Monday, July 13, 2015

Greece again

I read this morning's news of a deal -- we'll see how long it lasts -- with interest. Here's a video exchange with Rick Santelli on the subject on CNBC (I can't seem to get the embed to work, so you have to click the link.)

My main thought: what about the banks? The minute Greece reopens its banks, it's a fair bet that every person in Greece will immediately head to the bank and get every cent out. The banks' assets are largely Greek loans, which many aren't paying -- why pay a mortgage to a bank that's already closed and will probably be out of business soon anyway -- and Greek government debt; mostly Treasury bills that only roll over because banks hold them. They can't sell either, so the banks will instantly be out of cash.

The deal reported in today's papers really barely mentions that problem. But that is the problem of the hour.

Greece is basically off the euro now. Being in the euro does not mean that restaurants take euros. Being in the eurozone means that banks use euros, that you can take euros out and arrange international transfers using euros.

The economy is paralyzed. The main thing a deal needs is a way to reopen banks in a matter of days. Privatization and labor laws are fine, but that generates growth a year from now at best. And raising taxes? They must be kidding.

I've read with interest some proposals that the EU take over the banks. The EU takes on the bad assets, gives or sells the rest to large international banks, and these operate under EU rules -- not Greek regulators; they can't buy any Greek debt, and Greece can't tax them.  It's expensive, yes, but it's basically as shoot-the-hostage approach. A functioning economy would help Greek finances. And then the EU can let the Greek government default if it wishes.  Saving the banks might be a lot cheaper than saving the Greek government and the banks.

There are two original sins in the euro, neither having to do with fiscal union. The first is that each country has its own banks, and each government uses its banks as piggybanks to stuff with government debt. European bank regulators and Basel regulations treat sovereign debt as risk free. Then, if the government defaults, the whole banking system is dragged down with it. The second is the endlessly repeated fallacy that government default means the country must change the units of its currency. If Chicago defaults on its debts, nobody thinks it must introduce a new currency, or that Chicago's banks will fail.

A currency union needs a banking union, or at least banks that are not stuffed with government debt. A currency union needs to let sovereigns default without changing currencies or paralyzing the banking and payments system. A currency union needs a banking union.


  1. I think a default with Greece does mean out of the currency union effectively IF the troika refuses to help them afterwards, because nobody else will lend them euros afterwards for years; so either the government/state collapses or they attempt to finance their expenditures with new money (drachmas) instead, whereas with Chicago they'd have support of the federal government.

    It's better to have your debt held by domestic banks than external creditors. With domestic banks you can basically force them to accept much lower interest rates, especially if you have your own currency allowing the central bank to buy as much debt as needed to keep rates down. Domestic banks also can't force ridiculous terms on your government like external creditors can. True there's a risk of inflation, but I'd take inflationary policy over a depressionary straitjacket any day. I like to think of inflation as just the market taxing itself, and hyperinflation as a vote of no confidence in the government by the market. The problem is definitely that this mechanism is not enabled when you're in a currency union.

  2. "A currency union needs a banking union."

    A debt based currency needs legal services provided by government. Or did you have in mind private banks printing competing currencies via fiat with no legal attachments?

    "If Chicago defaults on its debts, nobody thinks it must introduce a new currency, or that Chicago's banks will fail."

    If Chicago defaults on it's debts - both city representatives and Chicago's creditors will go before an Illinois state court to seek remedy. The Illinois state court system can impose tax / spending policies that contravene those set in place by the elected representatives of the City of Chicago. Now try that with a sovereign country.

    Who is the "higher authority" when it comes to sovereign Euro debt?

  3. "A currency union needs a banking union."

    Sounds good and was discussed in policy circles a few years ago. However, it turned that European politicians mean by banking union basically a full insurance system (strong banks cover potential insolvency losses of weak banks) without changing the current habit of using "banks as piggybanks to stuff with government debt". This cannot work.

  4. "Then, if the government defaults, the whole banking system is dragged down with it."

    The whole banking system of Greece is dragged down with it. So what stops someone living in Greece from using a bank outside of Greece and why is this a problem? Is banking such a sacred industry that it can't be outsourced?

