addition, for every
euro the ESM spends to recapitalize a bank, it would have to post two euros as collateral to preserve its
credit rating.
This reduces the ESMs total lending capacity, making it unlikely that it would be used
for the recapitalization of eurozone banks.
Some have argued that the establishment of the ESM, an international organization, and the EFSF, a
private company, were simply the instruments the eurozone used to violate EU law. The EFSF and the
ESM were developed outside the EU framework because an EU institution with the same mandate
would be in outright violation of article 125 of the TFEU the no-bailout clause. Based on this clause,
the EU and member states cannot be liable for or assume the commitments of other member states. If
indeed international law and private law have been used to violate EU law, legal engineering is as
radically disruptive as financial engineering.

See infra section 5.5.
The 1946 UN Convention on Privileges and Immunities provides some of the standard clauses used in
international treaties that establish international organizations.
Conclusions of the European Council, EUCO 156/12, para. 12, Oct. 19, 2012 available online
FAQ on the main features of the future ESM direct bank recapitalisation instrument, at 3 available online
Elli Louka Page 69

5.3. Economic Surveillance and Sanctions
The Maastricht Treaty was supposed to be the metamorphic moment of European integration
treaty that would transform a free-trade-plus association into a Union. Germany insisted on the
inclusion in the Maastricht Treaty of the no-bailout clause
and the excessive deficit procedure.
excessive deficit procedure is triggered when countries exceed the ceiling of three percent of deficit to
GDP or sixty percent of debt to GDP.
These treaty provisions have been beefed up by the Stability and
Growth Pact. The pact provides the apparatus for the surveillance and enforcement of debt and deficit
Germany conceded to the adoption of a common currency under the condition of strict
rules for deficits and public debt and an independent ECB
(like the German Central Bank) with the
mandate to focus on price stability.
The monetary union under the Maastricht Treaty was, in other
words, the extraterritorial application of German macroeconomic policy.
Some have considered it an
outstanding success of Germanys economic diplomacy.
Germany squandered that success, though,
by being one of the countries to violate the deficit ceiling, demanding impunity for that violation and
further machinating the weakening of the Stability Pact with amendments.
Some peripheral states
falsely believed that if Germany could play fast and loose with the pact, so could they.
With the 2005

See, e.g., J. H. H. Weiler, The Transformation of Europe, 100 Yale Law Journal 2403 (1991).
Art. 125, TFEU, supra note 5.
Art. 126, TFEU, id.
See art. 126(2)(b), TFEU id. See also Protocol 12, TFEU, id.
See Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary
positions and the surveillance of economic policies, OJ L 209/1, 2.8.1997 (the preventive arm of the Stability Pact);
Council Regulation (EC) 1467/97 on speeding up and clarifying the implementation of the Excessive Deficit
Procedure , OJ L 209/6, 2.8.1997 (the corrective arm of the Stability Pact) [hereinafter Stability Pact].
Art. 130, TFEU, supra note 5.
Art. 127, id.
See Proissl, supra note 76, at 14.
See Council Regulation No 1055/2005 of 27 June 2005 amending Regulation (EC) No 1466/97 on the
strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic
policies, OJ L 174/1, 7.7.2005; Council Regulation (EC) No. 1056/2005 of 27 June 2005 amending Regulation (EC)
1467/97 on speeding up and clarifying the implementation of the Excessive Deficit Procedure, OJ L 174/5, 7.7.2005
[hereinafter 2005 Stability Pact]. See also supra note 19.
See Jesper Jespersen, The Stability Pact: An Economic Straightjacket! 45, at 52, in The Price of the Euro (Jonas
Ljungberg, ed., 2004).
Elli Louka Page 70

amendments proposed by France and Germany
the Stability Pact was softened to such an extent that
it became no more than gentlemens agreement of non-intervention
in the economic affairs of
states. The sovereign debt crisis was one of the symptoms of this weakened system.
The excessive deficit procedure places the European Commission at the driving seat of monitoring the
debt and deficit ceilings, but with a weighty co-driver, the Council, which is comprised of representatives
of member states.
By its nature the Council cannot be the most stringent enforcer of deficit and debt
ceilings since its members (finance ministers) do not know when their turn would come to violate the
ceilings. If they ask for stringent enforcement of debt and deficit limits on other states, chances are that
those other states would ask for stringent enforcement of the same rules against them. There have
been ninety-seven violations of the three percent rule, including sixty-eight outright violations (twenty-
nine violations linked to a recession).
The sanctions imposed by the Stability Pact have been hard to
enforce since a country that violates the rules might be going through a recession. In that case, a fine
for breaching the three percent limit of deficit to GDP, as mandated by the Stability Pact, would only
make the situation worse.
The Stability Pact was not successful in securing fiscal discipline before the
euro crisis. This was because peer pressure among states was not working as planned. Governments
had too much flexibility on whether to impose sanctions and financial penalties were never imposed.

A number of countries have broken the deficit ceiling including Austria, Belgium, France, Germany, the
Netherlands, Poland and the UK.

The Stability Pact was amended in 2011 by the six-pack five regulations and one directive:
1) two regulations that strengthen the Stability Pact;

See 2005 Stability Pact, supra note 427.
See European Parliament, supra note 64.
Art. 126, TFEU, supra note 5.
Tirole, supra note 78.
ECB, A Fiscal Compact for a Stronger Economic and Monetary Union, at 81, ECB Monthly Bulletin, May 2012
available online
See General Government Data, Part II: Tables by Series, Spring 2012 available online
Regulation (EU) No 1175/2011 of the European Parliament and of the Council of 16 November 2011 amending
Council Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the
surveillance and coordination of economic policies, OJ L 306/12, 23.11.2011 [hereinafter Preventive]; Council
Regulation (EU) No 1177/2011 of 8 November 2011 amending Regulation (EC) No 1467/97 on speeding up and
clarifying the implementation of the excessive deficit procedure, OJ L 306/33, 23.11.2011 [hereinafter Corrective].
Elli Louka Page 71

2) a regulation on sanctions imposed on eurozone countries that violate the Stability Pact;

3) a regulation on the prevention and correction of macroeconomic imbalances that applies to all
EU member states;

4) a regulation on sanctions imposed on eurozone countries for having excessive macroeconomic
5) a directive on requirements for budgetary frameworks of EU member states.

Like its predecessors
the 2011 Stability Pact employs two arms: the preventive arm and the corrective
arm. The aim of the preventive arm is to ensure that governments do not overshoot the debt and
deficit limits.
The corrective arm strengthens the excessive deficit procedure.
In 2011, for the first
time a specific regulation is exclusively devoted to sanctions imposed on eurozone countries that violate
the preventive or corrective arm of the Stability Pact. These sanctions are triggered automatically on a
recommendation by the Commission unless the Council decides by a qualified majority to reject the
Commissions recommendation (what is called reverse qualified majority voting).

States are required to make significant progress towards medium-term budgetary objectives (MTO).

States are required to submit their medium-term budgetary plans annually for multilateral fiscal
surveillance under the European Semester.
The European Commission issues a warning if a state

Regulation (EU) No 1173/2011 of the European Parliament and of the Council of 16 November 2011 on the
effective enforcement of budgetary surveillance in the euro area, OJ L 306/1, 23.11.2011 [hereinafter Sanctions].
Regulation (EU) No 1176/2011 of the European Parliament and of the Council of 16 November 2011 on the
prevention and correction of macroeconomic imbalances, OJ L 306/25, 23.11.2011.
Regulation (EU) No 1174/2011 of the European Parliament and of the Council of 16 November 2011 on
enforcement measures to correct excessive macroeconomic imbalances in the euro area, OJ L 306/8, 23.11.2011.
Council Directive 2011/85/EU of 8 November 2011 on requirements for budgetary frameworks of the Member
States, OJ L 306/41, 23.11.2011.
See supra notes 422, 427.
Preventive, supra note 436.
Corrective, supra note 436.
Sanctions, supra note 437.
Art. 2a, Preventive, supra note 436 (for eurozone states the MTO shall be specified within a defined range
between -1% of GDP and balance or surplus, in cyclically adjusted terms, net of one off and temporary measures).
Not later than April 30, see art. 4, Preventive, id.
Elli Louka Page 72

experiences significant deviation from the MTO.
The Council recommends corrective action to the
non-compliant state within specific deadlines.
Sanctions up to 0.2 percent of GDP can be imposed on
non-compliant eurozone countries.
Moreover, the excessive deficit procedure can be triggered also
when a state has debt in excess of sixty percent of GDP.
Fines up to 0.2 percent of GDP can be
imposed on non-compliant eurozone countries.

It is unclear whether this supra-structure over a states fiscal policy will improve such policy or, at least,
increase transparency. According to the ECB, a states progress towards its MTO requires a complex
analysis and it may be difficult to verify all data in a timely fashion. Overall the increasing complexity
may reduce transparency, enforceability and accountability.
Furthermore, the Council still has
discretion to decide, through reverse qualified majority, whether a state should go through the torment
of the excessive deficit procedure.
New regulations on the prevention and correction of macroeconomic imbalances are for the first time
adopted. Such imbalances may include high level indebtedness in the household and private sector,
high unemployment, economic bubbles, trade deficits/surpluses and current account deficits/surpluses.
The European Commission has identified Belgium, Bulgaria, Denmark, Spain, France, Italy, Hungary,
Malta, the Netherlands, Slovenia, Finland, Sweden and the UK as having macroeconomic imbalances and
has asked them to correct such imbalances.
Slovenia and Spain have been isolated for having
excessive macroeconomic imbalances. This means that they might have to undergo the excessive
macroeconomic imbalances procedure (MIP). This means they could be punished for not correcting their
After a failure to comply with the recommended corrective action, possible sanctions
may include an interest-bearing deposit,
and, after a second compliance failure, that this interest-
bearing deposit becomes a fine (up to 0.1 percent of GDP).
Sanctions can also be imposed for failing

Art. 6(2)-(3), id.
Art. 6(2), id.
Art. 6, Sanctions, supra note 437.
Art. 2(b), Corrective, supra note 436.
Art. 6, Sanctions, supra note 437.
ECB, A Fiscal Compact for a Stronger Economic and Monetary Union, supra note 434, at 82.
Communication from the Commission to the European Parliament and the Council and to the Eurogroup,
Results from in-depth review under Regulation (EU) No 1176/2011 on the prevention and correction of
macroeconomic imbalances, at 3, COM(2013) 199 final.
See Regulation 1174/2011, supra note 439.
Art. 3(1), id.
Elli Louka Page 73

twice to submit a sufficient corrective action plan. The decision that leads up to sanctions is adopted by
the Council by reverse qualified majority voting.

