Despite whatt clueless econo-hacks with long and wordy blog posts will have you believe, the entity that ends up footing the bill for a Grexit is one: the ECB. Goldman explains below, and for those strapped for time, here is the TL/DR version:
"More cynically, if a default of bank liabilities is inevitable, it may deem it better to ensure that domestic claimants on Greek banks switch into hard 'convertible' Euro banknotes (or offshore accounts), leaving the residual claimants (the ECB which has provided ELA funding) to take the loss.
And now you now.
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Exploring uncharted territory, via Goldman Sachs,
- Negotiations between Greece and its official creditors have broken down. At the end of the month, we expect Greece to default on its IMF obligations as the extension of the current adjustment programme expires.
- Greece will hold a referendum on whether to accept the latest proposals from the creditor institutions on July 5 (next Sunday). The Greek government will recommend rejection of the proposals. With the government set to characterise the referendum as a choice between sovereignty and submission to Europe, the political situation in Greece and Greece's relationship with the rest of Europe looks set to be fraught for some time, whatever the result of the vote.
- From a longer-term perspective, such developments may be a necessary but painful part of the process by which a new (and more lasting) accommodation between Greece and its creditors is achieved, likely involving a realignment of domestic politics in Greece and potentially a new government.
- While our base case remains that Greece will retain the Euro (albeit likely with a prolonged interregnum where Greece's relationship with the rest of the Euro area is irregular), the risk of a 'Grexit' is rising and uncertainty is increasing as we enter the uncharted territory of default, deposit controls and payment in IOUs.
- The key short-term question is whether Greek bank deposits will be frozen. We do not think that the Greek government will take a unilateral decision to block deposits. The decision will rest on whether the ECB is willing to provide emergency liquidity assistance (ELA) in the face of deposit flight. While in principle the ECB would like to separate bank and sovereign problems and continue to support the banking sector, the political difficulty of allowing a further accumulation of Greek risk on the ECB's balance sheet implies a halt to ELA is likely. Our base case is that ELA will be capped as of Monday; a plausible variant case is that the ECB waits for Greek banks' collateral to run out and/or the expiry of the current bailout programme. Either way, if deposit outflows are substantial, we would expect to see Greek deposits blocked next week, ahead of the referendum.
- The European authorities are both prepared and equipped to act to preserve the integrity of the Euro area in the face of market and economic turbulence emanating from Greece. The ECB will likely have to do the heavy lifting, likely through an expansion of sovereign purchases tilted towards more vulnerable countries in the first instance. While still acting in response to wider market developments rather than pre-empting them, we expect ECB actions to be more prompt and more aggressive than in the past. As a result, while markets are likely to suffer in the coming days, we do not expect a repeat of the systemic and existential threats to the Euro area as a whole that emerged back in 2011-12, when Greece was last centre-stage.
1. As expected, interactions between Greece and its official creditors picked up in the past few days, as the end of the current bailout extension loomed at end-month. But developments were not in an expected or conciliatory direction.
- Following the optimism that emerged in many quarters (and was reflected in market pricing) last Monday, negotiations over the course of the week have proved difficult and ultimately unfruitful.
- Referendum on July 5. Late on Friday night, Greek Prime Minister Alexis Tsipras announced that he would call a referendum next Sunday (July 5), so that the Greek electorate can express its view on whether to accept the latest proposals coming from its creditors. Mr. Tsipras declared those proposals to be unacceptable to the current Greek government, which had been elected on a platform to bring austerity to an end. Lacking a mandate to accept such proposals, he said that the government was compelled to consult the Greek people. The government would recommend rejection of the proposals in the referendum. The Greek parliament approved the referendum in the early hours of Sunday morning (with party discipline on the issue maintained by all sides).
- Current bailout programme expires on June 30. In the context of Saturday afternoon's Eurogroup meeting of Euro area finance ministers, it became apparent that the decision to call a referendum was viewed by creditors as a de facto suspension of negotiations, implying that no further extension of official financial support was possible and leading to the expiry of the current programme on June 30. Notwithstanding requests from the Greek authorities for an extension to span the period up to the referendum next weekend, the Eurogroup have held the line that, in the absence of agreement, the programme will expire next Tuesday.
