Greece:Her banks need cash and a suggestion for the International Monetary Fund

After updating yesterday on the Greek financial crisis I thought that maybe it might calm down for a day or two but in fact the issues are escalating and we are now in a full-blown liquidity crisis albeit one which at times feels like it is arriving in slow-motion. There were two further developments on the day one which involved the Greek banks and the other involved the International Monetary Fund which is currently in Athens giving the Greek government some “advice”. I would love to be a fly on the wall as I will explain later. Also we will get at 1:30pm today a statement from the President of the European Central Bank (ECB) on collateral rules which readers of this web site will know have been altered mainly to help Greece and in particular Greece’s banks.

Greece’s Banks

Back in 2008 the Greek government gave various guarantees to her banks in a pattern which I am sure sounds familiar. However the Greek banks at the time did not fully use up the funds. The banks made use of 11 billion Euros of the plan’s funding by issuing preferred shares to the state in exchange for capital injections. But the biggest part of the plan which amounted to a further 17 billion Euros in state guarantees was unused. It was yesterday reported that Greece’s four largest banks (National Bank of Greece, Eurobank, Alpha Bank, and Piraeus Bank) have now requested the money. According to Greece’s Finance Minister George Papaconstantinou

“The banks have asked to use the remaining funds of the support plan … They want to have additional safety, now that the economy and the banking system are under pressure,” 

 

Why?

There is more and more talk of capital outflows from Greece and her banks. The Reuters news agency has reported that this year Greek bank deposits have fallen by just over 8 billion Euros or 3.6% so they are short of cash and need liquidity. Not quite a full-scale run on the banks but a drain.

There are alternative explanations for example it could reflect individuals and companies paying higher taxes as fiscal tightening bites or residents buying higher yielding government debt, or residents moving money abroad to avoid future tax increases. These are natural consequences of recent events but a more dangerous explanation is that  it could reflect increased concern about bank solvency.

Will it help?

In the short term then Greece’s banks will plainly receive some liquidity from it. However there are two main flaws.

1. The underlying reasons for the flight of cash will not be altered

2. Part of the money will come from the Greek government providing government bonds which can be deposited at the ECB in return for loans. Quite where the Greek government is going to get the money from in this crisis when it is already short of funding itself is the real question here. She is already struggling with her existing funding.

So in the medium-term very little is solved by this.

NB

In such a liquidity crisis Central Banks often step in and use their ability to create fiat money and make loans. For example the UK’s banks have been supported by the Special Liquidity Scheme of the Bank of England to the tune of around £170 billion. Greece does not have her own central bank and so this option does not exist on a national level as her central banking was out sourced to the ECB in 2001.

European Central Bank

Many may be wondering if it is a coincidence that the President of the European Central Bank is giving a speech today on collateral rules. The truth is probably more prosaic as the ECB has a meeting anyway and Greece and her problems would have been on the menu when the agenda was set. For those unaware of the importance of this issue I feel that these rules are much more likely to help Greece than the “rescue plan” announced on the 25/26th March.

This is a technical issue but it is very important so let us look at what was announced.

1.The present temporary increase of the threshold for losing eligibility for sovereign debt will be extended (cue cheers from Athens)

2.The present flat haircut structure for sovereign debt will be changed to a sliding scale. (amber light for Greece).

What this gave Greece was the ability to use its bonds as collateral for loans at the ECB in 2011 which is quite a relief for her and her banks. Apart from the liquidity it provides, estimates of the profits Greek banks made from this in 2009 were in the region of 3/4 billion Euros. So point one is a real gain.

The Problem in this

Consider again point 2. Greece will now face an increased haircut on her bonds if they are used as collateral at the ECB if we believe Mr. Trichet. Just at the time she needs to deposit some 17 billion Euros worth at the ECB to help her banks it looks as though the ECB is about to increase the haircut on them.

So as you can see many eyes will be on Mr. Trichet at 1:30pm. One suggestion that has been mooted is that the ECB should stop relying on ratings agencies for creditworthiness analysis (good) and replace it with its own analysis (bad). So a hopeful start leads us straight into a moral hazard. Another suggestion is that the ECB should say that she would always accept Euro zone members  government bonds as collateral. Maybe this would help Greece now but the danger is the sliding scale of haircuts that would be required.

