A resolution of the Greek impasse still looks remote, particularly given that Angela Merkel, in a speech to Parliament this morning, made all sorts of apple pie and motherhood statements about the importance of the Eurozone, but nevertheless pointed to the need for Greece to make concessions: “When the politicians in Greece muster this will, then an agreement with the three institutions is still possible.”
The alarming part of the deadlock is the lack of a plan on the creditor side to develop a Plan B, a sort of mirror image of the Greek government’s claim that its has bet everything on securing a favorable agreement. Even if the ECB has been gaming out scenarios (as was rumored as early as February), it can only do so much unilaterally. The Eurozone crisis is on the verge of entering a phase where a common view among different governments and institutions is necessary before any concerted action can take place. Even allowing for a relatively quick agreement on preliminary steps, there is still a ton of moving parts, as well as the near certainty of continued high friction with Greece.
A Eurogroup meeting today is expected to be short and inconclusive. Finance minister meetings extend into Friday, with all EU members attending. That may allow for further discussion, but it’s hard to see how anything more could emerge than a very high level agreement on a few principles, like “We need to develop a plan for how to keep Greece in the Eurozone if it defaults” and maybe also “We need to get serious about preparing for what happens in the event of a Grexit” (a variant might be “Can/should we assist Greece with a Grexit?” I think the latter is too hard to accomplish given the short timeframe and the fact that Greece would have to trust and rely on foreign technocrats, ironically including the IMF, which allegedly has the most technical expertise).
It is possible that as a result of the Thursday/Friday meetings, the Eurocrats hit the panic button and try to extend the bailout, which is set to expire June 30 (June 21 appears to be the last viable emergency meeting date). But that was offered to Greece before, with the condition that it agree to crossing its red lines of pension and labor market “reforms”. We keep coming up against each side’s boundary conditions. It’s career suicide in too many countries for politicians to vote through a deal with Greece with no pension reductions, and far too little time to soften public opinion by June 30.
The ball moves into the ECB’s court after a bailout expiration/IMF non-payment. Other lenders to Greece apparently do not have cross-default clauses with IMF debt, so the immediate impact of an IMF missed payment (the term of art is “arrearage”) is the blow to confidence, a bar on new IMF lending, and a reduction in the quality of the collateral pledged to the ECB for loans under the ELA, particularly Greek government debt (which is a comparatively small portion of total collateral). Note that the Eurozone member states, many of which are lenders through the European Financial Stability Fund and the Greek loan facility, won’t suffer any immediate impact. As Bloomberg notes:
No European state will be unable to balance its budget because of missing Greek interest payments, which have already been deferred by 10 years and would in any case be linked to the European Financial Stability Facility’s minuscule funding costs.
The bank run is certain to accelerate in anticipation of an IMF non-payment and immediately thereafter. So the liquidity demands will rise as the ECB will have every reason to impose higher haircuts on collateral, moving the banking system closer to the end of its ELA runway. Draghi stressed in his presentation to the EU parliament earlier this week that the ECB was a rules-based institution and would keep providing support to Greek banks as long as they were solvent and had collateral against which to lend. The Greek banks are deemed to be solvent by the ECB despite the fact that they clearly aren’t. And their underlying insolvency is getting worse. From a different Bloomberg story:
Greek banks, which received two capital infusions in the past two years, may need a third one as a recession drives up losses from bad loans.
The four biggest lenders, accounting for 91 percent of the country’s banking assets, could see their 12 billion euros ($14 billion) of tangible core capital wiped out by mounting provisions as overdue and restructured loans default.
Even if Greece reaches an agreement with European creditors to free up additional money, its next bailout will need to include a new round of funding for the ailing banks.
Bad loans rose last quarter as the economy slipped back into recession and Greeks delayed payments waiting for the new government to pardon debt. With the recovery stalled, the four banks — National Bank of Greece SA, Piraeus Bank SA, Alpha Bank AE and Eurobank Ergasias SA — could require 16 billion euros in additional provisions to cover losses if half of the 59 billion euros of overdue and restructured loans on their books sour.
While the ECB could in theory cut off the ELA air supply on June 30, the complexity of the situation, plus its “rule driven” message seems to signal that it will wait to act until it has a clear cut cause. But going past the June 30 event horizon means Greece will be under more pressure to introduce capital controls, particularly since experts have estimated that Greek banks will run out of collateral eligible for the ELA sometime in July, and that was before allowing for the possibility of increased haircuts on collateral as a result of the IMF arrearage. That is not a pretty picture. From the Financial Times:
If the bailout expires and Greece fails to make the IMF payment — but the ECB decides emergency loans to Greek banks can continue — Greece enters what Mario Draghi, ECB president, recently called “uncharted territory”. An economy hamstrung by capital controls, a government without any cash and a banking system struggling on life support, Greece would essentially begin a drawn-out process of economic suffocation.
