Saturday, September 5, 2015

Greece and Banking, the oped

Source: Wall Street Journal; Getty Images
A Wall Street Journal Oped with Andy Atkeson, summarizing many points already made on this blog. This was published August 5, so today I'm allowed to post it in its entirety. You've probably seen it already, but this blog is in part an archive. If not, here is the whole thing, with my preferred first paragraph.
Local pdf here.

Greece's Ills [and, more importantly, the Euro's] Require a Banking Fix 

Greece suffered a run on its banks, closing them on June 29. Payments froze and the economy was paralyzed. Greek banks reopened on July 20 with the help of the European Central Bank. But many restrictions, including those on cash withdrawals and international money transfers, remain. The crash in the Greek stock market when it reopened Aug. 3 reminds us that Greece’s economy and financial system are still in awful shape. 

Greece’s banking crisis revealed the main structural problem of the eurozone: A currency union must isolate banks from sovereign debt. To fix this central structural problem, Europe must open its nation-based banking system, recognize that sovereign debt is risky and stop letting countries use national banks to fund national deficits.

If Detroit, Puerto Rico or even Illinois defaults on its debts, there is no run on the banks. Why? Because nobody dreams that defaulting U.S. states or cities must secede from the dollar zone and invent a new currency. Also, U.S. state and city governments cannot force state or local banks to lend them money, and cannot grab or redenominate deposits. Americans can easily put money in federally chartered, nationally diversified banks that are immune from state and local government defaults.

Depositors in the eurozone don’t share this privilege. A Greek cannot, without a foreign address, put money in a bank insulated from the Greek government and its politics. When Greece’s banks fail, international banks can’t step in to offer safe banking services independently of the Greek government.

European bank regulations encourage banks to invest heavily in their own country’s bonds, even when they have lousy ratings. The flawed banking architecture of Europe’s currency union pretends that sovereign default will never happen. Wise Europeans have known about these flaws for years, but the system was never fixed because it allows indebted countries to finance large debts.

This is the euro’s central fault. A currency union must treat sovereign default just like corporate or household default: Defaulters do not leave the currency union, and banks must treat sovereign debt cautiously. When Europeans can put their money into well-diversified pan-European banks, protected from interference from national governments, inevitable sovereign defaults will not spark runs, or destroy local banks and economies. And government bailouts will be far less tempting.

That is the long-term fix, but how does the eurozone get out of its current mess? The ECB’s latest Greek bailout deal is focused on long-run structural reforms, asset sales, budget targets and illusory tax increases. It might at best revive growth in a year or so.

But without well-functioning banks, Greece’s economy will collapse long before such growth arrives. To revive the banks and the economy, Greeks must know their money is safe, now and in the future. So safe that Greeks put money back in the banks, pay debts and seamlessly make payments—with no chance of a euro exit, tightened capital controls that impede international payments or depositor “bail-ins,” a polite word for the government grabbing deposits.

The United States offers a precedent. The U.S. economy ground to a standstill in the banking panic of 1933. The administration of Franklin D. Roosevelt closed America’s banks with a national banking holiday to stem the bank run. It then took immediate steps to restore confidence with the clear promises of the Emergency Banking Act of 1933 to resolve insolvent banks, promises backed up by the remarkable rhetoric of FDR’s first fireside chat and the intact borrowing power of the federal government. When banks reopened, Americans lined up to redeposit their money. In the 1980s, the U.S. deregulated banks to allow extensive branch and interstate banking, further isolating local banks from local troubles.

Europe is headed toward bailing out both the Greek government and Greece’s struggling banks. Instead, Europe should resolve and recapitalize the banks alone, put them under private European ownership and control, and insulate them from further Greek government interference. Then Europe can let Greece default, if need be, without another bank run.

Then move on to Italian and Spanish banks, which are similarly larded up with government debts and are threatening the euro. These banks can still be defused slowly, selling their government debts, without huge bailouts.

Europe needs well-diversified, pan-European banks, which must treat low-grade government debt just as gingerly as they treat low-grade corporate debt. Call it a banking union, or, better, open banking. The Greek tragedy can serve to revive the long-dormant but necessary completion of Europe’s admirable common-currency project.