Default

In its way the concept of haircuts is gently bringing the subject of default onto the agenda for Greece. After all a haircut is a sotto voce type of default is it not? The clear implication is that the instrument is not worth its face value and in my view this is different from a price moving up or down as there is the clear implication that Greece’s debt is worth less than other nations in the eyes of the ECB. I would not shout the words from the rooftops it is more of a gentle whisper but it is there.

Comment

The International Monetary Fund

Now the IMF is physically in Greece it should take charge of events. However for this process to start its plans for austerity need to be accepted by her government. This is the price of her aid. In the short term IMF involvement would give Greece the following.
1. Cash of up to 10 billion Euros at much cheaper than market rates. So she saves some money.
2. An IMF backed plan to take to the markets which would probably settle them down as it would provide credibility and experience even if it is a faxed copy of someone else’s plan!( In case you are wondering they did do this recently)

3. Following an IMF plan other countries may make bilateral loans to Greece on better terms than she can currently get from the markets. This is complicated by the Euro zone and its grandstanding. It would have been better I think if they had said nothing and let Greece negotiate with countries individually. In the example of Latvia countries with heavy exposure for example the Scandinavian nations loaned money, this is not entirely altruism as their banks were exposed and they are protecting their investment. Of course Germany is the biggest investor in Greece but maybe on her own Greece could accept terms from other nations and continue to negotiate with Germany. The problem is that the water is now so muddy this may not be possible.

Now comes the pain as the IMF plan to have any chance of success will tighten Greece’s austerity plan further. This is a dangerous balancing act which particularly in the current climate can easily go wrong. I expect Greek GDP to shrink by 3/4% this year as it is and this will fall further if the IMF demands a further tightening.

So what happens after the IMF gets Greece through 2010?

Here is the real problem and they are 2011 and 2012. I have written before about the danger of a downward spiral for Greece where an austerity package leads to falls in economic output which leads to the austerity package not hitting its target which leads to further tightening and so on. There are already dangers of this from the plans that the current Greek government has. In my view the IMF would have to tighten further than the existing plans or face the question why are you there when nothing has changed? So let us say cuts of another 2% of GDP are imposed on Greece as a price for IMF involvement.

This would lead to a severe recession hitting Greece again but on its own it would not work. You see the competitiveness problem that Greece has would not have been addressed so we would also need a substantial fall in real wages. I hope the flaw in the plan is becoming clear falling output,rising unemployment and falling wages would begin to turn things round but would need to take place throughout 2011 and 2012 in my view and by then Greece’s economy would have shrunk considerably. It is not a happy prospect and one can imagine the union and social unrest and it is at this point that the plan troubles me and frankly looks likely to fail. However I expect the IMF under Mr Strauss- Khan to apply it.

My suggestion is that in 2011/12 there is a danger of a downward spiral into political unrest followed by default by Greece. So it would be more honest and rational for the IMF to step in and impose its usual plan but with a difference. Under a slogan of “everybody shares the pain” it should also look to a renegotiation of Greece’s existing debts where repayment of say 85% is offered. Then the plan would have a real chance of actually succeeding.

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  • Ioannis M

    Hello again,

    As I highlighted in a recent, rather gigantic, comment, the issue of structural reforming of Greece’s economy is very important, although of course as stated again, it cannot happen overnight.

    For instance, there is no real “competitiveness” problem for Greek economy, depends on who you ask of course. Working hours and productivity in the private sector are already quite high (and there are many working hours who are unpaid for by employers, and presumably do not appear in official stats that much).

    The public sector needs a drastic decrease in size, yes. However, the permanent nature of a public sector employee position is written into the Constitution (for those who know, this was done in the 1910-1930 decades to avoid public sector employees being fired every few years, to hire people of the governing party in their positions)…

    It cannot change drastically without a constitutional reform. Also, there is the social aspect (for which the IMF or any organization of the kind just does not care about) – public sector is overloaded, however with several hundred thousands, or even a million, people working there, the proposed cuts to a more reasonable size of 150-200 thousands would mean more than half a million unemployed!