And while imposing capital controls will help with liquidity (as in access to the ELA), it will further erode solvency. Back to Bloomberg:
As Greece and its creditors head for a showdown, the specter of the country’s exit from the euro or the imposition of capital controls is rising. The latter would try to halt the deposit flight from the banking system by restricting cash withdrawals and money transfers abroad. Such controls could hurt the economy more as importers face difficulty paying suppliers and consumers without full access to their savings cut spending. That could further sap borrowers’ ability to pay and speed up the rise in bad loans.
Greece has two payments due to the IMF on June 20 that total €3.5 billion. The Financial Times contends that “it would be virtually impossible for Greece to survive inside the eurozone if it defaulted on the ECB.” Analyst David Zervos of Jeffries (hat tip Scott) claims that an default against ECB would make all Greek collateral ineligible for Eurosystem loans. I’ve tried verifying that and have come up empty.
But independent of when the ECB decides to pull the trigger, Zervos gives an idea of how brutal the process is (and recall this sort of threat was what drove Ireland to assume responsibility for its banks even though there was no government guarantee). You need to read past Zervos’ schadenfreude; a more borrower-friendly writeup in Tagesspiegel of how the ECB executed the Cyprus bail-in made it clear that the central bank had planned its moves carefully and left Cyprus with no good escape routes. From Zervos:
And to be sure, making an example of Greece is a probably the greatest achievement for the fiscal disciplinarians of Europe. Maastricht never had any teeth. But this exercise is impressive. It shows that fiscal excess will be squashed in Europe. The Portuguese, Spanish and Italians are surely taking notice. And in the days that lead up to a Greek default on 30 June, and then more importantly on 20 July, these disciplinarians will surely display their power for all to see. Oddly enough, I actually think this has been the German plan all along. With no real way to ensure fiscal discipline through the treaty, they resorted to killing one of their own in order to keep the masses in line. It explains why Merkel took out Samaras when she knew a more hostile government would surely emerge in Greece. This was masterful political manipulation.
In any case, enough about the past, let’s run through the most likely end game for this Greek saga as a deal never gets agreed before default.
1. Greece misses its IMF payment on the 30th of June. This could be a trigger but it may not be. The IMF has 30 days to call Greece in arrears so technically Greek government guaranteed collateral, and hence the Greek banks, are still solvent after the 30th. However on the 20th of July the Greeks will surely default to the ECB without a deal. This is the official d day.
2. Upon default, the collateral at Greek banks cannot be posted any longer to the Euro system. The Greek banks then become insolvent and the ECB, through the newly created Single Resolution Mechanism (SRM), is obligated to resolve the Greek banks.
3. So the ECB goes to Tsipras and tells him – we are immediately instituting capital controls and we will begin resolution of your banks unless u sign the agreement and re-enter a program. Without a bailout program in place the Greek government, and banking system, are both insolvent. So Tsipras says – what do you mean resolve my banking system? And then Mario explains as follows. First we wipe out all equity and bond holders. And then, as in Cyprus, we bail in depositors. There are 130b in Greek deposits against 90b in ELA. And while those deposits are technically insured up to 100,000 euro, there is no pan European bank insurance yet in place. That only comes in 2016. Right now Greek deposits are only insured with a Greek deposit insurance fund that has about 3b in it. This Is hardly enough for the 130b in deposits. So we take the 130b against the 90b in ela. Any remaining deposits go to fund a bad bank that begins resolving all the NPLs. The good loans of course will go into a good bank which will be funded with German capital and most likely will have a German name. Of course depositors will get 2 to 3 euro cents on the dollar for their existing balances from the 3bio in the insurance fund. So you have that going for you!
4. Tsipras hyperventilates and quickly reaches for a bottle of ouzo.
5. Then it’s basically time for the gallows. He either signs a document cutting pensions, raising VAT and violating all his red lines. Or he takes the Greek people into bankruptcy and out of the euro. Either way he is a dead man. His own party destroys him if he does the former. And the 70 percent of Greek who want to stay in the euro destroy him if he does the latter. Of course there is one other choice for Tsipras. He could just resign and call for new elections. In that case maybe the banks stay closed and the ECB does not start the resolution process until the Greek people decide what they want. But in any event, it’s over for Tsipras in that case as well.
The German fiscal disciplinarians have won the battle. Tsipras dies under that bridge. The end!