    It seems to me that it would be easier to outsource the Greek banking system that is not beholden to the voters in Greece than it would be to replace the Greek government that is beholden to the voters in Greece.

  5. I take it as a given that the banks will be bailed out - although there may be a "bail in" for any remaining large depositors.

    It seems to be central to the plan that Greece will transfer 50 Billion Euros worth of assets to some sort of resolution trust. I don't know what Greece owns but I expect these assets will include things like airports, railways, harbors and other major pieces of infrastructure (maybe bridges). The problem is going to be: who in their right mind would buy a high profile asset? Buy an airport, for example, and you are probably guaranteed to have demonstrations, riots and eventual expropriation by a new Greek government. I suspect that the best that the resolution trust is going to be able to accomplish is to find private sector operators willing to pay some form of rent.

  6. As long as Greece stays in the euro zone with a hideously inefficient economy it will require perpetual fiscal transfers. Everything else is simply a matter of opinion as to how to deal with it.

    More cowbell!

  7. "There are two original sins in the euro, neither having to do with fiscal union."

    There is one original sin occurring with all sovereign debt - voting rights are not transferred when sovereign debt is sold from one party to another.

    If the Greek government had been able to internalize it's own finances with either higher taxes, lower spending, or a higher private savings rate, then none of this would have happened.

    If tax revenues are not sufficient to support the payments on sovereign debt held internally by Greek citizens, then Greek citizens (as a voting block in Greece) can demand change. Can Germans (or French, or any other nationality) do the same without fiscal (meaning legal system) union?

  8. Good post, although I'm not sure Rick Santelli got what you were saying.

    You've made this sort of analogy before, which I think is very instructive. Detroit defaulted and went into bankruptcy but the U.S. didn't kick Detroit out of the dollar-zone so why should this apply to Greece? Because, as you noted, of the way they have their banks set-up on a country level.

    And, as you pointed out, if the ECB extends say 100 billion euros through the ELA to provide liquidity to Greek banks, it's a safe bet that 100 billion euros will vanish within 24 hours of re-opening the banks.

    I'm wondering if there are other ways to get your hands on euros. For ex., here in the U.S. I can withdraw more money than I have in my account. I'll get hit with overdraft fees but if I thought that the bank would be insolvent tomorrow then who cares.

  9. The main problem was that the authorities were threatening to amputate Greece from the euro system. With a commitment not to do that, the problems would have been manageable (except for the 'problem' that Greece would have negotiating leverage with its creditors). Likely there would have been no bank run to begin with, but in any case the system can painlessly accommodate one, as it was doing before June 28.

    Naturally the commitment must be mutual - it wouldn't be acceptable for the Greek central bank to amass euro liabilities and then depart the system (Hans Werner Sinn's worry).

    In time the euro zone banking system may become so homogenized and interconnected as to make an amputation unthinkable.

  10. It seems to me that Greece is providing a great opportunity to explore the relative effects of various ways of using Keynesian stimulus. I embodied this idea into a post Three Experiments in Keynesian Stimulus .

    I certainly feel empathy for the Greek people. Their economy has come apart at the (monetary) seams.

  11. The EU takes on the bad assets, gives or sells the rest to large international banks, and these operate under EU rules -- not Greek regulators; they can't buy any Greek debt, and Greece can't tax them. It's expensive, yes....... And then the EU can let the Greek government default if it wishes.
    Excellent. How much does it costs though, because here it seems the creditors do not want to risk or lose much money. We are talking 25 billions to recapitalize the banks in the latest proposal and if you let Greece default on debt owed to IMF, BCE and UE we are talking another 200 billions.
    Having done that Greece has been freed from the endless cycle of debt rollovers and has banks that are also free to function for business. And it can finally kick out the Troika and put up a "keynesian" deficit of 8% of GDP like the UK and US a post 2009. And since it cannot be blackmailed anymore through its banks and its debt like now, Greece holds the knife and can threaten Grexit,,,,

  12. ALL YOUR BANK ARE BELONG TO US (know your Zero Wing memes!)

    Greece: What happen?