The enforcement of the macroeconomic imbalances regulation has been lopsided. This is because the
Commission has been aggressive in pursuing countries with excessive current account deficits, but it has
refrained from taking action against countries with large current account surpluses. This lopsided
enforcement of the MIP may have to do with a bias of the Commission that views surplus countries as
champions of the EU export growth. The bias of the Commission is evident in the scoreboard that it has
developed to measure countries compliance with the legislation.
The scoreboard includes upper and
lower alert thresholds that indicate that the Commission may have to take action against a state starting
with an in-depth review followed by policy recommendations and eventually by the threat of sanctions.
According to the 2012 scoreboard,
a current account deficit larger than four percent of GDP or a
current account surplus above six percent of GDP signals to the Commission that it may have to take
action against a state. The bias of the scoreboard is here obvious given that a four percent current
account deficit alerts the Commission to take action, but a six percent surplus is required for the
Commission to act. What is worse is that the Commission has been reluctant to confront big EU powers.
The United States Treasury Department was the first to admonish Germany and other core states for
their persistent current account surpluses. The US Treasury stated that Germanys current account
surplus was above seven percent
and noted that, while eurozone periphery countries had sharply
reduced their current account deficits, surplus countries (i.e., Germany) had not reduced their current
account surpluses. The Treasury blamed on the biased enforcement of macroeconomic imbalances
regulation the non-compliance by Germany. The enforcement of macroeconomic imbalances procedure
remains somewhat asymmetric and does not give sufficient attention to countries with large and
sustained external surpluses like Germany.
This acerbic attack on Germany may have been a way to
test the balance of power between two geo-economic powers. It was only after getting the nod from

Art. 3(2), (5), id.
Art. 3(3), id.
See arts. 3, 4, Regulation 1176/2011, supra note 438.
Available online
U.S. Department of the Treasury, Report to Congress on International Economic and Exchange Rate Policies, at
10, Oct. 30, 2013 available online
Id. at 25.
Elli Louka Page 74

the US Treasury that the European Commission got the courage to reprove Germany.
In Germany,
though, calls to reduce its trade surplus were still viewed as jealous attacks against the countrys
extraordinary economic performance.

In the midst of the euro crisis, creditor states demanded the adoption of the Fiscal Compact as a trade
off for granting loans to Europe-periphery that was fighting to avoid immediate default. At the heart of
the German-designed Fiscal Compact is a concept known as the debt brake, which Germany has
enshrined in its own constitution. Due to the high German debt that followed reunification, German
finance ministers put great emphasis on cutting the government deficit that had reached, through the
1990s, one trillion. They sought to achieve this by including the debt brake in the German constitution.
The Fiscal Compact was adopted as an international treaty by member states of the EU
except for the
UK and the Czech Republic, which refused to adopt it. The central rule of the compact is that the
structural budgets of states shall be balanced or in surplus.
The European Commission is in charge
of assessing whether states meet the criterion of a balanced budget.
In case a state deviates from
the central rule a correction mechanism is triggered automatically. The correction mechanism is the
obligation of that state to implement measures to correct the deviation.
Exceptions are allowed only
temporarily and only in exceptional circumstances
unusual events outside the control of a state
that have an impact on its finances or periods of severe economic downturn.

The Fiscal Compact is unusual for an international treaty because it specifies exactly how states are to
incorporate it into their domestic order. State parties have the obligation to transpose the central rule
of the Fiscal Compact through provisions of binding force and permanent character, preferably

See Olli Rehns Blog, Turning Germanys Surplus into a Win-Win for the Eurozone, Nov. 11, 2013 available online
Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (called informally Fiscal
Compact), Mar. 2, 2002 available online
[hereinafter Fiscal Compact].
Art. 3(1)(a)(b), (d), id. It is specified further that the rule is considered respected if the structural deficit is 0.5
percent of GDP; or alternatively, the structural deficit is one percent of GDP but, at the same time, the debt-to-
GDP ratio is below sixty percent and long-term risks to fiscal sustainability are low.
Art. 3(1)(b), id.
Art. 3(1)(e), id.
Art. 3(1)(c), id.
Art. 3(3)(b), id.
Elli Louka Page 75

constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national
budgetary processes.
In other words, states would have to amend their constitution or adopt rules
that are hierarchically superior to ordinary legislation. These hierarchically superior rules would serve as
an anchor for the national budgetary process. To make sure that the Fiscal Compact is enshrined in the
national order through constitutional or semi-constitutional rules, the ECJ undertakes to review whether
a state has indeed adopted such rules.
Action against a state can be brought by the European
Commission or another state party. If a state does not comply with the decision of the ECJ a second
action can be brought against that state. In that case the Court can impose a lump sum or a penalty on
that state that should not exceed 0.1 percent of that states GDP.
Furthermore, eurozone states have
to ratify the Fiscal Compact in order to receive financial assistance from the ESM.

Many criticisms have been leveled against the Fiscal Compact for the sweeping power it grants to the
ECJ over EU states. The ECJ has intervened before in the domestic order of states by declaring
incompatible with EU law even provisions of national constitutions. It is the first time, though, that the
ECJ is granted the power to scrutinize the exercise of a states sovereign power to issue laws of
constitutional nature.
Some even fear that, after the ratification of the Fiscal Compact is over, the
ECJ may acquire powers to discipline states that fail to adopt balanced budgets.

The European Parliament and the national parliaments are mentioned in the Fiscal Compact but as an
The rigorous implementation of the Fiscal Compact depends on whether the Council
will be willing to use its remaining discretion to reverse the recommendations of the Commission.

Given that the political discretion of the Council is not done away with, the costs of the additional
regulatory complexity introduced by the compact may be too onerous.
The Fiscal Compact has been
perceived as the magic potion that, if taken compulsively and inserted into a constitution, will avert
economic misbehavior. The problem is that, like most economic concepts, the debt brake can be

Art. 3(2), id.
Art. 8, id.
Art. 8(2), id.
Preamble, id.
Federico Fabbrini, The Fiscal Compact, the Golden Rule, and the Paradox of European Federalism, 36 Boston
College International & Comparative Law Review 1, at 25 (2013).
Id. at 25-26.
Arts. 12 and 13, Fiscal Compact, supra note 464.
See arts. 4-5, id.
ECB, A Fiscal Compact for a Stronger Economic and Monetary Union, supra note 434, at 93-94.
Elli Louka Page 76

subject to manipulation by governments. In implementing its own debt brake, the German government
has engaged in such subtle manipulations.

More legislation the two-pack places national budgets and debt issuance plans under Union
Starting in 2013, and each and every year thereafter, by October 15, eurozone states
must submit to the European Commission and the Eurogroup their draft budgets for the following
The draft budgets must be consistent with the recommendations given by the Commission in
the context of the Stability Pact.
The European Commission must examine these draft budgets and
give an opinion on each of them by November 30.
If the Commission identifies particularly serious
non-compliance with the Stability Pact, it must request the non-compliant state to submit a revised
budgetary plan.
This request of the Commission is not binding on that state. But this non-binding
character should not blind one about the power granted to the Commission. If the Commission labels a
draft budget non-compliant with the Stability Pact and the non-compliant state does not submit a
revised budget, the Commissions label could come back to sting that state later. The Commission can
use the failure of a state to submit a revised budget draft as part of the evidence when deciding whether
that state should undergo the excruciating excessive deficit procedure.

The excessive deficit procedure is not for the faint-hearted. A eurozone state undergoing the excessive
deficit procedure must present to the Commission and the Council an economic partnership program
describing the policy measures and structural reforms needed for the effective and lasting correction of

Manipulation is possible because there are many ways to determine what constitutes a structural deficit. See
Achim Truger et al., The German Debt Brake a Shining Example for European Fiscal Policy?, Institute for
International Political Economy Berlin, Working Paper, No. 15 (2012) available online
Regulation (EU) No 473/2013 of the European Parliament and of the Council of 21 May 2013 on common
provisions for monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficit of
the Member States in the euro area, OJ L 140/11, 27.5.2013 [hereinafter Regulation 473]; Regulation (EU) No
472/2013 of the European Parliament and of the Council of 21 May 2013 on the strengthening of economic and
budgetary surveillance of Member States in the euro area experiencing or threatened with serious difficulties with
respect to their financial stability, OJ L 140/1, [hereinafter Regulation 472].
Art. 6, Regulation 473, id.
See art. 4, Preventive, supra note 436.
Art. 7(1), Regulation 473, supra note 480.
Art. 7(2), id.
See European Commission, Two-Pack Enters Into Force, Completing Budgetary Surveillance Cycle and Further
Improving Economic Governance for the Euro Area, Press Release, May 27, 2013 available online
Elli Louka Page 77

the excessive deficit.
A state that is under the excessive deficit procedure must report to the
Commission regularly on the measures it has taken to correct its excessive deficit.
If the Commission
does assess that a state is at risk of non-compliance with its obligations under the excessive deficit
procedure, it can address a recommendation directly to that state.
That recommendation may help
the state avoid being labeled non-compliant and incurring economic sanctions.
States that experience severe financial difficulties or are receiving assistance on a precautionary basis
are subject to an even more rigorous enhanced surveillance procedure that goes beyond the
surveillance required by the excessive deficit procedure.
States that emerge from financial assistance
programs are subject to post-program surveillance. These states remain ensnared in economic
surveillance until they pay back a minimum of seventy-five percent of the financial assistance they have
received from other member states, the EFSM, the ESM or the EFSF.