2. With a payment of EUR1.6bn due to the IMF at the end of the month (and the maturity of Greek government bonds held by the ECB looming on July 20), the prospect of Greece entering a technical default on its official creditors is imminent (for a discussion of the mechanics, see here). More pressingly, the outflow of deposits from Greek banks appears to be reaccelerating, forcing the ECB to take a difficult decision on whether to maintain its provision of emergency liquidity assistance (ELA) to the Greek banking system via the Bank of Greece or acquiesce in bank insolvency and the freezing of remaining bank deposits. And as the Greek government cash reserves run dry, domestic payments to pensioners and public sector workers may be made in IOUs ('scrip') rather than in hard Euro cash.
3. In the bigger picture, this outcome is not unexpected -- even if the specific details of the situation were difficult to predict (and recognising that we also took some heart from the more positive news that appeared to emerge last Monday). In our analysis of Greece, we have long held the view that:
- Grexit is not as 'black and white' as typically characterised. Through the introduction of controls etc. as discussed above, Greece's relationship with the rest of the Euro area can become increasingly irregular while still falling short of a definitive 'Grexit'. That said, the length of time before such irregular arrangements become irreversible (and the slide to a more definitive 'Grexit' inevitable) is uncertain and potentially short.
- It may not only be the case that the impasse in negotiations will lead to technical default, the imposition of a deposit freeze and payments in IOUs; it may be necessary to enter such difficult and irregular territory in order to break the political impasse and move forward. The core constituency of the current Greek government -- pensioners and public employees -- has enjoyed the first claim on remaining government cash reserves. Only when those cash reserves are exhausted will that constituency face the direct implications of the liquidity squeeze the political impasse between Greece and its creditors has created. And only then will the alignment of domestic political interests within Greece change to allow a way forward.
4. Viewed in this light, developments over the past few days can be seen as a painful but necessary process to secure a new (and more lasting) accommodation between Greece and its creditors. But achieving this through confrontation and brinkmanship erodes trust. This is apparent in the statements of the leading actors following Saturday's Eurogroup meeting: Eurogroup President (and Dutch Finance Minister) Jeroen Dijsselbloem offered thinly-veiled hints towards the desirability of a change of government in Athens, while Greek Finance Minister Yanis Varoufakis sought to use the uncertainties of the coming week ahead of the referendum as a lever to improve terms on the existing proposals from the creditors.
- While ultimately we continue to expect Greece to remain in the Euro area -- albeit with a lengthy interregnum, when its use of the Euro is irregular in a variety of ways -- the probability of a more definitive exit has undoubtedly risen (and continues to rise) as a consequence of the erosion of trust resulting from the recent painful and inconclusive negotiations.
5. The likely imposition of controls and other exceptional measures comes with substantial risks, which may threaten Greece's membership of the Euro area (and EU) over the longer term. On entering such unchartered territory, uncertainty rises. The reaction of the Greek population and Greek politicians to the introduction of such controls is difficult to predict. If substantial economic and political dislocation were to follow, the anyway weak institutional basis of the Greek economy may collapse, rendering the momentum towards 'Grexit' inevitable. The pace at which such risks can materialise is uncertain, but could be rapid.
- Against that (and as Mr. Varoufakis mentioned following the Eurogroup meeting), the absence of any institutional mechanism for exiting the Euro area (other than leaving the EU) and the likely substantial Euro-isation of the Greek economy regardless of the formal status of the Euro as its currency render a clear-cut and definitive 'Grexit' unlikely (or at least complicated and drawn out).
6. Leaving these longer-run issues to one side, more immediate challenges emerge in the shorter term.
- Without an agreement (and therefore with no new inflow of liquidity), we expect Greece to miss payments due to the IMF on June 30, thereby entering arrears (technical default). While of itself this would not lead to cross-default on other liabilities, it is a negative political signal and precludes further IMF provision of support until arrears are cleared.
- While Greece may be able to meet immediate (end-June) pension and wage payments (part of the deposit outflow over the weekend is reported to reflect the payment of public pensions into bank accounts at the end of last week), as remaining government cash reserves are exhausted we would expect payments to pensioners and civil servants in IOUs to follow over the summer.
7. The most significant open question is whether, in the face of (reported) significant further outflow of deposits over the past few days, the Greek bank deposits will be frozen (e.g., by the imposition of controls on deposit withdrawals or announcement of a bank holiday).
