Plans for Greek default may cripple both the European Central Bank and the IMF

On Saturday evening news began to spread that the Euro zone was preparing plans for a Greek default and that this default would involve a 50% write off or haircut for her existing debts. As you can imagine the news created quite a furore particularly when it emerged that the latest trip into a world of fantasy by Europe’s leaders involved waiting until November! In the world of reality markets were likely to begin responding late Sunday evening UK time when  Asia started trading.

The International Monetary Fund responds

At the same time the IMF put out a statement which proclaimed that it was ready to help but its position was summed up by this part of it.

We are encouraged by the determination of our euro-area colleagues to do what is needed to resolve the euro-area crisis. We welcome that the IMF stands ready to strongly support this effort as part of its global role.

As ever with official statements these days there is an element of unreality about this. For example Euro zone and officials have spent the last 18 months or so dithering about the crisis they find themselves in! Indeed at times their actions have made it worse and not better. So the first sentence is in fact the opposite of reality. Unfortunately for the IMF it did not even get its own situation right as later in the statement we saw this.

Review of the adequacy of Fund resources;

Rather than being ready to help the IMF is worried that it will run out of funds if there are heavy drawings on its resources. Minds immediately turned to the problem that is Italy which would certainly be a heavy draw on IMF resources that they could run out. So it is clear that should matters deteriorate the IMF itself may only be able to help in a limited way.

This is an area where I have form as I have long questioned the role that Msr Strauss-Khan gave the IMF and I discussed this matter in detail on the 8th of June 2010 here, Just to give you a taste of it here is a quote from that time from Youssef Boutros-Ghali.

“If we are going to start including funds made available to Europe, then the IMF is not properly resourced,” he said. “We need to increase Special Drawing Rights very significantly.

As you can see this problem was known then but putting politicians in charge of the IMF has led to the same results as elsewhere in that it has over-stretched its resources. The IMF did,however give us a route map for progress for the Euro zone.The strategy is to restore sustainable public finances while ensuring continued economic recovery.

Good luck with that by the way…..

Default for Greece will ruin the European Central Banks balance sheet

One of the features of the Euro zone response to the peripheral debt crisis has been to dress up tactics as a strategy. One example of this that will be horribly exposed by a Greek default is the Securities Markets Programme of the European Central Bank. This involves it purchasing bonds and debt from countries in trouble to try to help them recover. I discuss it problems regularly and as we stand it is currently failing to help Italy. There will be an update later but so far it has placed 152.5 billion Euros of debt nobody else wanted at that price on the ECB’s balance sheet. Accordingly dealing with it has become the responsibility of the Euro zone’s taxpayers.

Why will a Greek default expose the flaws in this?

We do not get an exact breakdown of the purchases made but the ECB is holding around 45 billion Euros of Greek debt via this programme. Furthermore in spite of the fact that prices have fallen substantially since it purchased most of this it has made the assumption that sovereign nations in the Euro zone cannot default and that it will get all its money back. You may be beginning to spot the flaw here! Even more unbelievably it does book the interest as a profit! Only losses get assumed away.

So an actual default of the size suggested would leave the ECB with around 22/23 billion Euros of losses overnight that can no longer be assumed away.  Even worse for the ECB it has a capital base of 5.76 billion Euros which it is in the process of expanding t0 10.76 billion ( I wonder why….) but as is typical of Euro zone actions most of the extra funding has not yet been paid.

The 8%/92% split

The ECB will not take all the losses discussed above ( it can’t..) as it has the rule described above where it will split the losses with its shareholders the national central banks which make it up. So far they have only taken profits from this programme in the type of financial alchemy I discussed earlier. So the Bank of Greece, Central Bank of Ireland and Bank of Portugal will have to tak their share of the losses.

This burden will go to their taxpayers which would be fine if they had any money to pay it with. If they did we would not be in this position!