There is no question that the eurozones fiscal surveillance and sanctions constitute a severe intrusion
into states fiscal power. Even more mature Unions, such as the United States
and the Federal
Republic of Germany,
have more respect for the sovereignty of states than the European Union. In
2013 there were already skirmishes over the obligation of states to share their budgetary plans with the
Commission. The French president told the Commission that it could not dictate budgetary revisions
while an Italian politician called the Commissioner for monetary affairs, who urged the government not
to repeal a housing tax, a Mr. Nobody.

In 2013 the Council extended the deadlines for the correction of deficits of Spain, France, Poland and
Slovenia by two years and those of the Netherlands and Portugal by one year on account of a worse-

Art. 9, Regulation 473, supra note 480.
Art. 10, id.
Art. 11, id.
Arts. 3-4, Regulation 472, supra note 480.
Art. 14, id.
See, e.g., Fabbrini, supra note 474.
See, e.g., German finances: Federal Level Masks Importance of Lnder, at 6, 14, Deutsch Bank Research, May
27, 2011 available online
Its the Politics, Stupid, Economist, Oct. 5, 2013, at 59.
Elli Louka Page 78

than-expected deterioration in their economies.
In 2013 sixteen countries were undergoing the
excessive deficit procedure
and a number of countries had just exited the procedure.
most states have been unable to keep their debt under the sixty percent limit. In addition to the
obvious case of the PIIGS, the remaining countries are Belgium (99.6 percent), Germany (81.9 percent),
France (90.2 percent), Hungary (79.2 percent), Netherlands (71.2 percent), UK (90 percent) and Iceland
(99 percent).

5.4. European Central Bank
The European System of Central Banks (ESCB) consists of the central banks of the EU member states.
The eurosystem is the subgroup of the ESCB that includes the ECB and the National Central Banks (NCBs)
of states that have adopted the euro. The primary objective of the ESCB is to maintain price stability.

Furthermore, the ESCB shall support the general economic policies in the Union with a view to
contributing to the achievement of the objectives of the Union,
which include full employment and
solidarity among the member states and peoples of the European Union.
Unfortunately, the
prudential supervision of the financial system has weak underpinnings in the treaties.
The ECBs
anemic supervision was one of the reasons that the financial crisis wreaked such havoc on Europe-

Council of the European Union, Excessive Deficit Procedure: Council Extends Deadlines for Spain, France,
Netherlands, Poland, Portugal and Slovenia, Press Release, June 21, 2013 available online
Malta, Denmark, Cyprus, Austria, Belgium, the Czech Republic, Netherlands, Portugal, Slovenia, Slovakia,
Poland, France, Ireland, Greece, Spain and the UK. See
Italy, Romania, Latvia, Lithuania and Hungary corrected their deficits in June 2013; Germany and Bulgaria in
2012; Luxembourg in 2010 and Finland in 2011. See
Based on the 2012 data available by the Eurostat. See
Art. 127(1), TFEU, supra note 5.
See art. 3, Treaty on European Union, supra note 5.
See art. 127(5)-(6), TFEU, supra note 5. See also art. 25, Protocol No. 4 to the TFEU on the Statute of the
European System of Central Banks and of the European Central Bank [hereinafter ECB Statute], TFEU, id.
Elli Louka Page 79

The ECB must be completely independent in the performance of its duties.
Such independence
implies independence from the other EU institutions and national authorities.
The Governing Council
of the ECB manages the euro.
At the governing council each country has one vote. States, however,
cannot ignore the might of the country that has deep pockets in Europe. When the capital markets
digest the ECBs decisions they pay particular attention to a potential dissent of the German Central
Bank. The informal veto that the German Central Bank enjoys within the ECB has been used to try to
derail ECB decisions to which the German Central Bank has objected.
5.4.1. Carbon Copy of the German Central Bank?
The ECB has been called the twin sister of the German Central Bank since, as its statute mentions, its
primary goal is to control inflation. The ECB calculates inflation as the average inflation of member
states, of which Germany has the lowest inflation. Because the average is the weighted average (based
on the number of households in a state), Germanys low inflation counts more than other countries
higher inflation. Given these inflation calculations the ECB favored low interest rates, which encouraged
the periphery to take on excessive debt. A higher interest rate policy before the financial crisis would
have restrained the periphery from gorging on debt. The ECB has criticized ex post facto its interest rate
which was one of the causes of the euro crisis.
During the euro crisis, the ECB was criticized for focusing too much on price stability based on the
German model. This focus on price stability can be too constricting. The BIS has examined whether
excess savings surpluses in some countries (e.g., Germany) have led to capital outflows to deficit
countries, leading to credit booms in those countries. The BIS has concluded that the ECB, in its effort to
control inflation, focused on asset booms and overlooked credit booms. Central banks need to act even
when inflation is under control by looking at the whole economy, for instance excessive borrowing by
deficit countries. It is important for central banks to take into account financial imbalances and consider
that the economic interests of certain actors may not be aligned with the public good.

The ECB has been created to manage a currency modeled after the deutschmark, in essence a
deutschmark in disguise, now being the currency of other nations. Disagreements between the ECB and
the German Central Bank on the desirable monetary policy were, therefore, quite frequent during the
euro crisis. The president of the German Central Bank repeatedly tried to delegitimize ECB policies

Art. 282(3), TFEU, id.
See paras. 130-35, Case C-11/00, Commission v. European Central Bank, (2003) ECR I-7215.
Art. 10, ECB Statute, supra note 501.
See supra note 352.
Claudio Borio et al., Global Imbalances and the Financial Crisis: Link or No Link?, BIS Working Paper No. 346
(2011) available online
Elli Louka Page 80

aimed at restoring market confidence in the weakened periphery. A letter of the president of the
German Central Bank leaked to the press urged the ECB to reconsider its decision to buy government
bonds of the peripheral countries in the secondary market.
This was a breach of the code of conduct
of central bankers, a code based on circumspection and secrecy.
As a rule, disagreements among
central bankers are not aired to the electorate through leaks. Overall the intensity with which the
German Central Bank undermined the official ECB position led some to proclaim that it was not up to
the German Central Bank to decide the fate of the euro and Europe.

During the euro crisis, the ECB engaged in quasi-fiscal interventions and took credit exposure to weak
eurozone sovereigns and banks. But the periphery was not the only beneficiary of ECBs quasi-fiscal
operations. The creditor states banks, which were the original creditors of the PIIGS, benefitted also.
These were the creditors who, searching for higher yields, lent without restraint to the periphery.
Behind the creditors of the core countries stand the taxpayers of those countries. Without the fiscal
easing of the ECB, these taxpayers would have to bail out their banks, which lent, without moderation,
to the PIIGS and the PIIGS banks.
To his credit, Mario Draghi, the ECB president, announced in 2012 that the ECB would do whatever it
takes to save the euro.
Because of the audacity of that statement, it was speculated that there were
disagreements between the German government and the German Central Bank and that the German
government supported the ECB president. It was easier for German politicians to have the ECB with its
technocratic operations support periphery governments than to ask the German parliament for loans to
the periphery. Draghis statement triggered a surge of bond buying by hedge funds covering short
positions in Italian and Spanish debt. Institutional investors, such as pension funds, started to return to
the bond markets of the Southern countries.
In 2013 inflation was at record low levels and the EU was faced with the prospect of deflation followed
by yet another recession. The ECB was criticized, therefore, for not doing enough to revive the
European economy. The rate of inflation in the EU hovered around 0.7 percent in 2013, much below the
targeted inflation rate of two percent. Some argued, therefore, that the ECB must engage in a much
more aggressive program of buying sovereign debt and that the inflation goal should remain around

James Wilson, Bundesbank Squares Up to the ECBs Draghi, Financial Times, May 1, 2012
See, e.g., Marvin Goodfriend, Monetary Mystique: Secrecy and Central Banking, Working Paper 85-7, Federal
Reserve Bank of Richmond, 1984 available online
See, e.g., George Soros, Europes Future Is not Up to the Bundesbank, Financial Times, Apr. 11, 2012 available
See supra note 52.
Elli Louka Page 81

two percent even if that means higher inflation in Germany.
The ECB, though, especially because of
internal disagreements,
could not be the savior of the EU. A radical change of mindset was needed to
save the euro and that quixotic idea of the European Union.

5.4.2. Opaque Operator The Target2 System
The Target2 System (Trans-European Automated Real Time Cross Settlement System) is the payment
system of the eurozone. It settles claims among the central banks of the member states. When, for
example, a Greek importer places an order with a German company, payments to and from the
accounts of buyer and seller are channeled through the respective countries central banks. The German
exporter gets the money and the German Central Bank gets a credit with the ECB (that is a claim of the
German Central Bank on the ECB), while the importer gets the import and the Greek Central Bank gets a
debit with the ECB (a liability). Because of its nature as an automated system, when there is a balance
of payments crisis, like the euro crisis, the Target2 system performs a function similar to that of making
available foreign exchange reserves for the country that suffers the balance of payments crisis.

Critics claimed that the ECB looked the other way, allowing the PIIGS to amass spectacular liabilities and
creditor countries, like Germany, to amass far too many claims on the Target2 system.
In 2011, the
German Target2 claims on the eurosystem amounted to four hundred and sixty-three billion. On the
other hand, the PIIGS accumulated a liability of six hundred and fifty billion.
The ECB tolerated this
incredible build-up of credit through which, in effect, the central banks of the core countries were
lending to the periphery central banks. This form of credit financing helped the periphery countries in
the same way the loan facilities did later but it took place earlier, even before the availability of loan
facilities and without the knowledge of national parliaments. This was a clandestine fiscal activity of the
ECB. The major issue here was the potential default and exit from the euro of the periphery: What
would happen to the claims of Germany and other core countries if the periphery countries defaulted?

