by
The odds now favor the tentative deal struck over the weekend to “rescue” Greece, which many have correctly depicted as a brutal economic colonization of Greece by its lenders, coming unraveled. It’s hard to see how Greece could muddle through, given that a sketchy plan attribute to German Finance Minister Wolfgang Schuble over the weekend, that of a five-year temporary Grexit, was so obviously a napkin doodle rather than a plan as to be a negotiating chip and a taunt rather than a serious idea. But the lack of any alternative to the punitive plan that is starting to go pear shaped means that Greece would stumble into a Grexit utterly unprepared, with its banks unable to open at any foreseeable time in the future. That’s a game plan for utter catastrophe. If you think the unplanned Lehman bankruptcy was an unmitigated disaster, a Grexit would make that look like a walk in the park.*
Why does the deal now look to be in such dire shape? Unlike the earlier extended Greece v. everyone else impasse that went on for months, the underlying problem was that the two sides had no bargaining overlap between their positions and were conducting the negotiations in a media fishbowl. That made it impossible to find areas of mutual interest (having the new government improve Greece’s broken tax system, which only taxes the incomes of about 30% of the public, cracking down on oligarchs) and figuring out ways to come up with optical solutions on the issues where they were odds so each side could declare a victory.
The impediments now are what are informally called “too many moving parts”. It’s also one of the reasons that many people make bad calls about the likelihood of something succeeding, like a new venture.
If you ask someone who is starting a business and you ask them, “What are the odds this will work out?” you’ll almost certainly get answers well over 50%. Otherwise, why would they bother? But even if they tell you that it’s a slam dunk and they give you some very persuasive patter as to why the probability of winning is 90%, if you pick apart what has to happen, you can usually quickly ascertain why they’ve made a big overestimation.
That “90% odds of success” typically means that the entrepreneur believes that the odds of all the things that need to happen are around 90%. Let’s eliminate ones that are completely under their control and assume that the things that have any element of risk, like “We get our prototype into manufacturing in no more than nine months” and “We get no less than $50,000 of orders in the first six months” and “No more than 15% of the amount of our orders pay more than 60 days late” really are 90%. What happens if our venturer has to have seven things like that happen?
His probability is 90% x 90% x 90% x 90% x 90% x 90% x 90% = 47.8%
When we look at the Greek situation there are far too many things that have to occur for the deal to go through, and the odds for favorable outcomes for just about each one looks to be markedly below 90%. I’m not about to play bookie, but it’s looking uncomfortably likely that the tentative Greece pact will come unglued. And one big factor favoring that outcome: the critical actor, Germany (and specifically, Finance Minister Wolfgang Schauble, whose support as we have stressed is a necessary but not sufficient condition for having a deal be consummated) isn’t highly motivated to salvage the preliminary agreement if it goes off the rails. Schauble has long thought a Grexit was the best solution for Greece; Timothy Geithner’s memoir says Schauble was advocating it in 2012.
Understand the structure of what is happening. It’s essentially a three-part process: Greece passes mandated sets of bills on July 15 and July 22. Some key European parliaments approve must approve the weekend agreement. Separately, the European Commission, unable to find money to keep Greece afloat, as in not defaulting on the ECB on July 20. The only way it can find is to activate a dormant facility, the European Financial Stability Mechanism. In theory that should mean Greece gets its bridge financing, but as we’ll see soon that is not a given.
The bridge financing is essential because if Greece were to default on the ECB, the central bank could not lend to Greek banks under the ELA. That would be a death sentence to the Greek banking system. The big reason that Greece has been willing to prostrate itself is that it is desperate to get ELA funding back, hopefully Thursday after it passes part of its required legislation Wednesday,. It can then get its banks open again, ideally in some form this week before the damage to importers and the tourist industry becomes irreparable.
Let’s look at the things that need to happen for Greece to get its funding:
The Greek Parliament needs to pass legislation consistent with four of six creditor demands today. Even though Tsipras in theory has the votes, a revolt is underway on the streets, with strikes and protests planned. More important, Tsipras and his allies may be blocked procedurally. From the New York Times:
But with many other parties willing to vote for the package, his most pressing problem was more likely the speaker of Parliament, Zoi Konstantopoulou, also a member of Mr. Tsipras’s Syriza party, who objected to Mr. Tsipras’s attempts to pass narrower proposals last Friday.