The Covered Bond Purchase Programme

Here back in the summer of 2009 the ECB purchased some 60 billion Euros of what it calls “high-quality collateral” which immediatly poses the theoretical question of if it is such high quality why nobody else wanted it and the ECB had to intervene in the first place! As we step into another full blown banking crisis we can see that the ECB must have real problems with the quality of the assets underlying these bonds. So there are more losses tucked away here.

Other liquidity providing operations

I have added up the various liquidity programmes of the ECB this morning and they come to 570 billion Euros. Against this the ECB will have received quite substantial amounts of Greek debt as at the time it was the highest yielding asset that was preceived as safe. Now this is a different situation as the ECB will apply discounts and the assets do not belong to it, but what will it do if some banks collapse and it is left with Greek debt that has just been cut by 50%? It will have provided 100% liquidity but only have a 50% asset.


The problem for the ECB will be exacerbated by the fact that Ireland and Portugal will be looking on and it would only be natural for them to want to cast off the shackles of as much of their debt as they can. Indeed because of the way her problems came from her banking system I have argued before that Ireland is the country which would most benefit from a default. In essence she could cast her broken banking system aside.

So the problems for the ECB would multiply and be far more than her capital. And that is before we get to the problem that is Italy.

How might the ECB respond to this?

As the emergency escalates we cannot rule out an emergency interest-rate cut as a reponse to what is now taking place. I would imagine that the ECB is under enormous pressure right now from Europe’s politicians to do exactly this. Tjis would be at best embarrassing for an organisation which was only recently embarking on a series of interest-rate rises.

I also expect the central bank liquidity swaps programme to be used heavily and we may see more recapitalisations of European banks with French ones currently in the frame.

Claims for the European Financial Stability Facility have now gone beyond fantasy

I discussed the problems of the EFSF only on Friday. This instrument was supposed to be in operation soon after the “shock and awe” announcement of the 10th of May 2010 and yet it still lacks the promised firepower of 440 billion Euros some 16 months later. In spite of further claims of progress at the July 21st meeting of Euro zone leaders only Greece (who doesn’t have to contribute..) has actually ratified it since.

And yet we are told that it will mimic Superman and emerge from a telephone box able to deploy some 2,000 billion Euros to solve Europe’s problems. Depending on who you talk to it will be super-EFSF or a leveraged EFSF. The stupidity of a leveraged EFSF has to be seen to be believed.

Let me give you two major flaws in all this.

1. The EFSF has no money it has to borrow it. In a crisis it may not be able to, what then?

2. Countries in trouble fall off the list of contributors. For example Greece, Ireland and Portugal already have  meaning that the 440 billion objective is currently only going to reach 410 billion Euros. Should Italy fall of the list then a much larger sum will be lost placing a bigger and bigger burden on Germany, France and so on. So the lifeboat is inherently unstable in a crisis!

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This entry was posted in Banks, Economy, Euro zone Crisis, General Economics, Greek Financial Crisis, Quantitative Easing and Extraordinary Monetary Measures. Bookmark the permalink.
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  • Sovjohn

    Hello Shaun,

    Excellent post as always. In related news, signs of panic seem to emerge both inside and outside of Greece, specifically politicians in the EU, who seem to have grasped that they are caught, as Britons tend to say, “between a rock and a hard place”, or as Greeks tend to say (literal translation) “between a cliff and a stream”.

    It is discussed that even if all the 154-odd parliamentary majority of Papandreou does vote into law all the new measures proposed, their viability as a government is limited at best. I even saw FT columnists ask how much longer would a majority this thin be able to carry on, and I don’t blame them for pondering.

    What may be perhaps the most sarcastic thing of the week is that Samaras, chairman of the opposition “conservative” party of New Democracy, has publicly stated things along the lines of…

    “We were right, about the MoU and the unsustainable solution the government signed up for.”

    “We will renegotiate” (to this, I add – What exactly? Whether a nuke should be thrown on Athens and be done with it, or merely a napalm bomb to mitigate consequences?)

    And the most thrilling comments of all…

    “We do not support mass redundancies in the public sector, and would propose multiple 3-year periods of “placement in reserve” and re-education of public sector employees.”