The Perils of Falling Inflation, Economist, Nov. 9, 2013, at 11.
See, e.g., Jana Randow, Draghi Said to Have Pushed for Rate Cut in Tussle on Rate Timing, Bloomberg, Nov. 7,
2013 available online
timing-tussle.html (When the ECB decided to cut interest rates from 0.5 percent to 0.25 percent in November
2013, the press speculated that the German Central Bank had voted against the rate cut).
Stephen G. Cecchetti et al., Interpreting Target2 Imbalances, BIS Working Paper No. 393, at 5 (2012) available
Hans-Werner Sinn et al., Target Loans, Current Account Balances and Capital Flows: The ECB's Rescue Facility,
19 International Tax and Public Finance 468, 487 (2012).
Id. at 469.
Elli Louka Page 82

This was a gray area and it was unclear how Germany and other core countries could recover their
money. This ECB secret bailout of periphery states, through the Target2 system, in contravention of the
no-bailout clause of the Maastricht Treaty,
was condemned as illegitimate.

The ECB realized that financing the periphery through the Target2 system was not sustainable in the
long term. It urged, therefore, creditor states to create loan facilities that would support the
The ECB put pressure on Greece, Ireland and Portugal to seek bilateral loans from the
EFSM rather than use the Target2 system. The concern about the accumulation of claims on the
eurosystem was not without merit. While, in theory, these claims are liabilities of the eurosystem as a
whole, Germany ran a risk for extending credit through the Target2 system. If a central bank defaults,
the eurosystem is recapitalized by the rest of the central banks based on their share of paid-in-capital
contribution to the ECB. Germanys capital share is twenty-seven percent.
Multiple defaults across
the PIIGS and their exit from the euro would have increased the capital that Germany would have had to
contribute to recapitalize the eurosystem. It was argued that the continuation of Target2 financing
would inflate the foreign liabilities of peripheral countries and, in the end, the ECB and with it
ultimately Germany would become the real owner of the countries in the periphery of Europe.

By 2012, however, the Target2 imbalances had nothing to do with Greeks buying German goods and
financing their purchases through the banking system. They had to do, instead, with Greeks getting
their money out of Greece or with foreign investors whisking capital out of the periphery and bringing it
to Europe-core because of fears of euro breakup. The imbalances had to do with a run on the periphery
the speculation that Greece, and then other peripheral countries, would leave the euro. Germanys
2012 Target2 claims on the eurosystem resulted from international institutions re-arranging their
balance sheets to hedge against the risk of redenomination the possibility of the re-emergence of
national currencies in the eurozone.
Because of this the ECB acted within the bounds of its mandate
by anticipating the attack on the euro and intervening in the markets beforehand. By financing the euro

Art. 125, TFEU, supra note 5.
Sinn, supra note 514, at 488.
The ECB Must Change Its Policy, Ifo Viewpoint, July 8, 2011 available online http://www.cesifo-
See supra note 404.
Ifo Viewpoint, supra note 518.
Cecchetti, supra note 513, at 6, 12.
Elli Louka Page 83

periphery, which was draining capital due to fears of euro meltdown, the ECB essentially stemmed a
currency attack.

The Target2 system may be complex to understand, especially for someone without specialized
economic knowledge, but it is a system that operates in the open and it is widely known.
behaves occasionally as a compulsively secretive institution,
but the Target2 system is not one of its
5.4.3. Buyer of Sovereign Bonds
In May 2010 the ECB started the Securities Markets Program (SMP) through which it bought the
sovereign bonds of distressed debtor countries. The program was necessary because the exceptional
circumstances in the financial markets were hampering the effective conduct of monetary policy.

There were strong disagreements between the ECB and the German Central Bank on the adoption of the
SMP that led to the resignation of the president of the German Central Bank from the ECB governing
board. Eventually, the SMP was terminated in September 2012. As of February 21, 2013, the ECB held
two hundred and eighteen billion worth of bonds of distressed eurozone countries that it bought
because of the SMP.
By comparison, the Federal Reserve of the United States bought a much larger
amount of US bonds a total 1.7 trillion dollars between 2008 and early 2010. In November 2010 the
Federal Reserve started a second round of buying an additional six hundred billion dollars of long-
term US Treasury securities.

In August 2012, as the euro crisis deepened, the ECB announced the possibility of Outright Monetary
Transactions (OMTs) by making a declaration that it would do whatever it takes to save the euro. The

Id. at 14.
See, e.g., Joined Cases T-3/00 and T-337/04, Pitsiorlas v. the Council of the European Union and ECB (2007), ECR
II-4874. See also supra note 229.
Decision of the European Central Bank of 14 May 2010 establishing a securities market program (ECB/2010/5),
OJ L 124/8, 20.5.2010.
The amount breaks down as follows: 14.2 billion-Ireland, 33.9 billion-Greece, 44.3 billion-Spain, 102.8 billion-
Italy and 22.8 billion-Portugal. See ECB, Details on the Securities Holdings Acquired Under the Securities Market
Program, Press Release, Feb. 21, 2013 available online
Presentation by Steve Meyer, Senior Adviser, Federal Reserve Board of Governors, Recent Federal Reserve
Monetary Policy, January 14, 2011 available online
Elli Louka Page 84

goal of the program was to provide a fully effective backstop to avoid destructive scenarios.
scenarios were in effect speculations that the euro would break up. In contrast with the SMP, OMTs are
offered if a country agrees to adopt an EFSF/ESM program along with the strict conditionality attached
to such programs. At the time of writing, OMTs had yet to be used, leading to speculations that the
German Central Bank was exercising its informal veto in the ECB governing council.
The OMTs scheme is in essence an ECB financing of the distressed sovereigns of the periphery, a quasi-
fiscal operation. Those who purchase sovereign debt (in the primary or secondary market) finance the
sovereign for the full value of the debt they hold. The OMTs are in accordance with the letter of the
Maastricht Treaty, which (1) bans credit from the ECB to NCBs and sovereigns; (2) bans the purchase of
sovereign debt in the primary market;
but paradoxically (3) has nothing to say and, therefore, one
could argue, permits secondary market purchases of sovereign debt at any amount
in dire
circumstances of economic crisis with risks of contagion. The ECBs purchase of sovereign bonds has
been limited, and it has been used as a tool for disciplining states. In August 2011 the ECB stopped
buying Italian sovereign bonds, getting the bond markets to put pressure on the Italian government,
which at the time had gone back on its pledge to implement structural changes in the economy. When
the yields on Italian ten-year bonds rose to more than seven percent and the Italian prime minister had
to resign, the ECBs newfound mission as monetary disciplinarian was accomplished.

5.4.4. Liquidity and Emergency Backer
The ECB treated all eurozone nations the same by accepting their bonds as collateral, creating this way a
very liquid sovereign bond market.
European banks have to post collateral with the ECB in order to
obtain liquidity short-term loans. These are the Main Refinancing Operations (MROs) of the ECB.

The sovereign bonds of eurozone states have been readily accepted as collateral by the ECB. Any bank
who owned government bonds of any eurozone state could always turn to the ECB for funding. Small

ECB, Mario Draghi, Introductory Statement to the Press Conference, Press Release, Oct. 4, 2012 available online
Art. 123, TFEU, supra note 5.
See Willem H. Buiter et al., How the Eurosystems Treatment of Collateral in Its Open Market Operations
Weakens Fiscal Discipline in the Eurozone (and what to do about it), at 5, Center for Economic Policy Research,
CERP Discussion Paper 5387 (2005) (arguing, however, that purchases of sovereign debt in the secondary markets
would violate the spirit of the treaties).
Megan Greene, Did the ECB Just Warn Italian Voters against Berlusconi?, Bloomberg, Feb. 22, 2013 available
See, e.g., Buiter, supra note 530.
Elli Louka Page 85

European nations that, before the euro, had difficulty issuing debt could now tap into the markets and
get inexpensive credit. Major banks built up substantial portfolios of short-term sovereign debt and
sovereigns issued more debt encouraged by the system. It became clear that sovereign defaults would
be catastrophic for the banking system and, therefore, unlikely to occur.
The 2008 financial crisis led to the collapse of the credit market. The inter-bank loan market froze as
banks refused to do transactions with each other. The ECB decided to intervene in the markets by
providing liquidity to the banking sector. As mentioned above, through the MROs, the ECB regularly
provides short-term liquidity to banks. Before the financial crisis, the ECB also offered Long-Term
Refinancing Operations (LTROs), but the longest LTRO maturity was three months. Because of the crisis,
the ECB introduced six-month, twelve-month and thirty-six-month LTROs.
These LTROs were in high
demand. Periphery banks in Ireland, Italy, Spain and Greece absorbed the majority of the first thirty-six-
month LTRO issued in 2011. Overall, thirty-six-month LTROs totaling 1.1 trillion were heavily
subscribed by European banks.

