ECB to Greece: Drop Dead

Even by the standards of bank thuggishness, the move by the ECB against Greece last night was a stunner. Americans have become used to banks taking houses under dubious pretexts when both the investors and borrowers would do better with a writedown. But to see the ECB try take a country is another matter entirely. As one seasoned pro said, “If anyone had tried something like this against a country with a decent sized military, the tanks would be rolling.”

The ECB’s bombshell was to put Greece at risk of an intensification of its ongoing bank run in order to pressure it to agree to a deal with the Troika under an impossibly tight timetable, even shorter than the February 28 pre-existing deadline that Greece Finance Minister Yanis Varoufakis had planned to extend until June. As we’ve discussed at length previously, a longer negotiation timetable would be necessary to meet Greece’s objective of restructuring of the relationship with the Troika. Greece wanted that to be based on the recognition that Greece could never pay off its debts and that it was in both side’s interest to let Greece implement more growth-oriented policies. But the message from the enforcers at the ECB was unambiguous: Greece has no rights and needs to accept its debtcropper status.

The ECB has thus also effectively said that it would rather have fascists like Golden Dawn running Greece, which is what will eventually occur if it succeeds in breaking Syriza. It also just handed France’s Marine Le Pen, head of the nationalistic, anti-Eurozone Front National fantastic fodder for her campaign.

The February 28 date was the result of Greece presumably needing access to so-called bailout funds to pay off an IMF obligation coming due. Varoufakis said he would refuse those funds, and could get by until June, when more loans came due, by relying on existing tax receipts and getting what he regarded as minor waivers from the central bank. He also had some creative ideas for restructuring Greece’s debts and said that he wanted the OECD rather than the Troika to provide auditors on behalf of the lenders.

Even though we warned that the ECB was likely to use its control over liquidity facilities to stymie Syriza’s plans and force Greece to the negotiating table sooner rather than later, the smackdown was even more brutal than we imagined possible. The press release contains these main elements:

1. The central bank will not allow Greece to pledge Greek government debt as collateral for ECB loans after February 11. The mechanism was the lifting of a waiver that the ECB had in place. This in theory will not have an impact on the banks, since they hold little in the way of Greek sovereign debt* and in any event banks can still pledge Greek government debt for emergency lending purposes (note there has been misreporting on this issue). The immediate impact is to thwart Varoufakis’ plans to issue some additional short-term debt to carry Greece through June. Note that the ECB once briefly removed this waiver in 2012 when negotiations with Greece became fraught.

2. It stated that “it is currently not possible to assume a successful conclusion of the programme review.” This looks to be directed at Greece’s rejection of Troika bailout monitors.

3. It affirmed that Greek banks still have access to the emergency lending assistance, or ELA. But as we pointed out, that access is on a rolling two week basis. And now that Greece is officially on the ECB’s hit list, the renewal now becomes another choke point for Greece.

For the moment, the enforcers at the ECB seem to think they have enough of an upper hand via squeezing Greece via its access to funding markets. From the Wall Street Journal at the time of the ECB press release. Take particular notice of the final paragraph:

“Even with an extension of the current program, there will be challenging months ahead. But without such an extension the situation would become very tough,” one EU official said.

Another EU official confirmed that there was little willingness among eurozone governments and the ECB to allow Greece to issue more short-term debt, so-called Treasury bills, to plug funding holes in the coming days. An informal request to increase treasury-bill issuance to €25 billion from €15 billion currently—made by Mr. Varoufakis at meetings in Brussels earlier this week—is a no-go for Greece’s creditors…

Europe’s reluctance to let Athens borrow more short-term debt raises questions on how the government will meet debt repayments in coming months. In March and June, Greece has to pay almost €4 billion to the International Monetary Fund and smaller creditors. Bigger issues await in July and August, when some €7 billion in bonds held by the ECB mature.

But Greece’s financial situation could become dicey even before then. If the current bailout program expires as scheduled on Feb. 28, Greek banks won’t be able to get liquidity from the ECB anymore, due to the country’s bad credit rating. After that, they could still get funding from the Greek central bank, through so-called Emergency Liquidity Assistance or ELA, but this is also subject to ECB approval.

One of the EU officials said that ELA could continue “for some time,” without giving further details. The ECB has in the past threatened to cut off ELA funding to banks in Ireland and Cyprus to force national governments to agree on a new bailout program with the eurozone

And in an update in the European morning, the Journal describes, not surprisingly, that Greek markets are roiled. That was the point, after all. Key sections:

Athens’ main stock index plummeted 9% in early trade before recouping marginally, while the country’s two-year debt yield soared by more than three percentage points to around 19.30%.

Losses were particularly hefty in the banking sectors, where Piraeus Bank SA, National Bank of Greece SA, Alpha Bank AE and Eurobank Ergasias SA fell between 6% and 15% to the bottom of the Stoxx Europe 600 index, which was down 0.2%….

That heightened perceived risk of default was reflected in the Greek bond curve Thursday too. The yield on its five- and 10-year debt climbed sharply to trade around 14.9% and 10.7%, respectively. Yields rise as bond prices fall.

As we have said before, Greece is in a weak bargaining position. It may be able to go beyond February 28, but probably not very long. Some readers have suggested appealing to Russia, but not only would that unleash even more brutal treatment from the Troika, but the German press has also reported that Russia is not interested.

Varoufakis has ruled out a Grexit as ultimately hugely detrimental to Greece. Even if the Tsipras government were to decide to reverse course (likely leading Varoufakis to resign), he would probably want a referendum to make sure it had popular support. Most governments have procedures that don’t allow for them to be launched on short order. So even with this averse development, a Grexit seems unlikely.

The Greek government can implement emergency measures, like capital controls and restrictions on daily bank withdrawals, to reduce the bank run. Measures like nationalizing all domestic banks and implementing a plan to allow foreign banks to leave the country in an orderly manner works only if the Greek central bank can backstop the domestic banks, and that in turn works only in the event of a Grexit, since the central bank needs to be a currency issuer.

And of course, Greece can default.

In response to an e-mail tonight, Varoufakis wrote, “One thing we will not do is capitulate.” I hope readers will wish him and his fellow citizens good luck. But the Troika seems determined to destroy Greece if that is what it takes to show that their authority remains unchallenged. But the cost of discipling Greece is likely to be far greater than they imagine, not just in financial terms, but to the Eurozone project itself.

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* Details courtesy Bloomberg:

The Bank of Greece publishes a monthly balance sheet for Greek banks. Click on the liabilities tab: As of December 2014, the Greek banks owed €56 billion to the Eurosystem, via the Bank of Greece. What assets did they use as collateral to secure these loans? Click on the assets tab: The Greek banks only owned €12 billion in Greek government securities at the end of December, so these could only be securing a relatively small amount of the borrowing from the Eurosystem.

Taking a closer look, it becomes clear that Greek government securities are even less important as collateral than these figures make it seem. €7.4 billion of the Greek government securities owned by the banks were Treasury bills, so less than €5 billion were regular Greek government bonds. And other reporting (such as here and here) tells us the ECB has imposed a maximum limit of €3.5 billion on the use of Greek Treasury bills. (Another “rule” that’s basically just more ad hocery).

This means the Greek banks were using at most €8 billion in Greek government debt in December as collateral for loans from the Eurosystem. Set against the total loans of €56 billion owed to the Eurosystem this is fairly small beer. (Factoring in haircuts, its share in collateral would be even less than this comparison suggests).

So, on its own, the eligibility of Greek government bonds is just not that big a deal.