    Tsipras: Somebody set up us the financial bomb.

    Greece: We get conflicting signal.

    Tsipras: What!

    Greece: Mainstream Media turn on.

    Tsipras: It's You!!

    Schauble: How are you, gentlemen!! All your banks are belong to us. You are on the way to destruction.

    Tsipras What you say!!

    Schauble: You have no chance to survive make your time. Ha Ha Ha Ha ....

    Greece: Alex!!

    Tsipras: Take off every "zig"!! You know what you doing. Move "zig". For great justice.

  13. You can kill an economy through taxes and statism, and you can kill an economy through tight money.

    In Greece, they are trying both!

  14. I worry about the privatisation of state property. This looks like a repeat of the Asian Financial Crisis episode in Indonesia. I am amazed at how dignified the response of this country of about 10 million have been to all this. They say they need a bailout of 370 billion dollars; that compares with the 814 billion and 2.5 billion the noble guys at Goldman Sachs and Citicorp received.

  15. I think the argument about banks is very correct, but it is not the political climate to talk about saving the banks, unfortunately.

    Also, the EU recognized the need to break up the sovereign-bank loop/link when they have set up the ESM but they did not finish the work, as one can see. If the Greek banks are exposed mainly to the Greek economy, which is not going well, and the government does its best to increase uncertainty, the Greek banks become rapidly insolvent.

    An EU takeover of the bank (EU taking over the banks, supervising them, not allowing them to finance the Greek state and inforce the black economy and tax evasion) is, in my mind, good advice from an economic point of view.

    However, i can see even more people howling how Greece is humiliated, they became the economic ward of the Germans and all is just a very ugly international conspiracy to rob the proud Greek people and make them lose sovereignty.

  16. Let me see if I have this straight. In order to receive recapitalization of the Greek banks, Greece must agree to privatization. The assets to be privatized, however, are a traditional source of political bribes and favors used by Greek politicians. They're asking Greek politicians to give up the bag of goodies that empowers and enriches them.

    Even if they agree to privatization the banks are all but dead. They were carrying 40% bad loans before the capital controls and now nobody is making any loan payments so whatever requirements they're thinking about are probably too low as we saw in Cyprus.

    Another reform requirement is adoption of the new European policy on bank resolution that provides for bail-ins before hitting taxpayers for money. Deposits below €100,000 will be covered by Greece’s deposit insurance IF Greece accepts the current package. But will the amount promised be enough once the banking system collapses?

    If Greece rejects this offer there will be no money to bail out the banks or insure deposits. Who will have money for paying taxes? The government won’t be able to pay salaries and pensions, and refusal to take cuts in wages and pensions has been a sticking point during the past 6 months of drama. Greece would have to leave the euro and issue its own currency - if it can afford the paper and ink. Maybe the old drachma plates are still in storage. Perhaps they could convert to Bitcoin. You don't need banks or printing presses for that.

    It seems that accepting the deal means less short term pain (but still the potential for a bail-in) with never-ending debt-servitude, whereas rejecting it means much more short term pain but a chance to regain self-determination (which quite honestly hasn't really served Greece well either). An inadvertent benefit of privatization would be the gutting a major source of political corruption.

    I don't see a graceful way out of this. It's a great example of how kicking the can just means facing a worse situation later on.

  17. Bank deposits are insured up to EU 100,000 so do we have any estimate of how many accounts still in Greek banks exceed that figure, and by how much? Those accounts under the limit will stay in the bank, when it reopens, as long as Greece is in the eurozone.

    1. Per the FT, 20 billion of the 130 billion in deposits are above the cut-off. That leaves 110 billion. Greece's insurance fund has about 3 billion and the ECB is offering 25 billion. That means there's a buffer of 28 billion if Greece takes the deal but if the Greeks pull out every last euro they can, it won't be enough. That means capital controls for the foreseeable future or a bail-in, or both. Of course, if they decline the deal that 3 billion won't last very long at all.

      Greek banks also hold loan loss provisions that cover up to 60%, but since it's unlikely anyone is making loan payments and pre-controls bad loans were at 40%, it's doubtful whether that's covered either.

