Sunday, 28 June 2015

The end of the lifeline

Three years or so ago I wrote several posts about the financial crises in Greece, in which my view of the bail-out was that "it can't work and it won't work".  Well, it couldn't, but I was wrong to think that "this could break down very quickly."   In fact, the Eurozone did an outstanding job of kicking the can down the road, keeping Greece afloat for three years without ever coming close to fixing anything.

The difficulty with this strategy was that the electorate in Greece hated the austerity imposed on it, and the electorates in the rest of Europe hated paying for Greek pensions.  The beginning of the end was the election in Greece early this year of the anti-austerity Syriza party, which was committed not to accept the inevitable terms of the next bail-out package.  Meanwhile, the rest of the Eurozone had successfully reduced the vulnerability of its banks and debtor nations to a Greek default.

The recent bail-out negotiations between the Eurozone finance ministers and the Greek government (represented by prime minister Alexis Tsipras and finance minister Yanis Varoufakis) have been a game of chicken.  Both sides know that a Greek default would be horrible for both of them, but the negotiations have failed because the Eurozone isn't quite scared enough of the consequences of default, and Tsipras is scared enough of the consequences from his party and his electorate of giving in to Eurozone demands.  Tsipras has now fallen back on holding a referendum next Sunday to find out if the Greeks want him to give up the policies they elected him on, which would be admirably democratic were it not for the fact that the government needs to pay €1.5bn to the IMF on Tuesday, and apparently it hasn't got it.

Oh well, not paying the IMF is embarrassing — Greece is richer than most IMF members — and could be treated as a default by the Eurozone (page 33 here.)  But neither the IMF nor the EU need rush to do anything about it.  So in practice a Yes vote in the referendum could still result in a bail-out which enables Greece to meet its interest payments.

But there are more immediate problems.  First Robert Peston for the BBC reported that "the European Central Bank's governing council is expected to turn off Emergency Liquidity Assistance (ELA) for Greek banks at its meeting later today", and later the ECB issued a statement, saying that it would "maintain the ceiling to the provision of emergency liquidity assistance (ELA) to Greek banks at the level decided on Friday (26 June 2015)".  Which is a gentle way of saying that it would not increase the ceiling — it would allow no new ELA.

ELA is necessary because there's a run on the Greek banks, whose depositors reasonably fear that the banks may run out of cash or the government may redenominate deposits into a new, rapidly depreciating currency.  Withdrawals take two forms: cash or transfers to banks outside Greece, and both need bank reserves at the Bank of Greece, which the Greek banks haven't got, either to buy banknotes or to fund interbank transfers via the Eurozone's TARGET2 system.

However, contrary to many reports, ELA is not money supplied to Greece by the ECB.  It's provided by the Bank of Greece; all the ECB does is to authorize it.  And it doesn't cost the Bank of Greece anything either — the money it lends the banks is just an accounting entry, the banknotes it can print in exchange for owing money to the ECB, and TARGET2 is the same without the printing.  The banks borrowing the money have to post collateral for the money they're borrowing, because it's suppose to help banks which are illiquid but not insolvent.  I suppose the Greek banks are in fact solvent so long as their billions of Greek government T-bills are treated as sound (which is absurd, but the ECB hasn't said so up to now).

So what ELA means in practice is the Bank of Greece incurring increasing 'Eurosystem' debts to the ECB.  But Eurosystem debts are not like ordinary debts: there is no requirement for them ever to be settled, and they carry currently a very low interest rate — I haven't found a clear statement from the ECB on interest charges, but this helpful paper says they pay the Main Refinancing Operation rate currently 0.05%, whereas this press release says the deposit facility rate, currently -0.2%, is applicable to TARGET2 balances (presumably only if positive), and this report quotes an ECB spokesman denying that.  (Frances Coppola says the balance isn't even a debt: I don't quite agree, but the difference between her view and mine seems not very important in practice.)

I wonder what would happen if Greece chose simply to continue with ELA, without the ECB's permission.  That would be a gross breach of the rules, but when you're about to default, you might live with that.  What would the ECB do?  I suppose it would suspect Greek access to TARGET2, but it's not clear to me what it could do beyond that, other than promise future non-cooperation.

If it's not willing to defy the ECB, Greece can keep its banks afloat only by redenominating their liabilities into a new currency - Grexit.  I suppose the government won't take that step before the referendum, so there would have to be severe limits on withdrawals and transfers, or simply bank closures, for the next week.

The other problem is that the Greek government has salaries and pensions to pay.  Varoufakis said a month ago that he'd rather pay the pensioners than the IMF, and my guess is that they've got the money somewhere for this month.  If I'm wrong, they're faced with the same two choices: raise money by selling the banks T-bills paid for with money created and loaned by the Bank of Greece, all in defiance of the ECB, or pay the pensions in a new currency.

The Euro has been a remarkable experiment - a currency shared by dissimilar countries with independent governments, and run by independent national banks.  I confess to being intrigued by the way in which it's in part unravelling.  If only there weren't more at stake than entertaining bloggers...