The ECB has decided to lower the boom on Greece.
As we’ve mentioned, the ECB was well outside the intended use of the program that has served as the backstop to the Greek banking system, the Emergency Liquidity Assistance program. As its name suggests, the ELA was meant to provide support only for solvent banks, and then only for short-term liquidity crunches (this is why the ELA has to be re-approved every two weeks, but the voting rules favor continuation, since it takes a two-thirds vote of the current voting members to cut off the ELA).
The ECB has continued to deem the Greek banks as solvent when they clearly weren’t. The presumed justification was that Greek banks had run up huge tabs on the ELA in the 2012 debt restructuring (the so-called second bailout) and had weaned itself off it after the refinancing was in place and contagion fears in the Eurozone had receded. The ECB was clearly uncomfortable with the continued credit extension and kept the increases to the bare minimum necessary to keep the Greek banks afloat. This practice was coupled with the ECB also apparently stoking the bank run by publicizing information about the sorry state of the Greek banks, while during the financial crisis, it kept detrimental information under wraps. The ECB might have been trying to force the Greek government to request permission to impose capital controls, which would have been damaging to the economy and thus could have hurt the Greek government’s support. It appears that the ECB was trying to throw a spanner in the works, but far short of what they were capable of doing. The past ECB moves look to have been a shot across the Greek bow that the government either did not understand or chose to ignore.
But remember the critical fact: that the ELA support was premised on the idea that Greece and the creditors might come to a deal and Greece would get its bailout money. Once that matter was settled, the 2012 case showed that the cash that had been pulled out of the banks came back and the ELA use plummeted.So as long as negotiations were underway, the ECB was duty bound to keep extending ELA support. In fact, we’ve suspected that that was the biggest reason Greece kept the talks going despite the overwhelming evidence that they were going nowhere.
The European officials have interpreted the announcement of the Greek referendum on July 5 as tantamount to the termination of negotiations. As the Guardian reported:
Saturday night’s eurogroup meeting said the governments “stand ready to do whatever is necessary to ensure financial stability of the euro area”. Their meeting was the fifth to be held in 10 days. The decision to end the bailout, shunning the Greek requests to extend the rescue until after the national referendum, means that Greece is likely to go bust.
“Greece ended the negotiations unilaterally. There is no basis for further negotiations,” said Wolfgang Schäuble, the hawkish German finance minister. “I don’t see any possibility for doing anything. On Tuesday the programme ends.”
Jeroen Dijsselbloem, the Dutch finance minister who chaired the meeting in Brussels, said with his referendum decision Tsipras had “closed the door” for talks with the creditors.
The Greek government, astonishingly, appears not to have considered the possibility that the Eurozone nations would not extend the bailout, let alone the ramifications. We stated that the odds were in fact high that the request would be rejected, given the very late hour, the lack of any advanced warning, and the unpopularity in many nations, most importantly Germany, of cutting Greece slack, particularly given that they had ample opportunity to schedule a referendum prior to the bailout expiration. From the Financial Times:
Mr Tsipras stunned his nation and its international creditors by announcing the referendum, arguing only the Greek people should decide how to respond to what he called the creditors’ ultimatum. He urged a rejection at the polls, but two eurozone officials said Mr Varoufakis predicted a “yes” vote in the plebiscite during the eurogroup meeting.
Negotiators for the creditors had been preparing to present a new compromise offer to the Greek authorities that, according to one EU diplomat, included “lots of things they could sell”. But Mr Tsipras’s move dashed hopes of striking a deal at Saturday’s meeting, meaning there will be no programme in place when Greek voters go to the polls to offer a verdict on the creditors’ proposal…
In the clearest sign yet that eurozone officials are anticipating significant economic upheaval in Greece, Mr Dijsselbloem said “the situation in Greece will deteriorate very rapidly” without a bailout agreement in place.
At a post-meeting news conference, Mr Varoufakis appeared taken aback that his colleagues had cut off talks and allowed the programme to expire, saying he had anticipated negotiating up until the referendum vote so that his government could eventually campaign in favour of the deal.