      With apologies to Monty Python:

      This banking system is no more! It has ceased to be! It's expired and gone to meet its maker!

      It's a stiff! Bereft of life, it rests in peace! If the Troika hadn't nailed it to the perch it'd be pushing up the daisies!

      It's banking processes are now 'istory! It's off the twig!

      It's kicked the bucket, it's shuffled off it's mortal coil, run down the curtain and joined the bleedin' choir invisible!!


    2. Thank you very much, but don't you see that - coincidentally? - the total deposits in the Greek banking system are exactly matched by the valuation in the EURECA plan of 2010, promoted by Roland Berger, a consulting firm, but originating in the German finance ministry to avert the first Greek bailout.

  18. This was proposed by Voroufakis. The Troika (or whatever they are called now) said "ah yes, very good idea" and then proceeded to forget it. Now Voroufakis is gone and the "Institutions" are meet the new boss, same as the old boss.

  19. Varoufakis all along supported Grexit and default on all $400 billion Greek debt (not including accrued and contingent liabilities) and at this point Schäuble agrees with him on Grexit: there is no future state-space geometry in which the austerity Greece tries to avoid will not get considerably worse. The original EURECA plan called for EU 125 billion state assets to be privatized and they still could be, this EU 50 billion is the same number adopted in 2010 and never implemented.

    For comparison, $400 billion is the entire Pentagon budget.

  20. Interesting aside in FT blogpost, if a euro deposited in a Greek bank is trading at a discount to a euro deposited in another European bank, where do we find out how much is the discount, even in the old Russian collapse we knew roughly what a Ukrainian ruble deposit was worth compared to a Kazakhstan ditto, while of course a physical ruble was worth the same everywhere. Btw, this can't be the same as a deposit haircut (Cyprus style) because 1. the banks have some EU 32 billion in equity, preferred, hybrid, own bonds, before they get to the depositors, 2. however (and contrary to what was stated here before) the ECB isn't offering any EU 25 billion, that money is to come from privatizations, and 3. the US-based hedge funds, private equity firms, in addition to the long-suffering European investors, are finally losing patience and suing:

  21. Finally I can read a a sane article about problems in Eurozone. This one is way better than all the other article using "Optimum Currency Area" as some kind of incantation without really explaining what is really means. And these were the better ones, I also cringed reading "Milton Friedman was against Eurozone" pieces. So thank you for this.

  22. Thanks from me as well. Regret posting under pseudonym but even so can say I'm a longtime associate of prof. Mundell and he has always known money (euro) will only do well if credit is sound and credit backed by worthless sovereign paper obviously isn't. There isn't enough gold to make a difference in reserves but prof. Cochrane is right, sovereign paper should be marked to market and insured. Counting it as tier 1 capital no matter who issued it is a recipe for disaster - better yet, of course, would be barring banks from holding sovereign paper altogether. If I may add one more remark, concerning prof. Cochrane's concept of liquidity premium for cash being excessive: it's not, because money isn't simply credit at time zero, it embodies trust in the issuer, it's a symbol. Think of it as a kind of flag - people will risk their lives to save their flag, and that's not because they are in dire need of a piece of cloth! Thank you again :)

  23. "The first is that each country has its own banks, and each government uses its banks as piggybanks to stuff with government debt."

    Is it the case that 1) European banks are prohibited from operating branches across national borders, and 2) that Greek banks were forced to buy Greek sovereign debt? If that is indeed the case, were not the banks de facto nationalized already?

  24. I honestly don't see how the greeks can dig themselves out of this hole. Even if Greece created a new currency and left the eurozone and magically repaid their loans, they would be in bad shape down the line. Their economy is geared towards consuming imported goods and services. While they do have some tourism, it wouldn't be enough to keep them from a deficit. If they could have fixed that, they wouldn't have needed to enter in the eurozone in the first place. Raising their taxes or leaving the EU is not going to help them at all and will certainly raise more problems. However I don't blame them for taking that route, it doesn't seem that Greece has much options.


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