Greece –—- Stumbling Toward Default

Good Cop Under Fire

On June 5, Greece has to pay €240 million to the IMF. A week later another €270 million are coming due. All in all, Greece has to pay back €1.5 billion in IMF loans over the month of June. All indications are that the Greek government doesn’t even have the €240 m. that are coming due next week. In light of this, its intransigence in the negotiations with the euro-group may be slightly bewildering, but as we have pointed out already when it became clear that Syriza would likely win the Greek parliamentary elections, the situation always was akin to a Mexican standoff.


modern greece

Image credit: António Jorge Gonçalves


Some in the group leading the negotiations are now accusing the EU Commission and its president Juncker of giving the Greeks “false hope” by making it appear as though they will be bailed out no matter what:


“Some euro zone countries are accusing the European Commission of giving Greece false hope of new loans for less reform effort, but they still want Brussels to find a way to keep a defiant Athens in the euro.

After four months of talks with scant progress, hawkish governments privately blame Commission President Jean-Claude Juncker and Economics Commissioner Pierre Moscovici for muddying their message by playing “good cop”.

Greece is now close to default and still resisting unpopular labor and pension reforms that are conditions for more aid. Some governments believe the creditors would get faster results if the institutions representing them — the Commission, the European Central Bank and the International Monetary Fund — presented a more united tough front.

“In this respect, I think the European Commission plays a bad role,” a senior official from a euro zone government said. “Some people in Athens still think they can get money without reforms, and cite Juncker, his cabinet and Moscovici as supporting their view,” the senior official said. “They think Juncker wants them to stay in the euro zone at any price.”

Those unhappy with the Commission’s negotiating tactics include Germany, Finland, the Netherlands, Austria, Latvia, Estonia, Lithuania and Slovakia, the official said. Even dovish France was “starting to be a bit annoyed”.

But no government has gone public with this criticism. Juncker and Commission officials have insisted since talks began after the left-wing government of Alexis Tsipras won power in late January that there was no other solution than Greece remaining in the euro.

Juncker, a former chairman of euro zone finance ministers and veteran EU deal-maker, does not want the euro zone to break up on his watch, officials say. This limits negotiating options and strengthens the hand of those in Athens gambling that the euro zone would not allow Greece to default, so if the country holds out long enough against unpopular reforms, the euro zone will blink first.


(emphasis added)


greece-cartoonThe nonchalance may not last

Cartoon by Gable


Apparently, French finance minister Michel Sapin didn’t get the memo. He averred on Friday:


There is no Grexit scenario,” Sapin told reporters after a meeting of finance chiefs from the Group of Seven industrial nations in Dresden, Germany.”


Alas, there most definitely is a “Grexit scenario”. It may not be the EU’s preferred scenario; in fact, the Greek government is probably correct in assuming that the other euro area countries and the EU Commission are quite eager for Greece to remain a member of the euro zone. However, as the events of last week show, it is the very institutional set-up of the euro that could make a “Grexit” inevitable if no agreement on restarting the extend-and-pretend scheme is struck in time (i.e., real soon).


expelCartoon by Steve Bell


“Grexit” and the Euro’s Institutional Set-Up

Specifically, the ECB refused to raise the ELA ceiling for Greek banks further last week. While this was explained by indicating that it simply wasn’t necessary because deposit outflows had stabilized, Greek newspaper Kathimerini promptly disputed this assertion and pointed out that deposit outflows actually accelerated in late May. The problem is that the ECB is already in murky legal territory with the ELA funding it has approved thus far. The extension of ELA is predicated on the banks receiving it being solvent, and only suffering “temporary liquidity problems”.


chickenCartoon by Schrank


Of course no fractionally reserved bank is ever truly solvent, but Greek banks are undoubtedly in class of their own. Their books harbor more than €90 billion in non-performing loans. If the Greek government were to begin to default on IMF loans, Greek banks surely could no longer be assumed to be solvent. They are holding large amounts of Greek government debt, and have been financing a lot of the government’s stop-gap issuance of short term bills. The ECB would clearly overstep its bounds if it were to continue to raise the ELA ceiling after a Greek default. If the ECB stops funding the Greek banks via this mechanism, a further acceleration in the ongoing bank run has to be expected.

We have updated our charts, as the Bank of Greece has just now provided the data as of April. In April private sector deposit outflows amounted to approx. €5 billion. We have a feeling that when the May data become available a month hence, we will see even bigger outflows:


1-Greece, private sector depositsPrivate sector deposits in the Greek banking system plunge to a multi-year low, down another €5 billion in April – click to enlarge.


The liabilities of Greek banks vis-a-vis the euro system have of course increased commensurately:

2-Liabilities to Euro SystemGreek banks’ liabilities vis-a-vis the euro system have been soaring ever since it became clear the a new election would likely sweep Syriza into power – click to enlarge.


Not surprisingly, Greece’s TARGET2 liabilities continue to rise as well and have now climbed back above the €100 billion level:


3-Greece, TARGET2Greece: TARGET2 liabilities – click to enlarge.


We also continue to expect that the euro-group will somehow find a way to keep Greece in the fold. However, regardless of what Juncker, Moscovici and now Sapin are saying and regardless of what we believe, things could get out of hand real fast if the Greek government should fail to pay one of the debt tranches due to the IMF. If we were a Greek citizen, we would no longer have any money on deposit in a Greek bank. The risk has simply become too great. Without ELA, the banks are forced to tap their very last reserves if they want to continue to pay depositors. It isn’t difficult to foresee that this cannot last long. What happens then?

Obviously, should the government default and the bank run accelerate, capital controls would be on the menu next (this has already been officially denied, so it is a good bet it will actually happen). Nevertheless, at that point the government would evidently be bankrupt, and the banking system would be in grave danger of going under with it. The ECB would probably find a way to continue funding Greek banks if a clear indication that a new extend-and-pretend deal was likely to be done should emerge. However, nothing of the sort is even remotely in sight at present, and this time, the noose is really tightening.



In light of the large IMF payments Greece must make in June and the fact that the bailout negotiations seem stuck in the mud, things could unexpectedly become interesting rather soon (“interesting” in the Chinese curse sense). Up until now, the action in financial markets has suggested that market participants aren’t overly worried about a possible Greek default and exit from the euro. As we have mentioned previously, this complacency could well turn out to be misguided.

In the longer term, a Greek exit could well be seen as positive for the euro, as the euro area would lose its most unpredictable and unreliable member. However, this is by no means a certain outcome, as the dreaded “contagion effect” could make a comeback. It seems quite clear to us that Greece can never pay back the mountain of debt it owes; that strikes us actually as a mathematical impossibility. The whole bailout rigmarole is ultimately about finding a way to continue pretending otherwise.

Will the markets shrug off a Greek default? Perhaps they will in the longer term, but we doubt that equanimity will prevail in the short term. The month of June could turn out to be a tad more volatile this year than is usually the case.