- In our view, it is unlikely that the Greek government would unilaterally introduce a deposit freeze. This would undermine its own credibility with its core constituency. The government will likely deem it better to shift the political blame for the imposition of such controls to outside forces (the Eurogroup or the ECB) rather than accept the responsibility itself. More cynically, if a default of bank liabilities is inevitable, it may deem it better to ensure that domestic claimants on Greek banks switch into hard 'convertible' Euro banknotes (or offshore accounts), leaving the residual claimants (the ECB which has provided ELA funding) to take the loss.
- The fate of Greek bank deposits therefore rests in the hands of the ECB. A decision to cap the provision of ELA would render banks illiquid in the face of rapid deposit outflows, and thus necessitate deposit freezes. While the ECB Governing Council is loath to place itself at the centre of such an intensely political issue, it will soon be left with little choice. And the increasing financial exposure of the ECB to the risks inherent in ELA provision via the Bank of Greece are likely to weigh heavily on forthcoming decisions (cf. Bundesbank President Jens Weidmann's recent speech here [14]).
8. Banking union is intended to break the link between a country's sovereign and its banks. Acting on this principle, the ECB should be willing to support banks while letting the sovereign default. Intervening in the banks through its role as supervisor of the Greek banking system while maintaining liquidity provision would serve these ends. Of course, Greek banks may be rendered insolvent by their exposure to the sovereign (or its knock-on effect on the economy). But by bringing Greek banks' balance sheets under the control of the authorities through intervention, these solvency issues could be resolved over time in a managed way. On the basis that deposit freezes are typically imposed quickly but can only be removed slowly (as the credibility of deposits as safe and liquid assets needs to be rebuilt), in this context the ECB would have an incentive to maintain ELA to avoid a prolonged period of controls.
- Such an approach -- typical of the resolution of crises in other jurisdictions -- runs counter to the institutional framework of monetary union. While not an insurmountable problem in itself (after all, the authorities have exercised considerable discretion in the past in dealing with other pressing challenges during the financial crisis, stretching the boundary of their legal mandate), the cross-border nature of the transfer of risks and resources that is implicit in shifting Greek banks' balance sheets onto the ECB creates a political impasse. Especially given the mistrust and erosion of sympathy that has resulted from the difficult recent negotiations, the willingness to take on such risks is likely limited.
9. In this context, the ECB is unlikely to operate in a political vacuum. And the likely implications of the ECB's decision on domestic political situations in Greece will likely weigh heavily on how the ECB acts. Yet the issue is not clear-cut.
- On the one hand, were the ECB to cap ELA in a manner that led to a deposit freeze, the danger exists that the Greek middle class (most adversely affected by such an action) would become (yet more) disaffected with European institutions, fuelling the prospects for the referendum to reject a new adjustment programme and deepening the crisis in Greece's relationship with the rest of the Euro area.
- On the other hand (and in line with the argumentation offered above), the imposition of deposit controls would make the severity of the situation apparent to those constituencies that have previously enjoyed seniority in their claims on government cash reserves. The following realisation of what is stake could lead to acceptance of the creditors' proposals and promote desired (from the European authorities' perspective) political realignments in Greece.
10. The ECB Governing Council will meet again today to discuss the provision of ELA.
- As discussed in a recent note from the Banks team, the remaining collateral (on current definitions) at Greek banks would be exhausted in a matter of days (for at least some banks) if deposit outflows reaccelerate. Relying on this mechanism to limit ELA would avoid the need for the Governing Council to take a proactive decision that leads to a Greek deposit freeze, but obviously would imply accumulation of additional liabilities in the meantime.
- Once the existing programme expires (and Greece falls into arrears on its IMF obligations on June 30), the ECB would anyway be forced to review its existing ELA framework for Greece (which -- in particular as regards the treatment of Greek sovereign debt as collateral -- is premised on Greece being within a programme).
- So there are a number of opportunities for the ECB to impose stronger limits on ELA as a reaction to events triggered by others, rather than taking the political responsibility themselves.
- Nevertheless, in the current difficult political context, we anticipate a capping of ELA that would likely force a blocking of deposits by the Greek authorities on Monday. Whatever the mechanism, if (as likely) deposit outflows are substantial we would expect to see Greek deposits blocked next week, ahead of the referendum.