    And considering the average unemployment benefit in Greece is ridiculously low, at 200 EUR / month, I don’t presume they would live at all. They ought to be dismissed, since many of them are not productive or working at all, however it is not something that can be achieved in a short period of time:

    A constitutional reform would firstly be needed, for the action to go unchallenged.

    Then, massive redundancies – but with a plan to have these people do something somewhere else, and not die off… The Greek market would never be able to absorb 500,000 unemployed people on top of the current unemployed people.

    It’s an undoable feat. It would probably lead to…revolution. The alternative would be to maintain a solid hiring policy (outlined by the current government) at 1 new employee joining the public sector for every 5 who leave it.

    However, it’s something that would need some years to implement, and it appears that right now, nobody is willing to allow ample time for things to improve. This “right here, right now” mentality is bound to cause Greece to default, or worse. I am not sure if that’s the plan the speculators and profiteers have in the back of their minds, but it’s looking more likely as the time flows…

    PS: The Greek spreads rose up to 450 today. Good times – not.

  • concernedresident

    Hi Ioannis,

    Like you I live in Greece (but only for 4 years as an “ex-pat”) and I also feel a keen vested interest in a successful outcome from this crisis.

    I agree with much of your sentiments, but it seems that the Greek government is hardly covering itself in glory in the way it is handling the situtation and in many ways is making a bad situation worse. The following link summarises what I mean more eloquently than I could.

    http://ow.ly/1vJQH

    With so many leaks, rumours and denials, it is difficult to feel confident that “those steering the ship will get us safely to dry land”, and this uncertainty is undoubtedly affecting market sentiment towards the country.

    Maybe the involvement of the IMF will bring some of the stability and certainty needed, but only if the government can agree a realistic plan with the IMF this week and start “singing from the same hymn sheet”.

  • andy of yarm

    Perhaps if Western Governments had not hobbled their own balance sheets rescuing banks that should have been allowed to fail,we would have had more latitude to deal with the issue of sovereign risk.

  • Damien Giles

    Yes Andy of y, all depositors should have been bailed out by governments (up to the maximum protected) and the casino banks should have been allowed to fall into insolvency. That would have cost a whole lot less than bailing out complete banks did.

    However, we have to remember the real reason that the banks were saved by politicians. You only have to look at the continuing bonuses paid even where a bank has made an overall loss, and consider the fact that these bonuses have thus now been paid out of tax-payers future taxes (and the theft of savings by the generation of inflation) to understand the real reason?

  • DanielC

    Tell me more about the haircuts. Does a “5% haircut” mean that if you post a 100EUR bond you can only borrow 95EUR against it (at near-zero overnight rates, i.e. whatever the ECB calls its discount rate)? Or does it mean that you actually *pay* an additional 5% in interest because you’re posting low-quality collateral? (I assume it must be the former…?)

    BTW, I don’t suppose that the value of the posted collateral is marked-to-market, I assume that they would accept the face value and then apply the haircut to that?

    So as long as the ECB is willing, what is to prevent the Greek government from “synthetically” selling as many newly-created Greek bonds to the ECB as they wish? (by “synthetically” I mean through Greek banks as intermediaries; they keep borrowing short from the ECB, buying long from the Greek government) And isn’t the net effect of this that the ECB will be performing a traditional “print up money in an emergency” central bank function? (of course, entangling the Greek banks in a very morally hazardous trade that must eventually be unwound, at which point somebody is going to either make or lose a great deal of money).

  • http://notayesmanseconomics.wordpress.com notayesmanseconomics

    Hi Daniel

    The ECB press releases call it an add-on suggesting that you pay an extra 5%. It is unclear as to whether you could discount that. But its original documentation says

    “■Debt instruments issued by credit institutions, including certificates of deposits, which are traded on certain non-regulated markets as specified by the ECB [3] and which fulfil all other eligibility criteria. These instruments will be subject to a 5% haircut add-on.”

    It is a shame that it did not specify what the graduated haircuts will be as we will have to wait until July for that. As to some of the underlying securities the ECB has had concerns which is why it made announcements about asset backed securities. Translating into plain English it is worried that sub-standard securities have been used.

    As to your final point I think the issue is the ECB being willing as such moves would be fairly transparent and I can already envisage old Bundesbank council members spinning in their graves at the mere thought!

