Friday, 31 July 2015

In defence of the (conflicted) ECB

Everyone has been so transfixed by Yanis Varoufakis's "Plan B" revelations that his defence of the ECB's Mario Draghi passed unnoticed. Here it is, transcribed from the Lamont tape by Peter Spiegel at the FT:
Mario Draghi has handled himself as well as he could, and he tried to stay out of this mire, the political mire, impressively. I have always held him in high regard. I hold him in even higher regard now, having experienced him over the last six months. Having said that, the European Central Bank is set up in such a way that it is so highly political, it is impossible not to be political.

Don’t forget the ECB, the central bank of Greece – because that’s what the ECB is, it’s the central bank of all our member states – the central bank of Greece is a creditor of the Greek state, and therefore it is also [break in audio] once it is the lender of last resort, supposedly, and the enforcer of fiscal austerity. Now, that violates, immediately, the supposed distinction between fiscal and monetary policy. It puts Draghi in a position where, in acting as a creditor when we came into power, he had to discipline us, he had to actually asphyxiate us sufficiently in order to yield to the demands of the creditors, while at the same time keeping our banks open. So God could not do this in a non-political way.
In other words, the politicised nature of the ECB is an inevitable consequence of the political construction of the Euro. Draghi, along with his deputy Vitor Constancio, have been trying to steer a course through a very narrow channel lined with vicious rocks. On June 28th, they had to squeeze the ship through too tight a gap, and inevitably tore a large hole in the hull. The decision to restrict liquidity to Greek banks was in my view intended to be a politically neutral decision. But the consequences for the Greek economy were disastrous. From that moment on, the ECB could no longer be regarded as neutral. It had entered the game on the side of the creditors.

Yanis goes on to identify the fundamental conflict of interest that forces the ECB into an overtly political role. In its role as central bank, the ECB is ultimately responsible for maintaining liquidity in the European financial system in accordance with its inflation target. It is also responsible for financial stability, which means maintaining liquidity not only to the financial system as a whole but specifically to parts of it that are in danger of collapsing due to local liquidity constraints. As Yanis says, it is the "Lender Of Last Resort" for banks - including Greek ones.

But is it, really? Not everyone thinks so. The ECB provides liquidity to the European financial system through its monetary operations. But emergency liquidity assistance (ELA) for distressed banks is provided by national central banks (NCBs) within the Eurosystem. Therefore, some argue, the NCBs, not the ECB, are the lenders of last resort. In support of this argument they point to the final paragraph from this piece of legislation from the ECB:
Responsibility for the provision of ELA lies with the NCB(s) concerned. This means that any costs of, and the risks arising from, the provision of ELA are incurred by the relevant NCB.
So, the argument goes, the ECB is not liable for any losses arising from ELA, therefore it is not the lender of last resort.

If the NCBs had complete freedom to issue whatever liquidity they saw fit and accept whatever collateral they considered appropriate, with haircuts of their own choosing, they would indeed be lenders of last resort even though - as the legislation makes clear - they are issuing "central bank credit" on behalf of the whole Eurosystem. But NCBs do not have such freedom. They can only issue ELA to the extent permitted by the ECB and in accordance with the eligible collateral framework established by the ECB. The ECB can - and, as we now know from Greece, does - restrict the provision of ELA by NCBs:
However, Article 14.4 of the Statute of the European System of Central Banks and of the European Central Bank (Statute of the ESCB) assigns the Governing Council of the ECB responsibility for restricting ELA operations if it considers that these operations interfere with the objectives and tasks of the Eurosystem. Such decisions are taken by the Governing Council with a majority of two-thirds of the votes cast.
The restriction is supposedly to ensure the consistency of monetary policy across the whole Euro area. But the ECB's restriction of ELA to Greek banks was not done for monetary policy reasons. Nor was the subsequent raising of collateral haircuts. The ECB's press release on 28th June cited the breakdown of the talks and the expiry of the bailout programme. These are political, not monetary, reasons.

To be sure, the effect of the growing political instability was to degrade the quality of the collateral pledged by Greek banks for ELA funding, since it consisted of Greek sovereign debt and other debt securities guaranteed by the Greek sovereign. But the whole point of a lender of last resort is that when there is a systemic bank run - as there has been in Greece for the whole of this year, and acutely after the breakdown of the talks - it will accept as collateral assets that are degraded in value. A true lender of last resort by definition must be able and willing to accept losses.

For a central bank to increase haircuts on pledged assets because of raised sovereign risk undermines the "lender of last resort" function. After all, banks turn to the lender of last resort precisely because every other lender has raised haircuts so much that borrowing becomes impossible. There might be some justification for refusing as collateral for normal monetary operations the bonds of a sovereign actually in default, as the ECB did when Greek sovereign bonds were briefly downgraded to "selective default" at the time of the 2012 PSI restructuring. But in my view there is never justification for refusing emergency funding to banks in a systemic bank run. In restricting liquidity to Greek banks, therefore, the ECB was not only failing to act as lender of last resort itself, it was also preventing the Bank of Greece from acting as lender of last resort. In effect, Greek banks have no lender of last resort. Indeed - since we must assume that banks of other distressed sovereigns would be treated similarly - none of the Eurozone banks have an effective lender of last resort.