    “If elections take place and our party does not get a clear mandate to govern on its own, I will repeat the elections” (!!!)

    Er…yeah. That’s another concealed way of preaching Papandreou’s “Money does exist!”, his by now infamous proclamation before the ’09 elections.

    Considering this party may constitute the next government, either as a majority coalition partner or on its own, it’s frightening really…

    I leave you at that – I have to make a new draft of my CV with its latest updates to send to employers outside the country…


    PS: Private sector continues to bleed, in my workplace we are edging past 3 months unpaid and eventually I suspect that me and other of my co-workers will just resign or take legal action in order to get their owed money back, even without any other employment opportunities present. To use a German word I like very much, “Wunderbar!”.

  • Anonymous

    Shaun an excellent if frightening post. I read the figure of Euro 2 trillion has been promoted but where is this coming from? Neither Germany or France are in any position to help further (Vasillis 101 post from last Friday refers) and there are no other “big-hitters” in the game. Forget Eastern Europe. Forget UK. The IMF, as you state is ready (with words of support) but their fire-power is draining away. We cannot (should not) anticipate anything from the BRIC’s – so may I ask all your contributors: who pays and if they don’t pay, WHAT NEXT? Six weeks from Armageddon?

  • Anonymous

    don’t panic. The bond markets are predicting a Greek default and have been showing this for a long time. The world didn’t end when Russia defaulted, nor Argentina. Some civil strife is likely as the people have no other means to force the elites to admit that Greece is bankrupt.

    I’m getting in a big pile of firewood and potatoes for the winter. It’s normal in the mountains here and a hedge against financial instability and hunger. Got the tomato preserve & jam in the basement already.

    Going back to Shaun’s theme of accountability – will anyone at the ECB be held accountable for this fiasco ?

  • Anonymous

    I know what you mean – I have my potatoes also! Regarding accountability in the ECB, my view is that their Job Description deliberately omits this aspect – for obvious reasons!

  • Anonymous

    A wonderful exposure of what is going on, Shaun. To add to the absurdities, you could mention:
    1. The Governor of the Bank of France saying yesterday that he saw “no sign” of the |French banks needing further equity;
    2. The very fact that lagarde came straight from being the finance minister of France, overseeing this banking sector.

    My conclusions from all of this are that:
    1. Even if Greece gets its 50% haircut, it still will not be able to compete with Germany;
    2. If the Greeks have got any sense, they will wait until the 50% has been achieved and then demand say another 45% haircut or it will go bust. On past form, they would get the next 45% as well. What is so magical about 50% after all?
    3. While it may be fine for germany etc to fork out its 500 billion euros as part of the new shock and awe package, why on earth would, say, Poland, Estonia, Slovakia, Spain, Ireland, the Uk, Italy, Cyprus do so? I don’t think that any of these countries could justify to their electorates putting money in. I think that only France and Germany have sufficient obsession with their position on the world stage to get this past their parliaments.

    Off topic, but did you hear Balls on the radio this morning. Apparently, debt was lower when Labour left office than when they took over. I had to switch over at that point!

  • Anonymous

    Reading the minutes of the European Systemic Risk Board 5 days ago one sees that there is no rush towards the Geitner plan / variations on a theme. Steady-as-she-goes with improving the stability and growth pact, implementing 21 July agreement and getting more information about financial interconnectedness and liabilities of large financial institutions ( yes, they still arent sure of the shadow banking system). I then read of Jens Wiedman solidifying his support on the Council of the ECB against ECB fiscal financing either through temporary or Geitner-type measures. The current debate is failing to take in to account the fact that these various institutions have legal rules and objectives.Mario Drahgi will need to listen to Wiedman plus allies.Geitner’s ideas cannot circumvent these power bases.

  • Anonymous

    I see that S&P is now threatening a downgrade of European sovereigns if they back a bigger EFSF. The ratchet is really tightening if that happens. The politicians can either not increase the fund and have a catastrophe on their hands, or they can increase it and have a catastrophe on their hands.
    It looks as though their dithering is really coming home to roost.

