What Happens If Greek Payments Stop: Goldman's Thought Experiment On "The Day After"
Because it is one thing to predict the inevitable when one doesn't have a PhD in Economics, it is something totally different when it comes from the likes of Goldman Sachs (Huw Pill and Themistokis Fiotakis to be precise). In this case, that something is what happens at T+1, T being the inevitable (there's that word again) point where payments from the ECB to sustain the zombified Greek patient, all of which go to ECB funded entities anyway, stop. The biggest concern is that, as we suggested first thing this morning, the ECB is now engaged in a fatal game of chicken, whereby it is forcing Greeks to vote "Pro Bailout" (something that just dawned on the FT), in exchange for continued funding, because unlike last year when the threat of a referendum resulted in the termination of G-Pap, now there is no leader who can be sacrificed, and Europe has no real leverage over the people who have lost so much already, aside from threatening a full out bank system collapse. However, this could very well backfire as more and more Greeks pull their money out, not wanting to find out who blinks first as it would be their money that could be locked up in perpetuity, in essence making the ECB threat into a self-fulfilling prophecy. And as Goldman says, "If confidence is lost and a run on banks occurs, the implications are hard to assess." Well, as ZH warned yesterday, this is already starting. Again from the FT: "Athens-based bankers said withdrawals exceeded €1.2bn on Monday and Tuesday – 0.75 per cent of deposits – as President Karolos Papoulias failed in two final meetings with conservative, socialist and leftwing leaders to form a national unity government." Or double what was suggested yesterday...
From Goldman Sachs
A Stop In Greek Payments – ECB Reaction is Key
As mentioned earlier, the Greek adjustment programme is likely to soon come to a premature end, given the highly unstable political situation in Greece. With payments from the troika suspended as a result, Greece will neither be able to finance its primary deficit nor meet its debt servicing obligations.
This “stop” in payments would precipitate an immediate fall in economic activity, given the need to abruptly close the primary fiscal deficit (worth about 2.3% of GDP in 2011). As government arrears (worth about 3.5% of GDP) fail to get paid, supplies to public sector companies (e.g., power, water supply) and hospitals would be disrupted and their output and activities curtailed. In this context, the inflexibility of Greek wages will result in higher unemployment, while product market rigidities are likely to imply sticky inflation (or even price increases).
The state of the banking system in such a difficult environment will determine whether Greece experiences a sharp and painful recession or suffers a much deeper and more traumatic economic collapse.
A functioning banking system would: (1) preserve the flow of credit to corporations; (2) allow access to deposits for households to smooth their income shortfall; (3) ensure continued operation of the payments system; and (4) accommodate some marginal access to trade finance for exporters; while (5) importers would still be able to supply the economy with basic goods such as energy, oil and food. All these elements will likely contain the damage to the economy.
ECB Issues To Be Addressed The Day After Payments Stop
Whether the banking system remains functional will largely depend on the ECB’s reaction to any troika decision to stop payments to Greece.
There is no automatic relationship that could force the ECB to stop the flow of liquidity to Greek banks at that point. Rather, the ECB will have to take a set of key decisions:
- Greek bonds owned by the ECB, worth around EUR 50bn, will need to be serviced. However, given that the troika makes Greek debt servicing payments via the established escrow account, this does not directly affect the relationship between Greek banks and the ECB. Such servicing payments entail nothing more than an internal transfer of funds within the official sector (i.e., from the troika to the ECB);
- Collateral requirements for Greek banks. Once the newly restructured Greek sovereign bonds enter default, they would no longer be eligible collateral for use in the ECB’s monetary policy operations that provide the bulk of liquidity to Greek banks. Assuming that the ECB does not immediately call the repos it had previously extended to Greek banks – something that would immediately precipitate the collapse of the Greek banking system – this liquidity provision could be shifted to emergency liquidity assistance (ELA) provided through the Bank of Greece (where a much broader range of collateral is deemed acceptable). Although the ECB imposes limits on how much Greek banks can draw from the ELA facility (and collateral subject to haircuts is still required), there is still room for Greek banks to use ELA, as happened during the PSI;
- Bank capital. Recapitalization of Greek banks has not been finalized and the insolvency of the new bonds would create additional capital shortfalls. Without recapitalization, Greek banks will be insolvent. Providing liquidity to insolvent banks is not within the ECB’s mandate. That said, the current temporary provision of liquidity under the guarantee of the Hellenic Financial Stability Fund (to local banks) can be extended until there is a Euro area decision on the backing of the fund with resources; and
- A potential run on banks. If confidence is lost and a run on banks occurs, the implications are hard to assess. It implies an urgent and significant increase in liquidity needs for Greek banks and the commitment of additional resources by the ECB (at the extreme, even a relaxation of collateral rules).
In the end, the ECB is unlikely to accept final political responsibility for excluding Greece from the Euro area and/or precipitating a Greek financial collapse. It will therefore have to make decisions across these dimensions in conjunction with the governments of core Euro area countries, who would then decide Greece’s fate in that regard.
Big Picture Remarks
The discussion above is meant to show that there are no automatic and instantenous triggers of a systemic banking system collapse (perhaps barring a run on banks) linked to an interruption of Greek payments by the troika. The ECB has the facilities to sustain Greece even in that eventuality, should it be willing to bend its rules and even perhaps commit more funds to protect Greek banks from a liquidity-driven default.
The ECB’s decision as to whether to behave in this way will be guided by Euro area policymakers’ assessment of whether a standstill in Greek payments should trigger a full separation of Greece from the Euro area.
To a large extent, therefore, the decision will depend on whether there is a Greek government in place and on the stance of such a government. A unilateral repudiation of financing agreements from Greece’s side would likely provoke equally aggressive responses from its Euro area counterparties. In contrast, it is not clear what the course of action will be should Greece remain without a stable government for an extended period of time.
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