  1. Why would Greek banks collapse if, as at present, they can't diversify their reserve assets? Greeks still have to pay their taxes to their own Govt and can will do so using the Banking system. Those who sell goods and services abroad will be accommodated with a different type of account which permits some percentage of convertibility. In effect, you will have a multiple exchange rate regime.
    The Greek State's marginal propensity to import will be curbed because most of its revenue will be from non-exporters using the less favoured type of Bank account. The same goes for non-exporters.
    Greeks can then have whatever Tiebout model they want with little impact on the primary surplus required by the Financial Stability Facility.
    The alternative- viz. truly independent Banks- does not get round the problem that Greece may elect a Govt. which wants to mobilize foreign resources to achieve its Utopia and can do so in the short term before running into a liquidity crisis.

  2. What an interesting review, thanks professor Cochrane for sharing your angle on this central topic. Made me think about prof. Mehrling from Columbia in Coursera, he also as yourself pointed out in the direction of better institutions that could secure the entire EU system. Your review also transported me back to may 2010 to my first macro lectures, back then I understood how the monetary union meant to give away monetary independence. Fascinating how a little improvement as you point out can lead to a better outcome, cool reading! FDR truly was a new deal.

  3. US unemployment at its lowest since the great recession, last quarter almost 180thousend jobs were added bellow expected but good enough, and then there is China's slowdown. Crucial events are unraveling these questions that you resolve point out to were will output and inflation be in the future, as a prediction tool, man what cool tool! Awesome references, thanks for that. Now the fact is this to me as a student, when it will happen, and how this new bomb will shake the foundations. I heard these metaphor about the economy as a cargo train, meaning that it takes time to see slow or rapid growth. You mentioned that FED authorities have this impeding question, what will be the magnitude, projections can be such a feeble resource, better keep an open eye. Thanks for sharing proffesor Cochrane.

    1. You're kidding about making predictions, right?

    2. my bad this comment was meant on whither inflation what happens is that on that article there is a neat tour into macro modeling which in a sense is a cool tool to predict market behavior :) ....

  4. Two questions;

    If these restrictions were removed wouldn't everyone rush to put their money in banks of more stable economies? If I were a prisoner of the Greek banking system and I saw a way out I'd run to get in line without stopping to flush the toilet.

    Wouldn't yields in the periphery blow sky high if the national banks didn't have to buy them?

    Two of my tin foil hat concerns:

    There's a disquieting parallel between the formal EZ setup and the increasing difficulty Americans have opening foreign bank accounts. Our money is becoming increasingly trapped here.

    Executive Order 6102 and the subsequent devaluation of the dollar remind us to never underestimate the extent to which a desperate government will go to rob its citizens. We're so used to having our pockets picked by deliberate inflation and deficit spending most people don't realize what's happening.

  5. John,

    "When Europeans can put their money into well-diversified pan-European banks, protected from interference from national governments..."

    This is just silly. National governments provide a legal system for the protection of agreed upon contracts (for instance debt contracts through bankruptcy law). To say that banks should be protected from interference from national governments completely misses the legal protections that banks (as creditors) receive.

    If you think the banking system can survive on it's own without those legal protections, you are ignoring a lot of history.

    The question becomes - how do you unify a system of laws under a currency union without a fiscal union? Separate legal systems provided by various national governments create an environment of forum shopping - creditors look for legal protections of national governments that heavily favor creditors, debts look for legal protections of national governments that heavily favor debtors.

    1. I don't see your concern. We have thousands of pages of constitution and law saying the government can't grab your property, enforced by that very same government. We have effective prohibitions against the central bank printing money and handing it out. Why can there not be effective laws prohibiting banks from holding too much government debt?

    2. John,

      "We", the United States, has a central federal government that provides legal services (paid for by taxpayers in all cities and states). The European Union as a currency union does not. There is no European Union Constitution (Maastricht Treaty not-withstanding).

      "Why can there not be effective laws prohibiting banks from holding too much government debt?"

      Who enforces those laws in a currency union?

    3. John,

      Its a simple question, I am a debtor in Greece borrowing from a pan-national bank headquartered in Germany. Whose system of laws should govern if I fail to pay back my debt - Greek law or German law?

    4. "We have thousands of pages of constitution and law saying the government can't grab your property"

      Except for drug kingpin laws and the Patriot Act, which have been repeatedly abused to part honest citizens from their property without due process. And then there's eminent domain.

  6. Thank you!... the Greek debt problem is far more of a Greek bank problem than it is a Governmental problem.

    The scary event is not that the Greek Government misses a coupon payment. The scary event is that when they threaten to miss a coupon payment, it paralyzes the banks, and citizens cannot continue with their basic economic activities.


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