Will ECB Spur an International Banking Crisis?
The European Central Bank has stopped providing liquidity to some Greek banks as they have not been successfully recapitalized, the ECB said on Wednesday, confirming news earlier reported exclusively by Reuters.
The news sent the euro lower against the dollar, fanning concerns among investors and in Greece that the country may have to leave the euro zone.
The development highlights the weak state of the banking sector in Greece, where Greeks are pulling euros out of the banks in fear that their country may exit the European single currency despite the declared determination of EU powers Germany and France to keep Athens in the monetary union.
"As recapitalization wasn't in place, the ECB stopped monetary policy operations," a euro zone central bank source told Reuters, declining to be identified. "They are now in the ELA of the Greek central bank."
The ECB only conducts its refinancing operations with solvent banks. Banks which fail to meet strict ECB rules but are deemed solvent by the national central bank (NCB) concerned can nonetheless go to their NCB for emergency liquidity assistance (ELA).
The sources did not name the banks concerned.
An ECB official later added: "Pending the recapitalization of Greek banks that are severely undercapitalized as a result of the recent PSI (debt restructuring) operation, some of the Greek banks have been moved to Emergency Liquidity Assistance."
"Once the recapitalization process is finalized, and we expect this to be finalized soon, the banks will regain access to standard Eurosystem refinancing operations," the official added. "The ECB/Eurosystem (of euro zone central banks) continues to support Greek banks."
It was unclear exactly how many lenders were affected but the development marked a increase in the number of Greek banks depending on emergency borrowing from the Bank of Greece.
One person familiar with the matter said four Greek banks' capital was so depleted they were operating with negative equity capital. According to its own rules, the ECB cannot provide liquidity to banks in such a situation.
ECB policymaker Luc Coene told the Financial Times in an interview released earlier this week Greek banks on ELA were still solvent.
Greece's cabinet on April 27 agreed a state bank support fund (HFSF) would provide the country's four big banks with 18 billion euros worth of European bonds as an interim solution until they are recapitalized later in the year.
The fund will allocate the 18 billion euros by next week to the country's four biggest lenders as an interim recapitalization, its chief said on Wednesday.
"Procedures to allocate the funds should be concluded by next week," the head of the Hellenic Financial Stability Fund (HFSF), Panagiotis Thomopoulos, told Reuters.
Athens is working with EU/IMF officials on technical aspects of a recapitalization plan for its banks, likely to be unveiled after the national election.
About 50 billion euros ($66 billion) have been earmarked in Greece's second bailout to prop up its struggling banking sector.
ECB President Mario Draghi said earlier the central bank wanted Greece to remain in the currency bloc.
"I want to state that our strong preference is that Greece will continue to stay in the euro zone," he said in a speech, adding: "Since the treaty does not foresee anything on exit (from euro), this is not a matter for the ECB to decide."
When I read this article on Wednesday afternoon, my first thought was "what the hell is the ECB thinking? Are they trying to cause a major run on Greek banks and an international banking crisis?"Apparently, I wasn't the only one thinking this. Much to his credit, Jim Flaherty, Canada's finance minister, came out to warn that the ECB move on Greek banks could ‘shock’ global economy:
Canada’s economy is showing surprising signs of resilience, but the outlook for sustained growth, albeit moderate, is still clouded by events outside our borders.
The latest evidence that a recovery could indeed be gathering strength came Wednesday from the manufacturing sector. Shipments of factory goods increased far more than expected in March, bouncing back from an equally surprising contraction in the previous month.
But the finance minister tempered that optimism, warning the debt crisis in Europe could yet “create a shock that will affect Canada.”
“Our banks are strong but we’re not completely immune from the state of the global economy,” Jim Flaherty told a Senate’s banking committee, after the European Central Bank earlier Wednesday said it was no longer providing liquidity to some undercapitalized banks in debt-crippled Greece.
The European Union is Canada’s largest trading partner after the United States, with the United Kingdom the No.3 destination for our exports.
“No one can say for sure what will happen . . . if Greece ultimately leaves the Eurozone,” said Douglas Porter, deputy chief economist at BMO Capital Markets. “No one is really sure what the fallout from that will be. Suffice it to say, it won’t be pretty.”
Indeed, a Greek exit from the Eurozone won't be pretty and contagion effects will ripple across the international banking system. And as Mike Dolan of Reuters reports, Greece now faces limbo in euro twilight zone:
Speculation about an endgame in Greece’s protracted crisis has flooded markets with euro exit scenarios this week, but investors reckon there’s still every chance that uncertainty will simply drag on for months.
Seeking clear-cut outcomes to the euro saga to date has proven fruitless for investors, who have instead been forced to live with the “muddle through” of European politics.
And more used to precedent, probabilities and precise numbers, asset managers are far from their comfort zone when interpreting the hyper-politicized standoff over Greece’s future membership of the single currency.
So instead of mapping binary outcomes, investment strategists are once again looking hard at the grey areas.
The political vacuum in Greece after May 6′s inconclusive elections seems to have hastened a showdown where no government in Athens can deliver more budget cuts, so no more bailout funds are forthcoming and public money drains away, leading to mass defaults and a euro exit with all its wider ramifications.
And if that’s the will of the Greek people, then it may be tempting for all sides to try and manage the outcome as best they could. But nothing’s that simple. Even though Greek voters rejected austerity in favour of anti-bailout parties, opinion polls show more than 75% want to stay in the euro.
What happens when the cash runs out is the crux question. Greece will most likely need more outside funds from its bailout program before any new elections in June establishes a fresh mandate to secure further tranches of foreign money.
