It’s hard to find an official who is comporting himself very well in the wake of the Tsipras surprise announcement of a referendum on July 5 for a then-defunct bailout offer.* Obama called Merkel to make it look like he was Doing Something. Jack Lew called Tsipras to tell him to Do Something, apparently not having gotten the memo that Tsipras has tossed the matter over to Greek voters and there is no way he can reverse course now. Tsipras sent a notes to Eurozone heads of state on Sunday, asking them to override the decision of their finance ministers not to extend the bailout. Hollande tweets a deal is still possible. Merkel says it is up to Greece to capitulate, um, resolve the standoff, which contradicts Hollande and reaffirms that the bailout is not being extended.**
But the most bizarre display was European Commission chief Jean-Claude Juncker’s press conference. Even through the dry medium of live blog comments and tweets, it comes off as if he became unhinged. He seems desperate to resurrect a deal and his reputation. He urged a Yes vote on Sunday in Greece as a way to affirm the Eurozone. But he lost all credibility when he claimed the creditors hadn’t wanted Greece to cut pensions, and he went on way too long about how he had been treated badly by the Greek team and misrepresesnted: “the selfishness and tactical games of populists prevailed”, leaving him betrayed by Greek “egotism”. Junkcer had released a document Sunday night that he claimed was a better offer to Greece that the negotiating team was reading when Tripras aborted the talks with his tweeted referendum announcement. Even if what Juncker reported was the gospel truth, given his blatant distortion of the lenders’ position on pensions, it’s impossible to take the document seriously.
Now there is a reason for Juncker to be so eager to try to secure a “Yes” vote from Greece. It represents virtually the only chance to save the Greek banking system and with it, Greece’s continued membership in the Eurozone. But even then it could be very hard to achieve. If Tsipras were to form a new coalition, it might be possible to put together a stopgap deal to forestall an ECB default on July 20. But with a no vote, or if Tsipras calls new elections after a yes vote (which runs the risk of the timetable for forming a new government too close to July 20; readers who know lead times for elections in Greece please pipe up), it seems likely that the the ECB default takes place, which will force the ECB to either cut the ELA by imposing more stringent collateral requirements or withdrawing it entirely. Either one would lead to a failure of the Greek banking system and force the government to resolve the banks and issue drachma to recapitalize the banking system.
Even now, with the a mere bank holiday and capital controls in place, conditions are not pretty. Banks are closed and customers can’t even get access to safety deposit boxes. ATM withdrawals are limited to €60 a day, according to Bloomberg. Pensioners have not been able to access their monthly stipend; the government is set to announce at 4 PM local time which bank branches they can go to to get their funds. What happens if branches run out of cash?
The Guardian live blog reports that grocery stores in Athens are being stripped bare by anxious customers[Update: the live blog, in a later entry, shows pictures of grocery stores that are normal, so it isn’t clear how widespread the food hoarding is]. Lines are long at gas stations as customers not only fill gas tanks but also cans. It also points out:
But a former deputy governor of Cyprus’s central bank, Spyros Stavrinakis, has warned that reopening the banks will be hard.
Stavrinakis lived through the 2013 Cyprus crisis, in which capital controls were imposed for almost two years.
Once you impose capital controls, you immediately send a message that there is something wrong with the banking sector.
It is very difficult to phase down and unwind capital controls, once they are imposed, Stavrinakis adds.
And in case you missed it there is something very wrong with Greek banks. And make no mistake, this train wreck is an indictment of the lousy job the Eurocrats have done in dealing with the crisis. One symptom is what has happened in Greece: keeping the country hanging in the breeze with continued draconian policies that induced and perpetuated depression and deflation. Another is the failure to address the rot in the Greek banking system. Third is the lack of remotely adequate deposit insurance.
This estimate is from a couple of weeks ago, when we first posted it, but it gives you a flavor:
Analyst David Zervos of Jeffries (hat tip Scott) claims that an default against ECB would make all Greek collateral ineligible for Eurosystem loans…
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!
As Nathan Tankus elaborates:
Most things in the European Union are designed to actively obfuscate reality. These are called deposit insurance schemes but that is a legal lie. In the United States the FDIC is Federal (its right in the name). The EU imposes a requirement that each country “insure” their deposits but it provides no financing for this. The last data I saw (which I can only verify from 3 years ago) is that the Greek deposit insurance fund has a paltry 3 billion dollars in it. In short there is no current backstop for Greek depositors. This is why they are talking about implementing a European wide deposit insurance union but that isn’t supposed to come until next year at the earliest and who knows if that will really happen and to what extent it will be universal among current Eurozone members. relevant links below.
Now in fact we already have capital controls and a bank holiday. The ELA is still at just under 90 billion. More deposits have left but even with the rapid outflow, the general picture is the same. And the Wall Street Journal points out, even with the current efforts to reduce the cash burn rate, Greek banks could become hopelessly insolvent before July 20:
Three-and-a-half billion euros. That is roughly how much cash Greece’s banks need to get through the week if each adult takes out the €60 ($67) they are allowed each day. It isn’t much for Greeks to live on, but it may be more than the banks have.
