As most readers know well, Greece made concessions yesterday to the Eurogroup that, although contested as to how far they went, were seen as big enough concessions to win the support of Eurogroup head Jeroen Dijsselbloem and Italy. But Germany’s Wolfgang Schauble almost immediately rejected them, setting the stage for a showdown today. As we’ve discussed from the outset, the biggest bone of contention continues to be “conditionality,” otherwise known as structural reforms. Greece wants to be able to revise some measures as long as it can still meet its primary surplus target. Germany insists a deal is a deal and Greece must reaffirm all the terms of its existing agreement.
The meeting is set to start in Brussels at 3 PM local time, so we’ll know soon enough how things turn out. Many observers think that German opposition alone is enough to scupper a deal, while others like Ambrose Evans-Pritchard view the outcome as less certain. Moreover, there is the possibility that Merkel will seek to moderate Schauble, although she runs the risk that Schauble could resign, having been overruled by her before on Greece in 2012 and on QE. If so, that would be a seismic event in Germany. So it isn’t clear that Merkel can or will do much to pressure Schauble.
The US was also trying to get things back on track, but this report from Bloomberg was not terribly encouraging:
Treasury Secretary Jacob J. Lew talked Thursday with Varoufakis, French Finance Minister Michel Sapin and Jeroen Dijsselbloem, who chairs meetings of the 19 euro-area finance ministers. Lew has also spoken to his German counterparts and officials at the European Commission and the International Monetary Fund.
Notice who is not mentioned? The key actor, Schauble. However, the Guardian live blog shows Reuters snap updates showing the German government trying to look more reasonable, which either suggests that Merkel has had a talking to with Schauble or the spokesman is messaging out of line with Schauble’s plans (which would be very unusual but not impossible):
20-Feb-2015 10:36 – GERMAN GOV’T SPOX SAYS WILL WAIT TO SEE RESULT OF EUROGROUP MEETING ON GREECE TO DECIDE WHETHER FURTHER MEETINGS ARE NECESSARY
20-Feb-2015 10:45 GERMAN GOV’T SPOX SAYSLATEST VAROUFAKIS PROPOSAL MAKES CLEAR GREECE INTERESTED IN EU HELP, THIS IS GOOD BASIS FOR FURTHER NEGOTIATIONS
20-Feb-2015 10:49 – GERMAN GOV’T SPOX SAYS CHANCELLOR HAS FULL CONFIDENCE IN FINANCE MINISTER
20-Feb-2015 10:57 – GERMAN FIN MIN SPOX SAYS WRONG TO SAY SCHAEUBLE DOES NOT WANT A SOLUTION FOR GREECE
In America, when the President says he has confidence in someone, that means his days are numbered. Is this also a sign of an inevitable breach in Germany?
Yesterday, the Greeks loudly signaled they have gone as far as they can. That is in no small measure due to the fact that they are boxed in domestically; Syriza’s leadership is already under fierce attack for giving as much ground as they did in the Thursday offer. Today, they are calling for a Plan B of sorts:
#Greece will request EU summit should Eurogroup talks fail, a top ranking SYRIZA official has told dpa.
— Holger Zschaepitz (@Schuldensuehner) February 20, 2015
Media sources have speculated that one possible source of short-term relief for the Greek government would be if the IMF payment due in March were suspended as long as debt talks are still under way. But if anything, the big reason to keep talks going, aside from the desire to reach a deal of some sort, is to keep the ECB from terminating or putting restrictions on the ELA.
We can’t stress enough how abominably the ECB has behaved so far, and the press and pundits have not called them out on it sufficiently. Der Spiegel is now reporting that the ECB is planning for a Grexit. Note that is consistent with a FAZ story we reported on yesterday. Note that the ECB issued a denial, but only of one rumor in the story, that they were considering recommending that Greece implement capital controls.* The central bank did not dispute the FAZ claim that the ECB was considering a Grexit.