Since the ECB is not allowed to provide direct support to eurozone governments
a large portion of the
financing provided to eurozone banks by the ECB, through the LTROs, was used by these banks to buy
periphery sovereign debt. This became known as the 'Sarko trade' after Nicolas Sarkozy, the French
president, suggested that the LTROs meant that the Italian and Spanish governments should depend on
their countries' banks to buy their bonds. The Spanish banks used the first LTRO to boost their holdings
of sovereign bonds to two hundred and thirty billion.
By buying the bonds of their sovereign, national
banks, which were already weakened by the financial crisis, were trying to boost weak sovereigns. To
break this vicious circle between weak banks and weak sovereigns, many recommended that the ECB
should intervene in the markets and buy government bonds.
The Emergency Liquidity Assistance (ELA) consists of loans granted by NCBs to troubled commercial
banks against adequate collateral.
The ELA support is provided, in exceptional circumstances and on a

See Matthieu Darracq-Paries et al., A Non-Standard Monetary Policy Shock: The ECBs 3-year LTROs and the
Shift in Credit Supply, ECB Working Paper No 1508 (2013) available online
Stability and Integration Report, supra note 209, at 17.
See no-bailout clause, supra note 516.
Karen Maley, Can the ECB Avert Catastrophe? Business Spectator, Mar. 1, 2012
Approval of the governing board of the ECB is needed when the amount of ELA provided exceeds certain
thresholds, see ECB, ELA Procedures, Oct. 17, 2013 available online
Elli Louka Page 86

case-by-case basis, to temporarily illiquid but solvent banks after approval by the ECB.
The ELA loans
are reflected on the balance sheet of the NCB that provides the ELA and, therefore, on the financial
statements of the eurosystem, but not on the ECB's balance sheet. Eventually, since states are the only
responsible fiscal backstop, they have to make up for any potential losses incurred by their central bank
due to the ELA. The exact details of the ELA have not been published but it is estimated that a penalty
interest rate is charged probably a hundred to a hundred and fifty basis points higher than the ECB's
overnight lending rate.
During the euro crisis, the ECB waived the credit rating requirement for Greek, Portuguese and Irish
bonds it accepted as collateral. The ECB decreed, however, that the Greek debt would be temporarily
ineligible as collateral for ECB credit. This decision came after the S&P rating company cut Greeces
credit rating to selective default.
In the meantime Greek banks used the financing under the ELA at
higher interest rates than the LTRO. Greek bonds became again eligible as collateral in December 2012
after the positive assessment by the troika that Greece was on track in the areas of fiscal consolidation,
structural reforms, privatization and financial sector stabilization.
This is how the ECB uses its
monetary might to discipline periphery governments. Similarly, the government bonds of Cyprus were
not accepted as collateral in the ECB's regular refinancing operations after June 2012
and the ECB
even threatened in March 2013 to cut the ELA to Cyprus unless the country concluded an agreement
with the troika on the restructuring of its banking sector.

The ECB followed a cautious path during the euro crisis, confining itself to limited emergency measures.
The most audacious policy was the statement that it would do whatever it takes to save the euro, which
markets hesitated to challenge as an empty threat. The ECB was unable to influence the behavior of
banks in the periphery where credit was scarce and, therefore, its transmission of monetary policy to
peripheral countries was non-existent. Maybe the ECB signals were not transmitted to the periphery
because peripheral banks knew that the ECB was glued to policies that were unlikely to improve growth

ECB, Eligibility of Greek Bonds Used as Collateral in Eurosystem Monetary Policy Operations, Press Release, Feb.
28, 2012 available online Based on its post-2008
policy, the ECB kept the minimum credit threshold for the collateral it accepted at investment grade level (BBB-).
See ECB, Speech by Jean-Claude Trichet, President of the ECB before the European Parliament, Press Release, Mar.
25, 2010 available online

ECB, ECB Announces Change in Eligibility of Debt Instruments Issued or Guaranteed by the Greek Government,
Press Release, Dec. 19, 2012 available online
Cyprus Government Bonds are no Longer Eligible as Collateral for Refinancing Operations with the European
Central Bank after the Countrys Credit Ratings Fell Below the Minimum Standard, Reuters, June 26, 2012 available
See supra note 165.
Elli Louka Page 87

drastically. They knew that in time of trouble ECB help would be limited and conditioned. It was better,
therefore, to exercise precautionary judgment by keeping leftover cash in the stash rather than to lend
to new business.
5.5. National Courts
The mechanisms that were used to address the euro crisis were challenged before the German
constitutional court by German citizens who believed that their country should not participate in
financing the emergency assistance to the periphery.
The German constitutional court decreed that
the German parliament should be the decision-making body when the country commits money to the
European mechanisms that provide emergency loans to peripheral countries. On September 12, 2012,
Germanys constitutional court upheld the constitutionality of the German legislation that ratified the
ESM treaty and the Fiscal Compact.
As mentioned before, the ESM is the permanent mechanism
established to lend money to states in financial trouble provided that they comply with strict
conditionality. Germany provides a substantial portion of the funds that make the ESM. About 37,000
Germans petitioned the German constitutional court to look into the constitutionality of the legislation
that incorporated the ESM into German law.
Those who opposed the legislation stated that it was
against the democratic principle enshrined in the German constitution. This was so because it took
away from the German parliament the responsibility of controlling the national budget, as the ESM
entails liabilities not included in the regular budget process.
Supporters of the ESM argued that the
ESM is drafted in a way that the approval of the parliament is needed for any disbursement of money.
In addition, most decisions require unanimity so that any country can block decisions. For decisions
that require a majority, that majority is eighty percent based on capital contributions. Since Germanys
vote counts for twenty-seven percent, the German parliament has effective veto on all decisions of the

The court approved the ESM legislation, but it stipulated that the German government, through the
ratification procedure, must make clear that the German contributions to the ESM would be limited to
one hundred and ninety billion. Any increase in the German contributions to the ESM would need the

See,e.g., Helen Pidd, German Court Clears Greek Bailout, Guardian, Sept. 7, 2011 available online
Official English translation of the court decision available online [hereinafter German ESM].
German Court Backs Eurozone's ESM Bailout Fund, BBC News, Sept. 12, 2012 available online
See para. 151-56, German ESM, supra note 545.
See para. 170, id.
Elli Louka Page 88

approval of the German parliament.
The court also argued that the professional secrecy clause
included in the ESM should not stand in the way of giving comprehensive information to the German

The German constitutional court is wrought up about the EU infringement on German sovereignty. In
its 1993 judgment on the Maastricht Treaty,
it emphasized the importance of monetary stability for
the Union and suggested that, in case stability is not pursued, leaving the Union is a legitimate
In its ruling on the Lisbon Treaty,
the court clarified that the German constitution, as it
stands, does not allow Germany to participate in a European federal state.
The court added that the
parliament, which represents the German people, must be active in deciding matters pertaining to the
Transfers of national competences to the EU must be decided by the parliament in the form of
German law.
The Lisbon ruling mentions the word sovereignty thirty-three times even if the word is
not mentioned in the German constitution.
The ruling resonated with both the right and the left in
Germany, demonstrating that the court was in tune with the public opinion.
Other countries, though,

See para. 253, id.
See para. 260, id.
See supra note 5.
Manfred H. Wiegandt, Germany's International Integration: The Rulings of the German Federal Constitutional
Court on the Maastricht Treaty and the Out-of-Area Deployment of German Troops, 10 American University
International Law Review 889, at 901(1995).
See supra note 5.
See Frank Schorkopf, The European Union as an Association of Sovereign States: Karlsruhes Ruling on the
Treaty of Lisbon, 10 German Law Journal 1219 (2009).
See Philipp Kiiver, The Lisbon Judgment of the German Constitutional Court: A Court-Ordered Strengthening of
the National Legislature in the EU, 16 European Law Journal 578 (2010).
Id. at 582.
Proissl, supra note 76, at 23.
Elli Louka Page 89

lamented the constitutional nationalism of the German judicial sovereign,
the sacralization' of
national democracy and the abnegation of the possibilities of EU democracy.

The German constitutional court is not the only national court that has ruled on the euro crisis.
Portugals constitutional court has repeatedly ruled that the austerity measures adopted by the
Portuguese government, as dictated by the EU/IMFimposed conditionality, are unconstitutional.
decisions of Portugals court are another indication that political support for the European Union has
been dangerously eroding not only in Germany but also in other EU states. The European public of both
the core and the periphery, which has not been much consulted on the European project, feels trapped
in a forced Union.
5.6. The IMF
The IMF is a powerful institution because creditors refuse to offer debt restructuring without the IMFs
control of the fiscal policy of sovereign debtors. The IMF is usually brought in a debt crisis as an external
enforcer ready to impose severe conditions in exchange for debt restructuring. Certain core states
insisted on the IMF involvement in the euro crisis because they did not trust that the European
Commission could effectively monitor the loan conditionality by itself. The last thing that creditor
countries expected was for the IMF to criticize them openly for not doing enough to address the euro
To its credit the IMF understood that cutting the Greek public debt to a hundred and twenty percent of
GDP by 2020 required some debt forgiveness by the official sector (e.g., the EU governments, the ECB).
The IMF argued that it was not enough for the bondholders to take losses on the Greek debt. The official
sector would have to forgive some of the Greek debt. For instance, the ECB could incur losses on the
Greek sovereign bonds it bought (the ECB at the time was holding about thirty-five billion in Greek
or the eurozone governments could cut the interest rate on the loans they had granted to
Greece and extend repayment through a longer period.
In November 2012 the clash between the IMF and the eurozone became public. This happened when
the eurozone finance ministers suggested that Greece should be given till 2022 to lower its debt to GDP

See, e.g., Daniel Thym, In the Name of Sovereign Statehood: A Critical Introduction to the Lisbon Judgment of
the German Constitutional Court, 46 Common Market Law Review 1795 (2009).
Damien Chalmers, A Few Thoughts on the Lisbon Judgment, in The German Constitutional Courts Lisbon Ruling:
Legal and Political Science Perspectives 5, at 7, Center of European Law and Politics (ZERP), University of Bremen
(Andres Fischer-Lescano et al., eds., 2010).
See Andreas Dimopoulos, Constitutional Review of Austerity Measures in the Eurozone Crisis, Sept. 2013
available online
See supra note 526.
Elli Louka Page 90

ratio, while the IMF insisted that the 2020 target should remain. There was a sharp exchange between
the head of the IMF, Christine Lagarde, and the president of the Eurogroup, Jean-Claude Junker. The
IMF was obviously frustrated that its efforts to convince the eurozone to grant some debt relief had
gone nowhere. The German finance minister had already stated that a discount on the official loans
given to Greece was not legally possible.
Eventually a deal was reached to cut Greeces debt to a
hundred and twenty-four percent of GDP by 2020 and below a hundred and ten percent of GDP two
years later. Greeces interest rate was cut, maturities were doubled to thirty years and interest
payments were deferred by ten years. There was a promise to do more, if necessary, once Greece
reached a primary surplus by 2016.
The deal was in essence a write-off of some of the Greek debt.
Europe-core recognized that some losses were necessary to keep Greece in the eurozone.
The involvement of the IMF, an external institution, in the euro crisis created doubts about the
effectiveness of EU institutions. But the IMFs reputation, as an independent economic institution, was
bruised also. The opinions of the IMF mattered less than those of the rest of the troika did. In a paper
published in 2013, the IMF argued that steady fiscal consolidations rather than quick ones, which the
eurozone governments favor, work better.
The IMF has been increasingly outspoken about the
damage caused by excessive austerity and the lack of transparency. Governments planning for the
bailout of banks did not have access to the same information. Even the ECB, which had to assist in the
rescue of banks, did not have access to confidential assessments done by supervisors of their financial
Secrecy was used as a tool of bureaucratic control
as institutions vied for power in the EU
arena institutions of a member state versus the institutions of another member state or national
bodies versus the EU. The role of the IMF was particularly complicated because it had to collaborate
with the EU meaning a number of eurozone bureaucrats and national politicians that made
statements and expressed opinions often contradictory to each other. The failure of the EU to speak