Some analysts said that Ms. Konstantopoulou, a stickler for rules, could prevent him from using the fast-track procedures that would be necessary to get the job done in time to satisfy European leaders. Portions of the plan must be passed by Wednesday, and more a week from Wednesday.
Some parliaments, most important, Germany’s, need to approve the bailout for the deal to move forward. Remember that the baroque Eurozone rules require unanimous decisions. That means after the hoped-for Greek parliamentary approval, the other 18 nations of the Eurozone must all formally give their approval In many, this requires parliamentary approval. And this needs to happen by Monday to avert a default with the ECB. Fabrio Goria posted a timetable from SocGen. A key section:
Finland, Portugal, Spain, and the Netherlands have been more hard line than Germany. Finland has proven hard to contain in the past. Even before the events of today, it would probably be a smidge optimistic to put them in the “90% odds of approval” camp.
And now we have the huge complicating factor of the IMF threatening not to be involved if there is no haircut to the face amount of Greece’s debt. The memorandum that was hammered out on the weekend explicitly bars that. As we discussed at more length in our post last night, none of the Eurozone countries wants to give Greece debt relief that way because it would hit their national budgets as soon as the cuts were made. Under Eurozone rules, that mean they’d need to raise taxes to cover the shortfall. Even if they whacked away at Greece’s big fat debt heap over a series of years, it would still be painful unpopular domestically and deeply contractionary. It would amount to transferring a big chunk of Greece’s austerity to everyone else. That may seem more equitable, but for elected officials, it’s tantamount to turkeys voting for Thanksgiving.
By contrast, if Greece fails to pay any of its debts, the losses don’t start to hit national budgets till 2020 and they are spread out over decades (save possibly losses on Target2 and ELA exposures, but the Bundesbank might relent and let the ECB monetize those shortfalls). It’s not hard to see where the course of political least resistance lies.
The Eurozone members, again most of all Germany, regard IMF involvement as mandatory. They don’t have the expertise and staff to run the creditor gaol that they want to make of Greece, plus they want to keep their hands as clean as possible.
In addition, the well-deserved firestorm over the proposed Greece pact has likely reached the attention of the German press. That’s almost certain to strengthen the hand of nay-sayers: “Why should we bother with Greece when we’ll get so much heat, not just now but as the process continues? Better to let them go and have them take their lumps.” That will help Schauble and any other Grexit fans. And Merkel, who seems to be more aligned with Schauble than she was a month ago (do not lose sight of the face that Schauble has more clout with the German parliament on this issue that Merkel does) would regard the prospect of IMF non-participation with alarm.
Getting bridge funds via the EFSM released by Monday to make the €3.5 billion payment due to the ECB.** The Financial Times reports that the UK’s David Cameron is rounding up a group to block the funding:
Under the EU’s Byzantine voting rules, Mr Osborne must now rally a weighted majority of fellow EU members to block the proposal. Although he has the support of some other non-euro countries — both Denmark and Sweden registered their objections at yesterday’s EU finance ministers’ meeting — it is unclear whether Downing Street will have sufficient allies to block the plan.
The EU-wide fund, known as the European Financial Stability Mechanism, was set up at the outset of the eurozone crisis with €60bn in lending capacity. When the eurozone moved to set up a new, permanent rescue fund for the currency union’s 19 members, Mr Cameron won agreement at an EU summit that the EFSM would never be used again for eurozone rescues. But EU lawyers have argued that the 2012 deal was a political agreement, not a legal one, allowing them to re-tap the fund.