  • Anonymous

    Dealing with the debt is certainly troublesome. Somehow or other it will happen, though. But what of the future? Greeks are now accustomed to live as they have been living. To prevent a recurrence of massive unpayable debt, their living standard must fall to what it was 10 years ago. Any signs of that being even remotely acceptable to the population at large? If not, what’s the plan?

  • Drf

    “Plans for Greek default may cripple both the European Central Bank and the IMF”Let’s indeed hope so! It is about time the EU run by an unelected council of Socialist dictators came crashing down before they completely destitute the citizens they plunder and exploit. The whole Eurozone experiment is now clear for all to see as yet another failed imposition to lay waste to EU citizens wealth and civilisation. Originally the ECB was supposed to have been set up having the same discipline and modus operandi as the Bundesbank; but just look at it now, and see what the Council of Ministers has done to its original discipline and prudence! What a disaster.

    The IMF in its neo form is now little better, and has lost sight of its original purpose and discipline. As you vaguely imply, Shaun, this also is because political ideology has taken over, with an added intent to support the banks at all costs. How long does all of this have to go on before the disaster which it is becomes finally evident and we suffer serious global economic collapse? One is increasingly inclined to believe that all of this is intentional, so as to impose the final global currency and economic controls over all world citizens (which has been intended by those at the back of this destruction, right from the start). This is the new form of war.

  • Jason Aris

    I keep pinching myself to see if I have inadvertantly ended up in the matrix, all of this is too surreal for words. All I know is something bad is going to happen and soon it’s a case of making sure you can negotiate a way through this that is as painless as possible (not sure what that will be though)

  • Jason Aris

    Personally I would have walked out after the first month with no money, all contracts are null and void once that is rubicon is crossed

  • Sovjohn

    You are absolutely right to say this, however, the situation up until now was “bite the bullet and wait for the improvement which will come because the shareholders are fully supporting us”.

    It’s not that way anymore. Even if our shareholders promise to bring us two suitcases full of gold tomorrow morning, I’m not due to believe them… :) (and note, they are international investors with global presence, not the owner of the butcher’s shop in the neighborhood…one more reason why not to trust them at this point!)

  • Sovjohn

    If I’m not mistaken, in terms of purchasing power (perhaps more so than the nominal salary cuts / et al) currently resembles levels last seen in the ’80s, and has dropped sharply in the last couple of years.

    Of course, purchasing power or anything else will further drop if/when any sort of default hits. There’s no use denying that.

    By all probability the state will eventually guarantee a minimum state pension for everyone, below the poverty line, and let them loose to find the rest of the money somehow. Nobody I know of who is aged 20-50 believes they will get *any* sort of pension in Greece when they retire / if they are still here.

  • Anonymous

    The only way I can think that Greece can take a default and not have raging Irish and Portuguese storming the ECB, or whoever is responsible, is that Greece is asked to leave the Eurozone.   Frankly I think they ought to be asked to leave.   I am also sure that there are several bloggers out there who will patiently explain why this can’t be done.

  • Anonymous

    Many of the politicians have national concerns and several coalition governments may break up in preference to a bigger EFSF. Rosler and Schafler may bring down Merkel. Slovakia’s Sulik is opposed to the bailout. The Dutch government depends on Geert Wilders.

  • Fergus

    thanks, very interesting as ever :-)

    I would love to hear what you think the ECB should do, assuming that political and fiscal union doesn’t come along radically expanding their options..

  • Anonymous

    I have said numerous times, Greece for all sorts of reasons won’t leave voluantarily (ever, ony the other day a poll suggested that less than 10% of people would like to leave Euro). This is very unpopular in Greece and won’t change neither for people nor for main parties (for all sorts of wrong or right reasons). Greece will leave Euro only if it is pushed out by the rest. Of course then the problem (in the mind of EU elite) is that the markets will think that Eurozone is over. And if Markets think this, it will be over. I believe that if Greece leaves then EZ as we know it is dead. Then you will have major catastrophe and extreme poverty in several EU countries and if they do not get any help from others (large amounts but then one would ask why didn;t we help in the first place so that we avoid this), EU is dead also. If EU ends in such dramatic way, it will be dead easy to hae another war, easily it can start in the Balkans again. It is geopolitics at the end of the day, not economics.