See Denying Reality: Germany's Ongoing Refusal to Forgive Greek Debt, Spiegel, Nov. 26, 2012 available online
IMF Country Report on Greece, No. 13/20, at 87, Jan. 2013 available online
Derek Anderson, Fiscal Consolidation in the Euro Area: How Much Can Structural Reforms Ease the Pain?, IMF
Working Paper (2013) available online
Smaghi, supra note 303.
On the use of secrecy as a bureaucratic tool, see Agnes S. Ku, Boundary Politics in the Public Sphere: Openness,
Secrecy and Leak, 16 Sociological Theory 172, 176 (1998).
Elli Louka Page 91

with one voice made the IMFs task harder and contributed to the nervousness of the financial markets
and the public.

6. Banking Union and Fiscal Union
In October 2012 the European Council announced: It is imperative to break the vicious circle between
banks and sovereigns.
When an effective single supervisory mechanism is established the ESM could
have the possibility to recapitalize banks directly.

By 2011 the EU banking sector was in shambles. The banks were facing scrutiny from investors,
companies and savers. The banks were reluctant to grant credit and peripheral countries were suffering
from a credit crunch. Everybody was apprehensive of the nightmare scenario: when deposits that were
leaking out of the banks of the peripheral countries would become a full bank run. Corporations, which
were able to move deposits more easily than individuals, were shifting their money to the core
countries, the United States or other offshores.
The fragmentation of banking continued in 2013. Between 2007 and 2013, commercial banks sold off
more than seven hundred and twenty-two billion dollars in assets and operations with foreign
operations, counting for about half of that number.
Europes financial integration was in retreat.
Eurozone banks reduced transnational lending by 3.7 trillion dollars between 2007 and 2013.
Most of
this reduction was due to cuts on intra-European lending. Cheap credit was regional. The interest rate
for business loans in Southern Europe was four percentage points higher than that in Northern Europe.
The ECBs bond buying program was very limited in comparison with the program put in place by the
United States Federal Reserve.
In addition, monetary policies work in tandem with fiscal policies. In
Europe the credit crisis was accompanied by rigid fiscal policies demanded by creditor states for lending
money to debtor states.

See Franz Seitz et al., The Role of the IMF in the European Debt Crisis, Discussion Paper Number 32, University
of Applied Sciences Amberg-Weiden (2012) available online
Conclusions of the European Council, Oct. 18/19, 2012 available online
Susan Lund et al., Financial Globalization: Retreat or Reset? Report of McKinsey Global Institute, at 5 (2013)
available online
See supra notes 526, 527.
Elli Louka Page 92

The euro crisis has proven that national responses to the collapse of the financial sector are inadequate.
This is because of the colossal nature of EU banking. By the end of 2011 EU banks held assets worth
fifteen trillion.
In the absence of a banking union, each national government has to supervise its own
banks and to provide its own fiscal backstop even if a large bank with cross-border operations fails. The
national supervision of banks is woefully inadequate for countries that have the ambition to be called a
Union. 'In some countries, like Germany and Austria, where the supervisory authorities are not part of
the central bank, the supervisors consider that they cannot deliver information on their own institutions
to the European authorities for reasons of confidentiality.
This reluctance is due to the fact that
states compete in the single market. In order to banish the disincentives that prevent the exchange of
information, it was eventually decided in 2013 to create a Single Supervisory Mechanism (SSM). The
SSM was established within the ECB but as a separate function from the monetary tasks of the ECB.

Given that the eurozones six-thousand-plus banks include many smaller lenders, and Germanys strong
resistance against having its small banks being under a European supervisor, certain thresholds have
been established for a credit institution to be under the direct supervision of the ECB. A credit
institution is under the day-to-day direct supervision of the ECB if:
1. the total value of its assets exceeds thirty billion; or
2. the ratio of its total assets over the GDP of the home state exceeds twenty percent (unless the
value of its assets is below five billion); or
3. the national competent authority notifies that it considers an institution of significant relevance
for the domestic economy and the ECB makes a decision confirming such significance.

Based on these criteria, about a hundred and thirty banks fall under the direct supervision of the ECB.
These banks come from all eurozone countries and cover about eighty-five percent of the assets of the

Stability and Integration Report, supra note 209, at 19.
See Smaghi, supra note 303.
See Council of the European Union, Council Approves Single Supervisory Mechanism for Banking, Press Release
14044/13, Oct. 15, 2013. See also arts. 19 & 25, Council Regulation Conferring Specific Tasks on the European
Central Bank concerning policies relating to the prudential supervision of credit institutions, ECOFIN 316, July 1,
2013 [hereinafter SSM Regulation]; Regulation(EU) No 1022/2013 of the European Parliament and of the Council
of 22 October 2013 amending Regulation (EU) No 1093/2010 establishing a European Supervisory Authority
(European Banking Authority) as regards the conferral of specific tasks on the European Central Bank pursuant to
Council Regulation (EU) No 1024/2013, OJ L 287/5, 29.10.2013.
Art. 6(4), SSM Regulation, id.
Elli Louka Page 93

countries participating in the SSM.
The rest, medium to small lenders, fall under the direct supervision
of the national authorities with ultimate responsibility residing with the ECB. The national supervisors
must report regularly to the ECB on their activities. The ECB must establish a detailed framework that
would specify the practical arrangements for national supervision.
The ECB can include, at any time,
an institution under its direct supervision, especially if such an institution has banking subsidiaries in
more than one eurozone state and its cross-border assets/liabilities represent a significant part of its
total assets/liabilities.
In order to be an effective supervisor, the ECB can conduct the necessary
investigations and on-site inspections and obtain all information necessary from the credit institutions
or third persons.
The ECB can additionally impose sanctions.
The SSM starts operations in 2014.
It is an essential feature of the banking union because it helps delink the credit of a state from the credit
of its financial institutions. Impartial and centralized supervision would make it possible for the ESM to
directly recapitalize banks and other credit institutions.

Despite these clear advantages, establishing the SSM has not been easy. In October 2013, the ECB was
embroiled in disputes with national banking supervisors over the extent of its powers. At issue was the
asset-quality review that the ECB had to conduct before undertaking full supervisory authority in 2014.
The resistance was not coming from the peripheral countries, but from France and Germany. Germany
and France were fearful that some of their banks were not as well-capitalized as advertised and that
they might come out of the asset-quality review looking much less stellar. It was widely believed that
many national supervisors had given too much latitude to banks in deciding which of their loans were
non-performing. It will be ironic if the SSM, which has been created to increase confidence in the EU
banking system, eventually exposes shortcomings in countries that consider themselves beyond
On October 23, 2013, the ECB revealed some details on how it would perform the asset-quality
This revelation gave away some of the arguments that must have taken place and the
compromises that the ECB had to make. The ECB was not to examine, at this stage, the internal risk

ECB, SSM Press Briefing: Transcript of the questions asked and the answers given by Ignazio Angeloni , Director
General Financial Stability, on the Comprehensive Assessment in advance of the Single Supervisory Mechanism,
Oct. 23, 2013 available online [hereinafter Transcript].
Art. 6(6)-(7), SSM Regulation, supra note 576.
Art. 6(4), id.
Arts. 9-12, id.
Art. 18, id.
Financial Integration, supra note 345, at 44.
See Transcript, supra note 578.
Elli Louka Page 94

models of banks or produce guidelines for the approximation of such models.
An in-depth
examination of the soundness of the variety of risk models used by banks could potentially reveal large
capital shortfalls and undermine confidence in the viability of the European banking system. If, as it was
expected, capital shortfalls were to be revealed by the ECB review, it was estimated that banks might
have to raise up to two hundred billion of additional capital.
Jacking up that much capital could
dampen credit at a time when the periphery countries were starving for credit. In 2013 the burning
issue was the exposure of eurozone banks to non-performing loans (NPLs).
It was estimated that the
asset-quality review might reduce the number of NPLs in Italy and increase that number in Portugal and
A more irksome question was what to do after the capital shortfalls of banks had been
documented: Who would be responsible to make up for the capital shortfalls? The European
Commission preferred for the private sector to shoulder the losses, but the ECB was fearful that private
sector losses would rattle the markets. The ECB wanted the ESM to step in and recapitalize ailing
antagonizing the German conviction that national sovereigns should be responsible for their
own banks.
In June 2012 the European Commission submitted a proposal for a directive on recovery and resolution
of credit institutions and investment firms. The directive encourages cooperation among national
authorities for the resolution of institutions that have cross-border holdings and envisages a number of
tools such as sale of business, bridge institution and bail-in of creditors for the orderly resolution of
financial institutions.
The directive relies on a network of national authorities and national resolution
funds to resolve banks.
In July 2013 the Commission proposed to centralize the resolution of banks in a Single Resolution
Mechanism (SRM).
The SRM would ensure that failing banks are resolved quickly and would eliminate

Id. at 12.
Ernst & Young, Eurozone Forecast: Outlook for Financial Services, at 5, Winter 2013/14.
Ernst & Young, Flocking to Europe: Ernst & Young 2013 Non-Performing Loan Report (2012).
Fixing Europes Banks: Cleaning the Augean Stables, Economist, Oct. 26, 2013, at 80.
Transcript, supra note 578, at 15-16.
Directive of the European Parliament and of the Council establishing a framework for the recovery and
resolution of credit institutions and investment firms and amending Council Directives 77/91/EEC and 82/891/EC,
Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC and 2011/35/EC and Regulation (EU)
No 1093/2010, COM(2012) 280/3.
The Commission proposed the Single Resolution Mechanism on July 10, 2013. See Proposal for a Regulation of
the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution
of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single
Elli Louka Page 95

the pressure to keep banks up and running in order to prevent a confidence crisis. If the proposal of the
Commission becomes law, the SSM will become the unbiased institution that will identify whether a
bank needs resolution, while the SRM will ensure that a timely and effective resolution takes place.
Germany claimed, however, that the proposal of the Commission was illegal because it centralized too
much power. Germany does not want its small banks to be potentially resolved by an SRM.