We warned readers that the creditors had implements of torture that they had yet to deploy. The forced choice of a bail-in versus a Grexit is the ugliest, but the fact that the ECB has used this weapon before (under its “we’re just following the rules” excuse) means it might resort to it again. Since this post is already long, we will save the description of some of the other possible discipline mechanisms for future discussions.
What about a default in the Eurozone? The big impediments to the ECB going down the path above is concern that it can’t contain financial contagion after a Grexit and not wanting to buck EU political leaders who are correctly worried about political contagion. But other roads are hard to clear. I’ve read twice the most definitive legal brief on this matter, a 2009 ECB paper, which tooth-gnashes over ambiguities in the treaties. One of its firmer conclusions is that a Eurozone exit means an EU exit, and Varoufakis also seemed to be of that view (he has mentioned the loss of EU subsidies, particularly agricultural subsidies, as one of the many reasons to shun a Grexit).
The consensus is moving away from our initial view, that the best solution for Greece is a default in the Eurozone. The problem is that the country remains in what I’ve called the creditor sweatbox, without a primary surplus due to the deterioration of its economy. It has to pay pensioners and government employees in scrip. Even if the Eurocrats tolerate that (and my guess is they will), this will put the Greek economy in even more duress and damage the ruling coalition’s credibility. This state is probably not sustainable for more than a period of months. The creditor hope would be that Tsipras has to form a new coalition, and the result would be a more tractable negotiating counterparty. Most observers think that default morphs into a Grexit; but if the creditors have steeled themselves to that risk, they have little to lose if they can keep Greece in a zombie state and see what happens next.
Even if the creditors decide to be more generous, it’s hard to make that work. A Politico article today gives a high-level overview of how messy the legals issues are. On the one hand, that means some can probably be fudged, but even fudging takes time, and that means more uncertainty for Greece, which in turn hurts its economy and isn’t so hot for the rest of Europe either (except for making the euro cheaper).
The worry is that European law could force Greece to abandon the EU before it can leave the eurozone.
At a time when anti-EU parties are on the rise across much of the Continent and the U.K. is debating its future in the union, Europe’s leaders don’t want to risk letting Greece go…
Greece’s Central Bank, in rare public comments Wednesday on the crisis, echoed those fears, warning that a default would force Greece from the euro and “most likely from the European Union.”
From a legal standpoint, however, Greece would still be a member. Even if a country violates the treaty, there’s no mechanism for kicking it out.
Yves here. While that is true, there is a mechanism for suspending membership in the EU. Back to the Politico article:
Europe has a long history of giving political expediency precedence over the fine print. Both the U.K. and Denmark, for example, were granted exceptions to a requirement that EU members eventually join the euro. Why not let Greece leave the euro and stay in the EU, advocates of a compromise argue.
If Greece defaults, it will have left European taxpayers holding the bag for more than €200 billion in aid. Offering Greece a special arrangement is likely to cause a further outcry in Germany and other EU countries
So while there may be a remedy, financial time moves faster than political time, making it much harder to reach consensus on any “don’t cut off your nose to spite your face” options to give Greece a glide path.
What about Russia? We’ve argued that the idea that Greece will get a rescue from Russia is overdone. Putin has signaled that he is not overly eager, even bothering to make clear that certain contacts were initiated by Greek officials, not Russia. There’s an old saying in finance, that you don’t buy on the courthouse steps (on the verge of bankruptcy) if you can get it cheaper after bankruptcy. Anything Putin might want from Greece he can get at lower cost later….if he can get it at all.
The reason we doubt the concerns voiced about Greece slipping into Russia’s orbit is that the US, which is treating Putin as Public Enemy Number One, isn’t worried enough about it to cudgel the Europeans into being less bloodyminded in the Greek negotiations. Even Guntram Wolff at Bruegel, a card carrying believer in austerity, argues that the primary surplus targets that the creditors are seeking are unproductively high. Perhaps the US believes it can give Turkey rope to discipline Greece if it gets too cozy with Russia.
But the objective risk of a new Greece-Russia alliance is not what will drive European reactions. It is whether Europeans are worried enough about this risk to change course. Despite the fact that this issue is mentioned regularly in the mainstream press, Merkel has also not moved her position meaningfully regarding Greece either since deciding to back the IMF two and a half weeks ago. And Merkel likes Putin about as little as Obama does.
Now Merkel is in a tough position with her coalition on Greece and she may be doing a lot of behind the scenes arm-twisting, and the Russia card is probably her best leverage point to bring other countries along. But at this juncture, the fear of Russia getting a foothold seems secondary to domestic political considerations.
I must confess to being fried by following this drama so closely, and the idea that this could go on another month or even longer is draining. Imagine how the officials involved feel. Frayed nerves and exhaustion increase the already high odds of bad decisions and impulsive action.