  • Anonymous

       Greece pushed out of the eurozone and the zone is dead!   I must say I would view it as a strengthening of the Zone.   If you misbehave you must go.  After all the UK was pushed out even before the zone was formed and the world didn’t end.    So Greece defaults and one member gets relief that others cant get, or do you envisage all of the PIGS + any others calling a default.   What do you envisage then for the Zone?   Surely there has to be some response from the Zone for allowing a default.   Yes, if Greece is forced out, the Zone as we know it is dead, but what lives is the Zone minus Greece and if Italy has to go too so be it.   The very thought of being jetisoned will focus the minds of of the remainder.   The politicians and the people may take the whole thing more seriously.

  • cosmo

    greece is done for as toast.

  • Anonymous

    The first who misbehaved was France and Germany by throwing away the stability pack. If the issue is moral about misbehaviour then I have serious doubts if Greece is the worse offender.However this is a minor point, if Greece, then Portugal, then Ireland, then Italy, then Spain etc. leave the Eurozone, I have serious doubts if the surplus countries would remain with surpluses. Problems almost for ever until Germany and a couple of satellites are left. Death by thousand cuts for everybody. Better disassemble the whole thing now for everobody. A common currency has to be of the interests of all economies not only of Germany. Otherwise, obviously is not a common currency but an occupation currency. Germany has to understand this, if not just forget it. It is not a common project, it is a German project.

  • Anonymous

    Hi Ray

    Over the next 6 weeks the Euro zone has some choices to make. The problem for it is that it finds both choices unpalatable! It doesn’t like the fiscal/political union/Eurobonds route and it does not want to dissolve either..

    So I expect the next 6 weeks to be choppy as new plans rise and then fall.

    As to the 2 trillion Euros I remember Willem Buiter ( who was a tutor of mine at the LSE) recommending it some time ago as being sufficient to cope with Italy and Spain as well as the smaller countries. Along the way it became the benchmark. So that answers the why? But the how is much harder as the Euro zone has no plans at all to actually raise it.

  • Anonymous

    Hi ExpatInBG

    I think that the issue of countries refusing to contribute to a 2,000 billion Euro EFSF will become a bigger and bigger issue. Some will be worried about potential downgrades for themselves and even Germany will have worries. If one or two do not want to join in and Italy falls off the list the burden on even Germany will start to build.

  • Anonymous

    Personally I have always thought that if Greece default she would be better off leaving the Euro and having  new Drachma. I cannot really see the point of a 50% default and then remaining as in 5/10 years we could easily be back in the same situation.

    I know that this distinguishes me from many who argue that going to an individual exchange rate would be a disaster. To which I reply look at the economic numbers and the reports of Ioannis and Vassilis and tell me it isnt a disaster as it is.

  • Anonymous

    Hi Fergus

    Thank you. I thought for a moment you had endgamed me but there is always a way..

    How about the ECB abandoning the SMP and handing the 156.5 billion nominal Euros of debt ( but worth much less) over to say the European Commission? A vehicle would have to be constructed to take it and there would have to be the beginnings of a type of fiscal union so it would have to be split from some EU/EC funds as countries like the UK are not in the Euro.

    Then the ECB could return to central banking and leave the political decisions and most importantly the consequences with the politician’s….They could raise taxes to finance it if they wished and the situation would look very different. I am not saying they are anywhere near ever doing it but if I was on the ECB I would have been arguing this from the early days of the SMP.

    Over the next 6 months there looks like there will be plenty to do for a central bank without doing what is a politicians job.

    The merging of central banking and fiscal policy and politics has created an unholy mess and thsi would be the beginnings of reversing it.