11. As reflected in the statements of Mr. Dijsselbloem and German Finance Minister Wolfgang Schaeuble following Saturday's Eurogroup meeting, the current impasse between Greece and its creditors does not lead immediately to Greece being expelled from the Euro area. Moreover, the Eurogroup has emphasised that (a) the rest of the Euro area is more robust and resilient to the turbulence that may follow from Greek uncertainties; and (b) there is a preparedness to act to support the integrity of the Euro area in the face of that turbulence.
- As we wrote in a recent note, from the political side such actions are likely to be rhetorical in nature. The heavy-lifting will fall to the ECB. Now armed with stronger instruments (e.g., the Outright Monetary Transaction (OMT) programme, the legitimacy of which was recently reaffirmed by the European Court of Justice), the ECB can be relied upon to do "whatever it takes" to support other vulnerable Euro area countries. The likely method in the first instance would be an expansion and/or reorientation of sovereign debt purchases within the ECB's existing programme.
- While broader European markets are likely to show some response, we do not expect the impact to run to the systemic and existential threats to the Euro area as a whole that emerged back in 2011-12 when Greece was last centre-stage (and a referendum on an adjustment programme was also (briefly) envisaged.
- Nevertheless, the majority of investors was expecting a resolution to come this weekend and, in our assessment, was largely priced for one. As we wrote on Friday (see here), we have taken the view that the risks for European peripheral fixed income securities were skewed to the downside. We would expect Italian and Spanish spreads versus Germany to widen back out to around 150-175bp initially, testing the wides seen in recent weeks, as the ECB’s stance is scrutinised. Should controls on deposits be introduced and the government resort to making domestic payments with IOUs, Italian and Spanish bond spreads would widen to around 200-250bp. Spreads would go even wider (300-350bp) in the event of 'Grexit', barring intervening responses by the ECB. The ECB response would, however, need to be reinforced by institutional upgrades to the Euro area (e.g., common deposit guarantees envisaged by banking union) for their effects on prices and intra-EMU flows to be lasting.
12. Given the tenor of Saturday night's debate on the referendum in the Greek parliament, the government looks set to characterise the vote as a choice between Greek sovereignty and democracy, on the one hand, as against an imposition of a flawed neo-liberal economic plan from the outside (by the Eurogroup and IMF), on the other. By contrast, the opposition will try to turn the referendum into a vote on Greece's membership of the EU and continued use of the Euro, rather than on the specifics of the latest creditor proposals.
- As so often with referenda, the outcome will likely hinge on the specific question asked and (even more crucially) on the way that the question is framed in the broader debate. While opinion polls published overnight point to continued high support for the Euro in Greece and a majority (of those that express a preference) in favour of a deal with the creditors, we should be cautious in drawing too much from such polls. The outcome of the referendum is uncertain.
13. But the referendum is unlikely to produce the definitive choice and credible future path for the Greek economy that is sought by all sides.
- In the event of a vote against the creditor proposals (as advocated by the government), the existing impasse between Greece and its creditors would be reinforced rather than relieved. For the time being, Greece's membership of the Euro area would enter a state of 'suspended animation' (mimicking the situation in countries that are Euro-ised by not formally part of the Euro area, such as Montenegro). Such an outcome would weigh heavily on the economy, and would be highly unlikely to be politically sustainable. Yet moving in the direction of an exit from the Euro having entered this intermediate state would still likely trigger strong opposition internally. Post-referendum, there would still be no political mandate for 'Grexit' (indeed, the Greek government argues that the issues addressed in the referendum are separate from the Euro).
- In the event of a vote for the creditor proposals, the incumbent government would be in a position of implementing a programme that it had actively opposed. This is unlikely to be effective or credible in the eyes of the creditors. Having lost on this central plank of its original electoral platform, the viability of the current government would be in question. A new mandate would need to be sought, likely by early elections. In the meantime, the Greek economy would also be left in a state of 'suspended animation', as the Eurogroup is unlikely to move forward decisively with further financial support for Greece until political issues are resolved.
Either way, Greek looks set to enter a new, irregular and economically costly relationship with the rest of the Euro area that will need to prompt a domestic political realignment before further decisive steps are taken.