The SRM, as designed by the Commission, will ensure that the losses that occur at the time of resolution
are borne by the shareholders and creditors of the institution under resolution. Additional financing, if
needed, would be provided by a Single Bank Resolution Fund (SBRF) to which all banks would make ex-
ante contributions.
Ex-post contributions could be made, too, if there is a need. A fiscal backstop for
the SBRF is also necessary, but fiscal contributions can be recovered through ex-post taxes on the
financial sector. The Commission proposed that the target size of the fund should be at least one
percent of covered deposits in the banking system of the eurozone countries. This would correspond to
about five billion. The size of the fund would increase automatically should the banking industry

By the end 2013, hesitant steps were taken towards the creation of the SRM.
The Council made a
commitment to negotiate by March 2014 an intergovernmental agreement on a single resolution fund,
which would be financed by taxes on banks collected at the national level.
The fund would consist of
national accounts that would be merged together over a period of ten years.
During the transitional
ten-year phase the fiscal backstop would be provided by the member state where the bank to be
resolved is located. A common fiscal backstop is to be developed after the ten-year transitional

Bank Resolution Fund, and amending Regulation (EU) No 1093/2010 of the European Parliament and of the
Council, COM (2013) 520 final [hereinafter SRM Regulation].
But according to the Commission, creating different resolution authorities for different sizes of banks would
imply different fiscal backstops, perpetuating the vicious circle between weak banks and weak sovereigns. See id.
at 8.
Id. at 4.
Id. at 15.
See Council of the European Union, Council Agrees General Approach on Single Resolution Mechanism
17602/13, Press Release 564, Dec. 18, 2013 available online
Elli Louka Page 96

Without a doubt a bank resolution fund could help cement together the monetary union. The ten-year
transitional period, though, is too long for countries whose banks are already in financial trouble. In
times of crisis, national authorities do not have incentives to cooperate. Instead, each tries to save its
own banks or grab as many assets of a failing institution as it can get its hands on, prioritizing the
survival of its own financial system at the expense of other countries systems.
The whole purpose of
a banking union is to break the nasty feedback loop between weak banks and weak sovereigns. If the
resolution of insolvent banks is left to national budgets, if there is not a common EU backstop, the
vicious cycle between banks and sovereigns will be perpetuated.
In the 2012 Roadmap towards Banking Union
the Commission proposed a common system for
deposit protection in the eurozone. The Commission proposed the European Deposit Insurance and
Resolution Authority (Edira) and the European Deposit Insurance and Resolution Fund (Edgar).
Part of
that proposal survived in 2013 as the SRM and the SBRF. The idea of creating a European Deposit
Insurance Authority and a European Deposit Insurance Fund, however, has not been pursued. Core
countries have refused to contemplate joint deposit guarantee schemes that would lend credibility to
the deposit guarantee schemes of peripheral countries. Even a Commission proposal on strengthening
the national deposit guarantee schemes
by allowing for financing, borrowing among them and faster
payouts is still at the inception phase.
A report by the president of the European Council has envisaged a road map towards a genuine
economic and monetary union.
The report mentions that different forms of fiscal solidarity
will be
necessary to move closer to an economic and monetary union, including the development at the euro
area level of a physical body, such as a treasury office.
In addition, a central budget needs to be

Financial Integration, supra note 345, at 45.
Communication from the Commission to the European Parliament and the Council, A Roadmap towards a
Banking Union, COM(2012) 510 final.
Andr Sapir et al., A Contribution from the Chair and Vice-Chairs of the Advisory Scientific Committee to the
Discussion on the European Commissions Banking Union Proposals, at 5, Report of the Advisory Scientific
Committee, European Systemic Risk Board, Oct. 2012 available online
European Commission, Directive of the European Parliament and of the Council on Deposit Guarantee Schemes,
COM(2010) 368 final.
Report by the President of the European Council Herman Van Rompuy, Towards a Genuine Economic and
Monetary Union, June 26, 2012 available online
Id. at 3.
Id. at 6.
Elli Louka Page 97

A common eurozone budget may be a semi-covert way of transferring some funds to the
periphery. In the United States having a federal budget has helped smooth the consequences of the
financial crisis. Florida was less severely hit by the housing bubble because it received significant
transfers from the center, thanks to the federal tax system and a number of federal programs.

Nevada did not suffer as much as Ireland because the losses of the banks were taken up by federal

The US system is composed of the federal budget, which is responsible for most of the public debt, and
state budgets subject to balanced budget rules.
Today the United States federal government does not
bail out the states, but this has happened only after it assumed significant responsibilities. In the 1930s,
for instance, the federal government did not bailout the states but a massive fiscal shifting took place
as the federal government adopted new programs that injected money into states and localities while
states cut spending.
During the 1980s savings and loan banking crisis the United States federal
government took the responsibility of restructuring the banking sector that was fragmented along
state/regional lines.
During the 2008-2010 restructuring of the banking system, the states role was
minimal and the injection of money into the banking system did not affect the fiscal position and the
creditworthiness of states.
As a matter of fact, the American Recovery and Reinvestment Act of
provided financial support to the states. In 2011 the federal government provided six hundred
and seven billion dollars in grants to state and local governments.
This amount includes funds
provided by the American Recovery and Reinvestment Act. Because the federal government has the
role to stabilize the economy during crises, the balanced budget rules at the state level make more

Alessandro DAlfonso, Rationale Behind a Euro Area Fiscal Capacity: Possible Instruments including a Dedicated
Budget, at 2, Library Briefing, Library of the European Parliament, June 26, 2013 available online
Id. at 4.
C. Randall Henning et al., Fiscal Federalism: US History for Architects of Europes Fiscal Union, at 14-15, Working
Paper, Peterson Institute for International Economics, 2012 available online
Id. at 8.
Id. at 18
American Recovery and Reinvestment Act, Public Law 111-5, Feb. 17,2009.
Congressional Budget Office, Federal Grants to State and Local Government: Report, Mar. 3, 2013 available
online (referring to the 2011 fiscal year).
Elli Louka Page 98

sense. The United States is a real transfer union because transfers among different regions of the
country take place through the federal system of government.
Furthermore, the United States issues debt at the federal level. Some have claimed that the eurozone
must do the same by issuing eurobonds. Eurobonds are classic schemes of joint and several liability.

Obviously Germany has been opposed to issuing joint bonds
since it knows what that entails.
Eurobonds mean that Germany would have to bail out the countries with the weakest economies in the
eurozone in case they are in trouble. Any type of joint liability regime with these weak economies
would raise Germanys borrowing costs, which have plummeted since Germany has been viewed as a
safe haven during the euro crisis.
The interest rates that Germany pays on its debt are now negative.
Investors do not mind getting negative rates on German bonds as long as their capital is safe in
Overall, throughout the financial crisis, the United States had potent powers at the federal level from
deposit protection to resolution, recapitalization and debt issuance. What the EU accomplished, even
after experiencing the chaotic years 2008-2013, was the creation of a common bank supervisor. Many
question whether the ECB would have the heart to point out the weaknesses of national banks if more
states were to be knocked down together with them. Furthermore, the detailed fiscal scheme dispersed
in a number of directives, regulations and international treaties has not been accompanied with any
concrete action plan on how to promote investment in the distressed states, or how to address the high
unemployment in the beleaguered South.
Finally, those who doubt the legitimacy of budgetary
surveillance and fiscal discipline are purportedly appeased by the haphazard interjection of more
European parliament in mechanisms over which neither the European parliament nor the national
parliaments have decisive control. Not a modicum of effort has been made to address the deep public
discontent with the deformation of Europe the transformation of the EU into a German hegemony.

European Commission, A Blueprint for a Deep and Genuine Economic and Monetary Union: Launching a
European Debate, at 30, COM(2012) 777 final/2.
Tirole, supra note 78, at 27.
Allard, supra note 18, at 23.
Compare the Fiscal Compact, supra note 464, with the general and vague character of the Compact for Growth
and Jobs, see European Council, Conclusions of the European Council, Annex, EUCO 76/12, June 28/29, 2012.
Elli Louka Page 99

7. No Exit No Voice
7.1. EU Legitimacy: A Citizens Perspective
We view institutions as legitimate if one or two conditions are satisfied: control and/or like. We view an
institution as legitimate if we have some control over it or like it (because of its utility). Control has to
do with how much say
we have on how the institution is run. If we do not control an institution, we
tend to view it as legitimate only if we like it. There are many gradients between like and dislike. In old
times, people did not control their queen, but, at least in some cases, they did not dislike her.
Bad Queen
Good Queen
Figure 1: Legitimacy of Institutions

Figure 1 depicts the legitimacy of institutions based on the two variables of control and like and gives
examples of institutions expressing legitimate/illegitimate options. When we control and like an
institution that institution enjoys a high level of legitimacy. In those cases, the institution is more like a
club where we socialize with like-minded equals.
When we control an institution, but we dislike it, the institution can enjoy legitimacy because we still
have control over it and we perceive that we can possibly change it to our liking. However, there are
cases that even if we have control over an institution, we cannot change it significantly either because
there is not enough consensus for change or because a consensus exists that the institution is the best
of all possible worlds. Today, some people feel this way about Western representative democracy.
Some do not like representative democracy and prefer more direct democratic models that make
possible active citizen participation in political affairs.
At the same time, most agree that, due to