  • Anonymous

    Shaun – thank you for your comments. The concept of raising this vast sum of money seems to me to be a “normality” amongst the EUrocrats. As you say, the easy part is having the idea; the most difficult aspect (HOW) is always left in abeyance. Thank you.

  • Anonymous

    I do see your points Vassilis.   I hasten to point out that being Irish, though I live in S Africa, I see the problems for Greece only to well.   I do support the concept of the Euro (with the UK in it) and would see the break up of the Zone as an unmitigated disaster.   So the differences between us boils down to our perceptions of what is best for the Zone and hopefully at the same time what is best for the member states of the Zone.  Naturally I think I am correct but my knowledge of the whole thing is so scant i wouldn’t take any form of bet on the matter.   I simply hope that the problems are resolved and that Greece can remain a member – like Ireland and Portugal and any others – chastened.

  • Dougbateman

    Economics lesson please. If the central banks like the US federal reserve or the European central bank can write cheques against nothing, i.e. no gold standard, why can they not write off any amount of debt just as easily?
    The implications of my question; I have heard the complaints that the USdollar has uncertain value since coming off the gold standard. Concerns that the fed can ‘print money’ as it sees fit by writing cheques for loans to governments or financial institutions with no assets to back up the cheque, but still expect payback with interest.
    I recognize there are social and moral implications to consider here, but if a default were to take place and the ‘haircut’ was primarily given to the presiding central bank, there would be little consequence to Joe public, and his chartered bank holding his savings.  The European central bank could buy up Greek bonds and write them off as a loss without the burden being on the rest of European society.
    The questions I can think of that would have to be answered are;
    Inflationary?  Is it really an increase in the money supply? The money is already spent and in the system? Arguably paying back billions or trillions of dollars is deflationary.
    If Governments can do this what incentive is there to balance the budget? There has to be a cost, checks and balances.
    Could that be a condition on the bailout/write off that governments have fully balanced their budget?
    If the world knew the nations could be bailed out too easily, what is to stop individuals and institutions from buying bonds and t bills and financing deficit spending with cheap money knowing the debt could be sold to the central bank?
    Answer to above. Central Bank would not pay full price to buy the toxic assets from private investors or banks. There would be some price to funding deficit spending. Formula needed.
    There is where the requirement for a balanced budget would come in, if bondholders take a haircut the market would quickly dry up, at least in the near and medium term.
    In the case of the us where there is no loose monetary union as in Europe, Could the federal reserve write off debt to the federal government only without private investors or other institutions and nations paying any price? What would the implications be around the world? Domestically?

  • Anonymous

    Hi Doug and welcome to my part of the blogosphere

    You ask a lot of questions and partly answer some of them but here are some thoughts for you.

    1. If default was so easy then everyone would want govt. bonds which perform dreadfully as they could buy them back for a profit! i.e issue at par or 100 and buy back at 50 thereby making 50. Great game isnt it? And those in favour of fiscal expansion appear to be able to monetarily finance themselves ad infinitum.

    The problem is that along the way others have bought at higher prices and they will be forced to take a loss. Some will have bought at issue at 100 and here is a real danger as they will be pension funds and insurance companies (they typically by at issue) etc. others at 90/80/70 and so on. So there is another side to the balance sheet in that there are equivalent losses. This is hidden by the way that some private investors will have sold and maybe bought back for a profit but overall they lose.

    So now we have losses somewhere but as to exactly where they are we do not know.

    So there is your rule one of default: You can do it if you are small enough to be insignificant i.e the banks etc can shrug off the losses

    Rule two: People must not guess it in the first place as otherwise it would be irrational to buy your bonds. Here you could find yourself in a situation where you cannot sell bonds at all.

    An overall thought is that even a country as small as Greece (apologies to Greek’s reading this but she is only 2 to 2.5% of the Euro zone) these days is systemically significant. This means our world banking system is too unstable and we are back to the reform agenda I presented on Tuesday.