And mind you, that’s what has to happen just to get the bridge deal in place to prevent the ECB default and keep the rescue on track. There are plenty of other negotiations and approvals that have to happen after that, such as the next round of Greek legislation needs to be passed on July 22. And we didn’t mention another complicating factor: if a majority of the ruling coalition’s members vote against Tsipras’ legislation, it will force snap elections. How can the bailout process move forward in the interim? As Syriza Left Platform member Stathis Kouvelakis explains in Jacobin:
The reasoning is that Greek constitutional practice is the following: on every bill the government has to show that it has a majority coming from its own ranks, from the party itself or from the coalition…
Although it is not legally binding, it is the case that, in Greek constitutional history, when a government loses control of its majority, the famous dedilomeni as it is called (“declared majority”), it has to go for new elections. This is why immediately the discussion of new elections started. The new elections have already been announced — now it’s just a question of when they are going to happen.
The article explains at some length that not all members of the Left Platform voted against the proposals that the government sent to the Eurogroup on July 11 in order to prevent this trigger from being activated (I’m not clear how exactly that was achieved, but I infer “present” votes and abstentions played a role). But the votes Wednesday are seen as of even more historical importance, and all dissenters are expected to vote “no”.
So it is very much touch and go as to whether a default with the ECB can be averted, and any of the approval failures or a default itself are likely to be event horizons. And it’s hard to see how any sort of rescue process could be revived were that to happen.
Similarly, with the IMF and Eurozone nations now at loggerheads on the issue of a debt writedown as an almost certain condition of the perceived-to-be-essential IMF participation, we have a separate big reason for the deal to fail, even if it somehow manages to move through next Monday based on sheer inertia.
As terrible as this punitive “rescue” seems, the reason that Tsipras and a large number of MPs are pushing it ahead is that the human cost of a Grexit is even worse. If this deal is like having your arm cut off, a Grexit would be tantamount to having both legs amputated. The accelerating collapse of the economy as the bank holiday continues is a mere taste of what would be in store. As we’ve reminded readers, for starters, Greece is not self sufficient in food. Shortages are expected to bite by the end of them month if the banks don’t get back to something like a normal footing so importers can pay foreign suppliers. Drugs are also running out despite pharma companies being pressured to keep shipping insulin even though they are not being paid.
What is at risk is not merely more economic distress but Greece turning into a failed state. And Europe may soon have the discomfort and the guilt of seeing how quickly they made that come to pass.
___
* Note that we do not expect shades-of-Lehman market reactions, at least in the near term. The crisis of 2007 and 2008 had four acute phases, with the final being triggered by the Lehman collapse. We’d expect the economic and political blowback in the Eurozone to have a similar decay path. As Hemingway described how he went bankrupt: “Two ways. Gradually, then suddenly.”
** The EFSM funding would total more than €3.5 billion, but it’s the ECB payment default that would have serious consequences, and that is the €3.5 billion billion part of the total. From the Financial Times:
The European Commission has submitted a formal proposal to use an EU-wide rescue fund to rush aid to Greece to ensure Athens does not default on €7bn it owes on Monday, a proposal that will require Britain to rally allies if it wants to block it.
According to an EU official, the commission submitted the plan to use the European Financial Stability Mechanism late on Tuesday after deciding that it was the best option to avoid Greece defaulting on a €3.5bn bond Athens owes the European Central Bank and €3.6bn it owes the International Monetary Fund…
Valdis Dombrovskis, the European Commission vice-president in charge of eurozone issues, told reporters on Wednesday that Brussels had narrowed the bridge financing options for Greece down to bilateral loans from eurozone capitals or the EFSM, but that it had become clear there was “no prospect for bilateral help”.
Instead, the EU will rely on the EFSM for the entire €7bn loan Greece needs to pay debts that fall due on Monday. Mr Dombrovskis said EU authorities were working on ways to guarantee non-euro members will not lose money if Athens defaults on the EFSM loan….Even the formal attempt by Brussels to use this fund is a big political setback. Mr Cameron has trumpeted securing a “black and white” promise in 2011 that the fund would be mothballed so British taxpayers would not be part of eurozone bailouts.
The EU-wide EFSM was set up at the onset of the eurozone crisis with €60bn in lending capacity. When the eurozone moved to set up a new, permanent rescue fund for the currency union’s 19 members, Mr Cameron won agreement at an EU summit that the EFSM would never be used again for eurozone rescues.
But EU lawyers have argued that the 2012 deal was a political agreement, not a legal one, allowing them to try to tap the fund again.