Economist and former IMF staffer Peter Doyle has argued that the brinksmanship all parties have played is almost inherent, since (as the Eurozone’s designers anticipated) it will take a crisis to force the difficult political and economic integration to move forward. From Doyle, emphasis ours:
On the one hand, in an incredible reversal of practice during the global financial crisis—when central banks were at pains to conceal which institutions were receiving their emergency assistance for fear of compounding the adverse signals and therefore the crisis—the ECB has brazenly publicized exactly which Greek banks depend on its help and how much. And it has overtly warned it would withdraw that help. In this way, the central bank is overtly threatening to blow up the Greek banking system, in order to make the euro work. Walter Bagehot, the nineteenth-century father of lenders of last resorts, would be dumbfounded.
The wee problem with this strategy of putting the Greek banking system at risk is that financial time moves faster than political time. The ECB’s skimpy €3.3 billion increase in the ELA as the last board meeting looked intended to accelerate the ongoing bank run by almost guaranteeing that the Greek central bank will come close to bumping into the limits if the talks continue to be fractious, which was virtually guaranteed. Reader Jim Haygood estimatedt that the increase was likely to be used up by the end of the week. And as Fortune pointed out:
The ECB knows very well that money buys the Greek banks a week, two weeks tops. The Greek banks won’t need the money if the panic stops, but that won’t happen unless Germany relents and agrees to Greece’s demand for leniency. With Germany saying Nein today just to extend talks without granting any concessions, it is now clear that the whole situation may actually blow up this time.
Ambrose Evans-Pritchard was more pointed:
Greece is now prostrate. Tax arrears have reached €76bn and are rising by €1.1bn a month. “Greece is totally bankrupt. The ECB’s constant talk against us is causing a self-fulfilling deposit flight in the banks. It is so bad that anything could happen,” said one Greek official.
What is even more troubling is that the ECB’s thinking isn’t known and its actions are not predictable given that the composition of who gets to vote changes every two weeks (governing council members always do and the others rotate). France’s Noyer took a hardline position against Greece when the talks with Syriza began and yesterday, Bundesbank chief Jens Weidmann not surprisingly fell in with Schauble’s views. And when Doyle polled three banker experts who he thought would be representative of central banker thinking, one called on terminating the ELA if the current talks failed, a second said that if any talks were in progress to keep it going, and the third said to continue it no matter what. There is no way of knowing whether this thinking represents how board members would act, but this mother-in-law research suggests that the odds of the ELA being terminated are troublingly high.
FT Alphaville points out that this does not necessarily mean a disorderly Grexit, with the Greeks nationalizing the banks and scrambling to reintroduce the drachma. They quote a Nomura research note (emphasis theirs):
If ELA for Greek banks is halted, a bank holiday is almost certain to be needed, as the Greek banking system’s day-to-day liquidity management depends on such access with ECB liquidity currently close to 20% of the balance sheet size. Following such a bank holiday, there would be two basic paths.
1) Temporary and reversible stage: This path could be one similar to that of Cyprus in 2013. To prevent continuous deposit outflows bank holidays are temporarily declared and a new backstop arrangement is negotiated with official sector creditors (led by the Eurogroup). In the interim, to create further pressure to sign a bailout deal, the ECB could impose a deadline on the ELA provision. When banks are reopened, some limited capital controls may be needed to restrict capital outflows. But cross-border convertibility of the currency would largely be preserved, and a parallel currency would not develop in earnest. Furthermore, given the looming state financing constraints in March, a failure by the government to pay some of its liabilities is also possible although this could quickly be remedied after a bailout deal.
2) Full-blown EMU exit: – outright currency separation: If no political agreement can be reached during the bank holiday, banks would eventually open with liquidity provided directly by the Greek central bank. The Greek central bank would no longer be part of the ESCB (Euro System of Central Banks), and commercial banks in Greece would no longer have access to cross-border clearing of banking transactions within the TARGET2 system. In addition, severe capital controls would likely need to be put in place to avoid large-scale capital flight. This would be a scenario where the convertibility of the currency is fully broken, and an exchange rate between Greek deposit balances (and eventually cash) would develop relative to euro deposit balances. This scenario would likely involve the government defaulting on some of its upcoming liabilities as well. At some point, a new currency law would formalise the currency split and provide guidance on re-denomination of contracts.