So what analysts are homing in on is whether Greece can bridge any gap while still staying in the euro.
IOU OR PROXY DRACHMA?
Many are looking at the possibility that Athens issues IOUs to meet salaries and key service bills for a fixed period, much in the way California did during its budget crunch in 2009 when it issued ‘registered warrants’ with a coupon in place of dollar salaries and which banks then accepted for cash.
Much hinges on whether the European Central Bank would allow the Greek central bank to accept such IOUs and there’s little clarity on those hypotheticals.
However, strategists reckon any Greek government IOUs would quickly act as a proxy for a new drachma and exchange values against the euro would mostly likely plummet in practice as people rushed to cash out — offering Greeks a glimpse of the shock of devaluation in a euro-ized economy with euro-denominated debts.
“I’m really not sure Greece could survive for very long if external money was cut off,” said Darren Williams, economist at fund manager AllianceBernstein. “But what an experience of IOUs may do rather quickly is bring home to the average Greek citizen just how much more difficult a place it is outside the bailout program and outside the euro.”
Others said that such an unstable twilight zone within the euro but with a parallel proxy drachma could possibly last for several months as the euro policy machine churned.
“Whether it is something that lasts six to 12 months or something that lasts longer term depends on how many IOUs they have to put out,” said Erik Neilsen, global chief economist at Unicredit. “And that will be a function of how deeply the economy collapses.”
The limits of any half-way system hinge on domestic depositors’ anxiety and the risk of accelerated capital flight from Greek banks. It would be hard to calm fears of capital controls and, as per Argentina’s break with its dollar peg in 2002, forced conversion of euros in Greek banks into new drachmas.
But this is where the story changes. Depositor concerns in Greece could well infect other periphery euro economies and cause consternation — upping the ante for euro policymakers to respond, either through fresh action from the European Central Bank to reliquify banks or open-ended government bond buying.
RBS analysts warned on Monday that in the event of another hung parliament “Greek government IOUs could trade as proxy currency as early as July. This may then galvanize a large pro-euro vote intention into accepting Troika demands. If not, exit looms.”
But they added that only returns investors to guessing about wider policy responses.
“Opening up the Pandora’s box of exit means deposit risk across the periphery. The future of the euro would then be dictated by the subsequent policy response.”
Seeing binary outcomes by fixed deadlines still seems a dangerous way to invest on this and daily scenario sketching is probably a safer option through a likely fraught summer period.
David Shairp, global strategist at JPMorgan Asset Management, said the situation was “incredibly fluid” but one possibility was certainly prolonged stalemate, one that may be better for world markets than a dramatic end-game but carrying all the gnawing uncertainty along too.
“Increasingly we’re dealing in the realms of political economy rather than pure economy and that makes things so much more difficult for multi-asset investors.”
We are dealing in the realm of political economy, and not just any economy, the Greek economy. A caretaker government will take over till the next elections. Over the next month, Greeks will hear an endless barrage of political leaders slamming each other.
New Democracy head Antonis Samaras on Thursday slammed radical left SYRIZA and the coalition’s chief Alexis Tsipras for their calls to repudiate the memorandum, saying that such a move meant "jumping off the cliff."
Tsipras countered by blasting 'pro-memorandum' powers:
As I stated in my last comment on throwing darts on the Greek crisis, I consider Alexis Tsipras to be a 37-year old political clown. Every time I read his statements, I think he's completely out to lunch.
Greek people will put an end to a political system of vested interests and corruption on June 17 said Alexis Tsipras, leader of radical left coalition, SYRIZA, on Thursday.
Addressing the left coalition’s elected MPs in Parliament, Tsipras accused New Democracy and PASOK of inventing unfounded dangers and generating negative speculation regarding the Greek economy’s collapse.
Tsipras argued that the existing political system had been taken by surprise following the recent May 6 elections and was now fighting back.
He also slammed New Democracy’s Antonis Samaras for his efforts to develop a pro-memorandum front with liberal Democratic Alliance and right-winng Popular Orthodox Rally (LAOS) and accused the ND leader of having no economic proposals besides the full implementation of the memorandums.
“The eurozone is not in danger because of Greek resistance, but because of the bankrupt policies of the memorandum, of yesterday’s political system,” he said.
Tsipras accused PASOK and New Democracy of planning to privatize the entire public sector and complete their “disastrous work,” arguing that the left was the only power capable of putting an end to this.
“No matter what Mr Barroso says, no matter how many letters Mr Papademos sends, hope is stronger than fear,” said Tsipras.
Of course, the powerful Greek public sector unions will all stand behind him because they truly think he will save Greece and guarantee their jobs for life, but what they don't realize is that as bad as the Greek economy is right now, it will be infinitely worse if they follow Tsipras off the cliff.
During this precarious time, it's crucial that European leaders and the ECB show the Greek people that there is hope within the Eurozone. Increasingly divisive rhetoric from all sides will only fuel more resentment leading to the eventual breakup of the Eurozone.
Alexis Tsipras might be a dangerous demagogue but he now carries tremendous political clout in Greece among the poor, unemployed and public sector workers all experiencing the effects of harsh austerity. Political leaders within Greece and across Europe have to tackle Tsipras rising popularity head on and expose him for the snake peddling charlatan he truly is.
Below, Bloomberg reports on the ECB's move to stop lending to some Greek banks. This isn't the time for such drastic measures. The ECB better heed the warning of Canada's finance minister and get its act together. If it doesn't, it will spur an international banking crisis.