And the article points out a vector of contagion thanks to the failure to address the lack of deposit insurance, a banking prudence 101 provision in any advanced economy, combined with its depositor baii-in policies, which are almost designed to stoke bank runs. In Cyprus, only deposits over (€100,000 were haircut, but that was only after negotiation. The earlier proposals were to whack all depositors.
Whatever the outcome of the vote, both the ECB and the single European bank regulator need to look soon at how to ensure nervous depositors and investors don’t undermine banks elsewhere.
Portugal’s Banco Comercial Português, Italy’s Monte dei Paschi and Austria’s Raiffeisen Bank saw the biggest share-price falls Monday precisely because Greece highlights that banking union remains incomplete and banks in the bloc aren’t supported in the same way.
From now on, “whatever it takes” can’t mean only the ECB policy of buying bonds to hold down yields. Common deposit insurance, resolution authority and capital rules are critical to stopping the spread of financial instability.
Now with that ugly picture, one might reasonably argue that the bank bail-in mess is another insult to add to Greek injury. But that happens only if the ECB cuts or restricts the ELA. The choices now seem to be that it Greece voted yes and some sort of restructuring talks were underway, the ECB would figure out a way not to have July 20 be a default, despite that looking like an awfully hard date. Thus the alternative of a Grexit would force the government almost immediately into trying to make the payment system work, which at Nathan Tankus stressed, isn’t trivial, particularly since there are reasons not to seize the Bank of Greece, which for most practical purposes is an ECB operation. The lack of experienced government staff and specialists (even if they can round some up, they will be too few in number for the magnitude of the task) means if nothing else a protracted bank holiday. The longer banks remain closed, the greater the damage to supply chains and Greek businesses, which are the productive engine of the economy. Business collapses can’t be reversed. And as Nathan will discuss, financing imports after going on the drachma is difficult and will do more damage, not just to businesses, but citizens as well.
I wish Nathan had his investigations ready in end-product form and we hope to have some posts this week. Everything based on his granular work points to the impact of a banking system restructuring and conversion to the drachma being vastly more difficult and leading to more concrete harm than pundits and economists taking 50,000 foot views begin to comprehend. Mohamed El-Erain, no hysteric, placed the odds of Grexit at 85%, and gives a flavor of how deep the downside would be:
Greece is heading for a “massive economic contraction” and is likely to be forced out of the euro zone, according to Mohamed El-Erian, the former chief executive at Pacific Investment Management Co…
“What we are seeing here is what economists call the sudden stop, when the payment system stops. The logic of a sudden stop is a massive economic contraction, social unrest and it’s going to make continued membership of the euro zone very difficult for Greece….
“This is a tragic situation — we must not forget that there are Greek citizens that have already been suffering for five years,” El Erian said. “They’ve seen their living standards cut, unemployment is running at 26 percent, youth unemployment is over 50 percent and they’re about to face an even bigger depression.”
This is the biggest reason we have been so hard on the conduct of the Greek government. Varoufakis had concluded in his pre-Greek government writings that a Grexit would be a disaster for Greece. Yet his and his colleagues’ game of chicken approach to the negotiations meant that that was a very realistic outcome that they cavalierly assumed wouldn’t happen. As terrible as austerity is, a Grexit will be vastly worse, and not for six months or even a year. Aw we and others have stressed, Greece could well become a failed state, with human and social costs that would put any effort to assign mere economic damage to shame.
*Some readers insist a bailout could be revived. It could in theory be extended prior to June 30, although that is in practice impossible for a host of reasons we won’t belabor here. As we wrote in comments on another post:
And once Greece goes into default, all the parameters change. The country is guaranteed to go into an economic tailspin by virtue of the bank holiday alone, which is certain to last at least till July 5 and probably longer…. All the primary surplus numbers need to be rethought, just for starters. And the creditors will need to restructure the debt, something which was not on the table earlier. That means they need to decide what conditions (“reforms”) to attach to that.
Analysts at RBC have issued a research note, explaining why Tuesday will be a momentous day:
First, the current Greek bail-out programme expires.
This is important as this means the legal basis on which all potential further bail-outs were dependent expires. As the eurogroup meeting declined to prolong the current programme further that means that at the time of the proposed referendum, there is no contract in place that the Greek authorities could then accept or decline (i.e. technically, there is nothing to vote upon). Furthermore, the European side will find it difficult to then pay out any funds even if the referendum went in favour of any further bail-out. In that case, we reckon, a completely new contract would have to be drawn up that would then have to be passed by all relevant member states’ parliaments.
** Merkel couldn’t extend the bailout even if she wanted to. It takes parliamentary approval and she does not have the votes.