It is hard to reconcile Tsipras’ defiant remarks (he and Syriza officials said they would campaign for a “no” vote) with Varoufakis’ claim that the government wanted to continue negotiations with the hope of securing a package that they could recommend. It appears that the Greek side thought that the Greek referendum would be seen as a powerful countermove and would force eleventh-hours concessions from the creditor side. As we’ve said repeatedly, it has been evident for some time that the lenders are not afraid of a default, nor are they swayed by Greek opinion (Tsipras has had approval ratings as high as 80%). Thus the Greek gambit looks to have been a serious miscalculation.
Bloomberg reports that the team that was working on the negotiations in Brussels was in the dark:
No one was more surprised about Greek Prime Minister Alexis Tsipras calling a referendum than his team of negotiators in Brussels.
Shortly before midnight on Friday in the Belgian capital, the Greeks and representatives of the European Union and International Monetary Fund, tucked away in the EU Commission’s Charlemagne building, learned via Twitter that their efforts were in vain, according to an EU official….
Up until that moment, the mood on both sides had been fairly positive, the official said. They were reaching agreement on a joint proposal to be presented to a meeting of finance ministry officials set for the next morning.
Since negotiations have broken down, the ECB has a great deal of difficulty arguing that it continues extending ELA support, particularly since powerful hardliners like Bundesbank president Jens Weidmann have been pressing for some time to restrict ELA advances. The bailout will not be extended, Greece will lose the opportunity to get €7.2 billion in bailout funds, and an arrearage on the €1,6 IMF payment due June 30 and a default on the ECB payment of €3.5 billion due July 20 is certain.
The well-connected Robert Peston of the BBC tells us that the ECB will act on Monday which will virtually force Greece to impose a bank holiday. From the BBC:
The European Central Bank is expected to end emergency lending to Greece’s banks on Sunday, the BBC understands.
The country’s banks depend on the ECB’s Emergency Liquidity Assistance (ELA). Its governing council is meeting later.
Greece will probably have to “announce a bank holiday on Monday, pending the introduction of capital controls”, a source told the BBC’s Robert Peston…
Austria’s Finance Minister Hans Jorg Schelling said a Greek exit from the euro now “appears almost inevitable”.
This report is clearly from a single source, but Peston would not run the story unless he thought his interlocutor had a good reading on how this was likely to play out. If this contact’s take pans out, a bank holiday will be a major blow, particularly coming at the start of the peak tourist season. As Nathan Tankus observed in a post earlier this month:
Two years ago in Cyprus, an emergency bank holiday was declared and capital controls installed. The bank holiday only lasted for twelve days yet supply chains started drying up instantly. An ex-Cyprus central bank governor told the Guardian:
Supplies of food are being exhausted and there are cases of raw materials like iron and timber being held up in customs because importers don’t have the cash to pay for them … No one expected, myself included, that the EU, ECB md IMF, would behave like this. Cyprus has been treated very badly … Where is the solidarity principle that is supposed to underline Europe?
Even 6 months later after the banks had reopened and capital controls were loosened, businesses were still having trouble getting basic supplies. This happened because their working capital was largely frozen and/or written down in the bail-in, or they had made payments but their suppliers were frozen because their own working capital had been largely frozen and/or written down. It is important to emphasize that their nearly two-week bank holiday was only to resolve insolvent institutions, not to build or significantly modify the payments system. Cyprus experienced a storm. It is not an exaggeration to say that freezing the Greek payments system would be like a financial hurricane and this one certainly looks to be a category five.
We will know soon enough if the ECB takes the drastic move that Peston’s contact suggests. But even if they do not take in on Monday, I had thought it was very likely that they’d end or restrict ELA support no later than June 30, when Greece goes into arrearage with the IMF. And even if Greece decided only to impose capital controls, they’d likely need to be stringent, and thus would also badly crimp business activity.
Despite the belief of some readers that the Eurocrats would find a way to finesse the June 30 deadline, consistent with their past “extend and pretend” practices, we’d warned this was a hard deadline and would be very difficult to circumvent, particularly given the lack of good will on the side that would need to find the fix, that of the lenders. The endgame of the Greek negotiations is under way.