Europe’s plotwriters are deciding what form catharsis will take
There is a palpable sense that the Greece-eurozone stand-off is approaching some sort of an endgame. What is it going to be? Charles Wyplosz nicely sets out the possibilities. To avoid a Greek exit from the eurozone, you need to either (a) avoid a Greek default, or (b) make sure you can handle the bank run that would very likely follow it. For Wyplosz, either case requires ample funding resources from the eurozone. The first in the form of refinancing the debt, largely held by the European Central Bank, maturing this summer; the latter in the form of unconditional last-resort lending to Greek banks by the ECB.
Because a sovereign default would make a lot of Greek banks’ assets ineligible as collateral for central bank financing, Wyplosz argues the second option really comes back to the first and the need to avert a default.
That’s a little quick. The amount of further liquidity that could legally be supplied is not entirely obvious. Fortunately, Eric Dor has just crunched the numbers on Greek banks’ state-dependent collateral. Everything depends on what haircut the ECB would require the Bank of Greece to apply after a Greek sovereign default. It currently averages about 40 per cent, which leaves room for an additional €50bn of central bank liquidity. If a default led to a 75 per cent haircut being imposed, that number would fall to €10bn – not very much in the face of a bank run. At 90 per cent, the amount of liquidity that could be supplied would be less than today, and banks would have to pay some of it back.
But that’s not the end of the story. First, the ECB could permit a haircut of less than 75 per cent if the Greek state partially honours its obligations. Second, Greek banks could presumably securitise some of their private-sector loans and pass them off as collateral. Third, capital controls would limit the need for liquidity. And, of course, fourth, the banks can be restructured – at large depositors’ expense – to reduce the need for liquidity and increase their eligibility for it. And all these options could be combined.
It would admittedly not be pretty. So it does make Greek exit look like a real possibility. That is not something to be welcomed. Those who think a return to the drachma would be good for Greece should take a look at what happened to Argentina when it left its dollar peg. Its devaluation did little to improve the trade balance (which was largely driven by the commodity boom), but a lot to redistribute wealth to those more likely to invest it than spend it. The increase in domestic investment helped Argentina’s growth, but this is a type of recovery oligarchic Greece needs like another Peloponnesian War.
Then there is the impact a Grexit would have on the rest of the eurozone, namely to prove the euro is not irreversible. A new ECB paper quantifies how damaging “redenomination” risk can be. In 2012, the big yield spreads for Spain and Italy were commonly attributed to self-fulfilling runs on sovereigns unable to print money to service their debt. In fact, a third to half of the spreads reflected the risk of a euro break-up, which is subtly but importantly different from sovereign refinancing risk.
Paul De Grauwe is therefore right to take Greece’s creditors to task for, it seems, deliberately pushing Athens into default. He makes a strong case that Greece, by now, is solvent but illiquid. Its debt has been stretched so far into the future that it’s quite possible to service, but it faces some large redemption humps this summer and next – largely because of the debt swap that kept the ECB out of the 2012 restructuring:
The eurozone should just swap these bonds, which should have been designed with longer maturities in the first place, for an ESM loan, which would relieve the ECB as well. But Greece’s “partners” insist on directing Greek economic policy in matters far beyond those to do with an ability to repay the official loans in future. Even on the narrow point of fiscal sustainability, the institutions formerly known as the troika seem to be committed to their old mistakes of squeezing the economy so hard that the debt becomes harder, not easier, to service. The Greek daily Ekathimerini reports that the ex-troika is demanding €3bn (nearly 2 per cent of GDP) worth of additional tightening measures because the weakening economy has the earlier primary surplus target out of reach. Will they never learn?
An earlier Free Lunch mused that the IMF could force the eurozone’s hand on extending the maturity of the ECB-held bonds. Doug Rediker has tweeted his scepticism: “IMF needs 2 fill financing gap AND agree country is sustainable. ECB has no tool for debt exchange.” We beg to differ. The ECB did take part in a debt exchange in February-March 2012: that’s how it ended up holding these bonds (and avoided the haircut). And the IMF should have more reason to judge Greece sustainable after swapping the ECB-held debt than it does not. As we all know, it’s a political decision – which is why our proposal is so unlikely to happen.