  • Drf

    “And isn’t the net effect of this that the ECB will be performing a traditional “print up money in an emergency” central bank function?”

    Daniel, perhaps that used to be the stance of Western governments and their Central Banks some long while ago now, but I would suggest that the approach now is mostly to follow Lenin’s ideas? Debauchery of the currency by printing money (in one of the various forms available to governments now) has become a form of stealth taxation of ALL Western governments, to a greater or lesser extent, as a norm. For example, even a target of 2 % inflation means that a government is effectively raising an additional
    2 % in tax, but only levied on those holding money form. An inflation rate of 3.5% is that much more raised as effective tax.

    So raising revenue in this way has become the norm as one form of stealth taxation, no longer only to be used as an emergency Central Bank function. The outrage of also levying income tax on the yield from money held without taking inflation into account, so as not to levy income tax on the true profit or loss as an increase or reduction in real purchasing power terms, is another additional component of this now well-established stealth tax, which increases its taxation yield.

    As Keynes observed, this is a stealth tax so clandestine that very few understand or realise what is taking place. That is why Lenin rightly saw it as being such an effective method of redistributing wealth, to sequester from the supposed wealthy, effectively as revolution without bloodshed! Indeed it would be possible to use only this form of taxation to fund a complete economy.

  • daggerwolf

    a 85% repay? sounds like montevideo to my ears….

  • andy of yarm

    It would if yields were measured in percentage not basis points.

  • http://themeanoldinvestor.blogspot.com Mr.Kowalski

    The ugly truth is that unless Greece is enabled to continue to live beyond their means, there is a fair chance at some point that there will be severe unrest or revolution, possibly to be followed by a military government. While I sympathize with Ioannis and the common Greek peasant who really don’t deserve what’s about to befall them, the power to make real change in Greece lies with them.. to replace their corrupt, worthless governments with sound, better and smaller government. Sadly, I honestly think that the old regime will need to go down by serfs bearing pitchforks before something better comes along. The current lot running Greece seem on the surface to be less competent than an illiterate, toothless village elder in Outer Kyrgyzistan.

    I like your plan Shawn.. a combination of shared pain. But as you so noted, this will only buy them twelve months tops. I’m afraid that all roads here lead to Default Alley.

  • http://themeanoldinvestor.blogspot.com Mr.Kowalski

    “A democracy cannot exist as a permanent form of government. It can exist until the citizenry discovers that they can vote for themselves largesse form the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship”.. Alexander Tyler, 1778

  • Drf

    Mr. Kowalski – that is a most profound and true quotation, which sums up the delusion of supposed democracy. We ought to be most grateful to Alexander Tyler for having so adeptly expressed the terminal weakness of democracy so long ago. It seems that no one paid any attention to his wisdom then, just as they pay no attention now.

  • Mac

    Looks like the beginning of the end for Greece, even if Trichet is trying to talk the market calm. I feel sorry for the average Greek who was part of a pretty decent economy just a few years ago. Now through international chicanery and political double dealing they are about to be forced into a situation no one would like to go through.
    It’s always better to lead a charge rather than be at the head of a stampede.

  • Prof Dipak Basu

    There are two types of solutions: a Capitalist solution proposed by the IMF and a socialist solution.
    Capitalists are blaming the Greeks for living beyond their means. This argument hides the real reason for the crisis. It is a fact that Greek Banks received huge sum of money from the Greek Government in past. They have created deposits by lending these money to others. then they had lend money to the Greek Government. A substantial part of the Greek debt is due to its own banks, who are helping rich Greeks ( Latsis for example who owns a part of the German Airline Lufthansa) to take their money out to London.
    The Socialist solution is to nationalise all banks, seize the deposits of the rich Greeks. Ask the rich Greeks to return their money to Greece, otherwise the government would seize their shipping industry and cancel their passports. These measures would be enough to restore balance in Greek finance.

    Posak claims to be a socialist party, it should take Socialist measure rather than surrendering to the IMF. Thailand had surrendered to the IMF ten years ago. Today, it is a scene of social turmoils. The same situation may be repeated in Greece, which in the past had dictatorship for a prolonged period.