See Albert O. Hirschman, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States 4-5
See Elli Louka, Water Law and Policy: Governance Without Frontiers 205-43 (2008) (analyzing models of
participatory democracy).
Elli Louka Page 100

increasing populations and unenviable alternatives, representative democracy with some tweaks is the
optimum. When we dislike an institution but maintain some control over it, we have two options: to
exit or to exercise our control to try to change the institution to our liking. A minimum amount of
control can be exercised through dialogue and voting or even loud protests and threats.
In Western
democratic states, exit is rarely contemplated by the citizenry as it leads to forfeiting significant rights
and benefits. In principle, however, citizens are not afraid to exercise control by voting governments
out of power, protesting and striking.
When we do not control an institution and we dislike it, an obvious case being that of a bad queen, the
institution is illegitimate. We cannot leave without risking serious repercussions and we cannot voice
our dissatisfaction. Revolution, with the ensuing social chaos, is available when the situation becomes
Finally, there are institutions that we like but we cannot control. An example is that of a good queen,
who uses her power for the benefit of her constituents. These are the queens who are effective at
bringing peace and prosperity and they are liked even if they lack democratic credentials. The
legitimacy of the European Union, like that of a good queen, was not based on its democratic
credentials. On the contrary, Europeans liked the EU because it was useful to them. The EU was
effective at bringing peace and prosperity in a divided continent that had suffered many wars. Greece
joined the European Union shortly after it restored democracy, as it saw in the EU membership the
bulwark against foreign-engineered dictatorship. Eastern European countries joined the Union to shield
themselves against Russian imperialism. Most Europeans accepted the euro because it seemed to bring
clear benefits or, at least, do no harm. Once things started to go wrong Europeans started to protest.
Only their protests had the wrong audience. They could throw out their governments (and they did
based on the democratic principles of the nation state, but they could not disband European
institutions or sack the governments of other eurozone countries. Yet it was the European institutions
and creditor states that dictated the economic conditions in the periphery. Vis--vis these core
Eurozone governments, the citizens of the periphery felt disenfranchised.
Because of the coercive relationship between creditors and debtors, the EU has been deformed into an
illegitimate establishment. Europeans had willy-nilly convinced themselves that their delegation of
powers to the European Union, through their national government, was enough to satisfy their appetite
for democracy in the Union. Now that they are confronted by an entity they neither control nor like,
they regret the surrender of control. The discontent is palpable in debtor countries. In creditor

See, e.g., Hirschman, supra note 619, at 66.
See Lawrence LeDuc et al., The Electoral Impact of the 2008 Economic Crisis in Europe 87, in Economic Crisis in
Europe: What It Means for the EU and Russia (Joan DeBardeleben et al., eds., 2013).
Elli Louka Page 101

countries also, despite the fact that they have won,
there is backlash against the reckless periphery
and intra-European migration.

7.2. EU Legitimacy: Creditor States versus Debtor States
An institution is unlikely to listen to those who cannot convincingly articulate a threat of
countermeasures if their voices are not heard. During the euro crisis when Europe-periphery was
voicing dissatisfaction, it did not have any threats at its disposal to make that dissatisfaction heard in the
circles of Europe-core. The relationship between creditors and debtors is a power-relationship by
definition asymmetrical as creditors have the upper hand. The peripheral/debtor states have invested
their financial and political future in the euro membership and the penalties for exiting the euro are
tremendous. In organizations where entry is expensive or requires severe initiation, like the eurozone,
threats of exit sound hollow.
If exit is accompanied by further sanctions, such as financial isolation,
the very idea of exit is unthinkable. Organizations that deprive their members of both exit and voice are
like dictators or the bad queen. Exit from such organizations, if ever attempted, is equivalent to suicide-
Monetary policy is a public good because it regulates the economic breathing space for citizens and
states. Today the global monetary policy is set by the United States Federal Reserve, which prints the
reserve currency of the world. States that challenge the United States monetary supremacy must find
some way to exist in a self-sufficient manner running their own economy isolated from the world.
many states can achieve that. Today Germany is an informal empire because nothing really can be
accomplished in Europe without its consent and the periphery states have become third world countries
indebted in a currency they do not control. States of the European South have no control over the
currency and the printing press the way emerging states do not have such control when they issue debt
denominated in a foreign currency.
Moreover, the loss of sovereignty over monetary policy has led to

See supra note 99.
See Anna Myunghee Kim , Foreign Labour Migration and the Economic Crisis in the EU: Ongoing and
Remaining Issues of the Migrant Workforce in Germany, IZA Discussion Paper No. 5134, Forschungsinstitut zur
Zukunft der Arbeit (Institute for the Study of Labor) (2010) available online
Hirschman, supra note 619, at 96.
For example, Iran, Syria, North Korea. See Elli Louka, Nuclear Weapons, Justice and the Law (2011) (on the
economic isolation of states that are allegedly manufacturing nuclear weapons and are not the internationally
recognized nuclear powers).
Paul De Grauwe, Governance of a Fragile Eurozone, at 3, CEPS Working Document, No. 346, Centre for
European Policy Studies, 2011. See also Barry Eichengreen et al., The Pain of Original Sin 13, in Other Peoples
Money: Debt Denomination and Financial Instability in Emerging Market Economies (Barry Eichengreen et al., eds.
Elli Louka Page 102

the loss of sovereignty over fiscal policy. The PIIGS are now the exemplification of the periphery but
they do not have the advantages of the classic periphery: they cannot devalue their currency, they
cannot impose capital controls unless they are told to do so they do not control fiscal policy.
In the eurozone, the ECB, in which the German Central Bank holds an effective veto, dictates monetary
conditions. The rest of the states can keep nagging or exit at their peril. Certainly constant nagging can
irk some officials, but it is not effective voice. Core states knew well that the debt and deficits of the
periphery were not the cause of the crisis. Europe-core was willing to overlook these problems of the
periphery before the crisis because supposedly political priorities
were more important than
economic disparities. When the crisis erupted, Germany understood quite well that the repayment of
debt could not be guaranteed given the condition of the periphery. It insisted, however, on unmitigated
conditionality in the midst of a recession as it pursued single-mindedly the export of its economic

It has been said that if one strikes us on the right cheek, we must turn to offer her the left. Today the
name of the game is to stop the first strike preemptively, by blowing off the hand that is about to inflict
If that is not feasible, one must be able to effectively administer a second strike. Certainly we
must not convince ourselves that we are in a Union with states that are relentless at inflicting strikes.
The primordial understanding of whos the enemy
is the cornerstone for the survival of states.
When an economic war is taking place, sovereign is the state that can insulate itself as much as possible
from economic crises.
By surrendering monetary sovereignty, the peripheral states have deprived
themselves of the little independence they had. Now the citizens of these states are at the mercy of the
governments of other states. These governments, by definition, cannot be enamored with the well-
being of citizens who do not vote for them.
Assuming that exit is excluded as an option, the European Union is faced with the following choice:
(1) Political union; or
(2) an abiding German hegemony.

See supra note 341.
See generally Sebastian Dullien et al., The Long Shadow of Ordoliberalism: Germanys Approach to the Euro
Crisis, European Council of Foreign Relations Policy Brief No. 49 (2012) available online
See Elli Louka, Precautionary Self-Defense and the Future of Preemption in International Law 951, in Looking to
the Future: Essays on International Law in Honor of W. Michael Reisman (M. H. Arsanjani et al., eds., 2011).
See generally Carl Schmitt, The Concept of the Political 26 (foreword by Tracy B. Strong, 2007).
States that have had the most successful ammunition against economic crises include Switzerland and China.
Elli Louka Page 103

Only a real political union (like that of the United States or Switzerland) would make it unnecessary for a
single member state to remain a hegemon. For Germany and many other states the idea of a real
political union is the founding myth of the European Union. It is a distant myth that has absolutely no
bearing on the experienced reality.
The European identity is a pretend identity. Europeans endorsed this manufactured identity, believing
that it would grant them powers they have never had before. The idea of the European Union was based
on the equality of sovereign member states that emerged equally scarred from many wars.
As these
states grew and diverged in policies and growth paths, the European identity kept them together, even
if clearly some of them grew more powerful and more prosperous than others did. After the euro crisis
turned into economic conflict,
which divided Europe into creditor states and debtor states, the
European identity has crumbled. The trumpeted equality of member states, the foundation of European
integration, has been unmasked as a sham. The EU can punish weak states, like Greece and Cyprus, but
it is powerless against the dominant member states that define the rules and the exceptions to the rules
the real sovereigns.
The periphery, as a result, has been grabbed by old fashioned nationalists
who believe they have a duty to defend it.
Good luck they need it. The Leviathan
is being Made
in Germany.

See, e.g., Henri Cartier-Bresson, Europeans (1955).
This type of economic conflict is not new. Before World War II, the League of Nations emphasized the
importance of economic disarmament. See Herbert Samuel, The World Economic Conference, 12 International
Affairs 439 (1933). For the economic foreign policy of the United States before World War II, see Jeff Frieden,
Sectoral Conflict and Foreign Economic Policy 1914-1940, 42 International Organization 59 (1988).
See Carl Schmitt, Political Theology: Four Chapters on the Concept of Sovereignty 5-6 (translation George
Schwab, 1985). See also Bodin, On Sovereignty 1 (defining sovereignty as the absolute and perpetual power,
what the Greeks call akra exousia) (Julian H. Franklin ed., 1992). According to Bodin, the sovereign can never
become the underdog. The sovereign cannot tie his hands even if he wished to do so. See id. at 13.
See Timothy Garton Ash, 2014 is not 1914, but Europe is Getting Increasingly Angry and Nationalist, Guardian,
Nov.17, 2013 available online
Thomas Hobbes, Leviathan or The Matter, Forme and Power of a Common Wealth Ecclesiastical and Civil 251-
61 (C.B. Macpherson, ed., 1971) (analyzing the commonwealth by acquisition).