The key point is that there are various degrees of currency separation, from temporary restrictions on bank transactions to full-blown breakdown in currency convertibility. Since there is no political desire in Greece currently to actively adopt an independent currency, euro exit would likely be a two-stage process. The risk of reaching stage 1 is fairly elevated. But the risk of reaching stage 2 is lower.
Readers need to bear in mind that the Cyprus solution was ugly, since Cyprus was made to revoke its deposit guarantee and imposed a “bail-in” that forced losses on depositors. As Ed Harrison summarized the deal in 2013:
Europe has hammered out a 10bn euro “bailout” of Cyprus. I put the term bailout in quotes because the key feature of this deal is the bail-in of Cypriot depositors to the tune of 5.8bn euros, about a third of Cyprus’ GDP. This means that depositors went to sleep on Friday night and woke up Saturday to find that their money, deposited safely in Cypriot banks, had been seized and used to “bail out” the country….I see this as an extreme measure which, if the European banking crisis continues elsewhere, will have very negative implications for bank depositor confidence in other European periphery countries.
The deal terms as reported by Reuters are as follows:
1. A 9.9% levy on deposits over 100,000 euros and the 6.75% tax on deposits under 100,000 euros.
2. The IMF will contribute to a bailout. The size, maturity length, and interest rate have not been determined. And it is not clear yet what, if any, guarantees are associated with this as opposed to loans.
3. Russia will re-finance a loan which is ostensibly to the sovereign for 2.5 billion euros. The 5-year loan will be extended to 8 years and the interest rate will drop.
4. Telecoms, ports and utilities privatization may be a pre-condition of loans/guarantees.
5. The banking sector, now 8 times the size of Cyprus’ GDP, will be downsized. The average banking sector size in the EU is 3.5 times GDP. Outliers in Europe of this type include Ireland and the UK. (see here for a 2009 calculation of outsized individual European institutions and here for the largest banks by assets as of 2010). Iceland was also an outlier in this regard.
Cyprus was widely seen as one-off, in part because the media paid little attention, it was widely depicted as a money-laundering venue (that charge was greatly exaggerated as we explained at the time), and the parties most badly hurt, aside from the Cypriots themselves, were Russian and British property owners and retirees who’d chosen Cyprus as a cheap and pleasant spot. But having depositors whacked by virtue of living in a country that was unable to meet predictably unrealistic austerity targets is another kettle of fish entirely. While depositors in other periphery countries are unlikely to wake up to the risks immediately, if they vote in an anti-austerity government, the message is meant to be that they would get the Cyprus/Greek money waterboarding. In other words, pulling the ELA would be consistent with the hardliner line of thought that Greece needs to be made a demonstration project pour decourager les autres. We’ll know in the next week or so whether they get their way.
*Before readers point out that having the ECB plan for a Grexit is rational, the issue is not the planning but the leaks. Central banks are hermetic, and thus the odds favor that these leaks were planted.
Update 8:10 AM: This does not look good at all for Greece. It is being muscled into pretty close to total capitulation. From Paul Mason:
Yesterday finance minister Yanis Varoufakis (former professor at the University of Texas) climbed down on his previous refusal to ask for an extension of the old deal – but he still wants leeway to set his own budget targets, and to implement new laws giving workers back their job contract rights..
Last night I was told that, in the working group that prepares the Eurogroup meetings, the Greek compromise was the draft basis of agreement. That keeps Greece around the table. But overnight it looks like Germany has got words into the draft the Greeks can’t accept, and the pre-meeting ended without result.
In the next few hours, something decisive has to happen. Either the Greeks cave in completely. Or they trip the crisis into a new phase.
The meeting start has been delayed to 4:30 PM Brussels time. There is now a pre-meeting set with Varoufakis, Schauble, Dijsselbloem, and Lagarde.