Why is the Eurosystem ineffective as a lender of last resort? Because the Eurozone political leadership is dangerously obsessed with preventing central bank financing of governments.

All banks pledge as collateral the debt of their own sovereign and sometimes the debt of other sovereigns too. Some banks - as in Greece - also pledge other debt securities that are guaranteed by sovereigns. So sovereigns effectively guarantee the funding of commercial banks. This is true even in the Eurozone where sovereigns do not issue their own currency and therefore can only guarantee bank funding to the extent that they have the fiscal space to borrow. Pledging sovereign debt or sovereign-guaranteed debt as collateral exposes the central bank to sovereign funding risk. If the sovereign is distressed, such use of sovereign debt as collateral can maintain funding to the sovereign even if it is shut out of markets. Jens Weidmann of the Bundesbank regards this as a form of monetary financing of government and therefore outlawed under Article 123 of the Lisbon Treaty.

This is questionable, frankly, but as Weidmann is a member of the Governing Council of the ECB it was no doubt a consideration in the decision to restrict ELA to Greek banks. But actually the direct exposure of the ECB to sovereign debt through both normal and extraordinary monetary operations is a much more serious problem. It is this, plus the nature of the ECB's ownership, that causes the conflict of interest that Yanis noted.

Back in 2010-11, when Greece was on the verge of default and the Eurozone was in danger of collapsing, the ECB bought lots of Eurozone sovereign bonds under what was known as the "Securities Markets Programme" (SMP). The purpose of the SMP was to stabilise the yields of sovereign bonds, not just Greece's but also those of other distressed sovereigns, in order to calm bond markets and relieve liquidity pressure for financial market participants. The ECB described this as an extraordinary monetary policy intervention:
The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism.
The SMP programme is an example of what Perry Mehrling calls the "dealer of last resort" function, where a central bank intervenes directly in markets to backstop prices by buying up sovereign debt that everyone else is dumping. It is an essential financial stability function which at present in the Eurozone is seriously undermined by Article 123 of the Lisbon Treaty. This poisonous piece of legislation desperately needs repealing, or at least amending to allow the ECB to do its job properly.

The last purchases under the SMP programme were made in 2012, after which it was superseded by the OMT programme, which provides support for sovereign bonds only for countries in a fiscal adjustment program. Unsurprisingly, OMT has never been used - though its legality was challenged by the German constitutional court and finally confirmed in the European Court of Justice earlier this year.

The ECB's LTRO programmes, and - more recently - QE are also applications of the "dealer-of-last-resort" principle, although the ECB's QE is rendered inconsistent and confused by the exclusion of Greece and Cyprus - the very countries that most need a dealer-of-last-resort function. Obsession with avoiding monetary financing of government at times seriously compromises not just financial stability but monetary policy too.

But the effect of the SMP purchases is that the ECB's balance sheet now includes significant holdings of distressed sovereign bonds, including Greece's. Furthermore, the ECB is jointly owned by the Eurozone member states, who are also Greece's creditors. So the ECB's decisions are inevitably skewed towards the concerns of creditors. As Yanis notes, the concerns of creditors forced the ECB to act harshly towards Greece. But the ECB's responsibility for financial stability meant that it could not act so harshly that the banks failed. It was genuinely a conundrum for the governors. What policy stance would both meet the demand of creditors that Greece should be pressurised AND enable the ECB to fulfil its responsibility for financial stability?

It is the conflict of interest between ECB-as-creditor and ECB-as-liquidity-provider that makes the ECB ineffective as a lender of last resort. And because NCBs are controlled and restricted by the ECB, they too cannot act as lenders of last resort. So the Eurozone banking system effectively has no lender of last resort. The lack of a lender of last resort is terribly dangerous, since it vastly increases the likelihood of devastating systemic runs. Deposit insurance helps, but since that too is dependent on sovereign solvency there is a gaping hole in the infrastructure supporting the Eurozone financial system.

How to resolve this? The "doom loop" between sovereigns and banks must be broken: the funding of banks must be separated from the solvency of sovereigns, as must the funding of deposit insurance. That means full banking union, common deposit insurance and the issuance of Eurozone-level bonds that can be used by banks as safe assets. The ESM is a step in the right direction, but the current "banking union" is utterly inadequate. Much more needs to be done if the Eurosystem is to become effective as both lender and dealer of last resort.

Image from Greenfields Lawyers.

Wednesday, 29 July 2015

Lies, damned lies, and Greek statistics

Guest post by Sigrún Davídsdóttir

The word “trust” has been mentioned time and again in reports on the tortuous negotiations on Greece. One reason is the persistent deceit in reporting on debt and deficit statistics, including lying about an off market swap with Goldman Sachs: not a one-off deceit but a political interference through concerted action among several public institutions for more then ten years.

As late as in the July 12 Euro Summit statement "safeguarding of the full legal independence of ELSTAT” was stated as a required measure. Worryingly, Andreas Georgiou president of ELSTAT from 2010, the man who set the statistics straight, and some of his staff, have been hounded by political forces, including Syriza. Further, a Greek parliamentary investigation aims to show that foreigners are to blame for the "odious" debt. But there is no effort to clarify a decade of falsifying statistics. 

In Iceland there were also voices blaming its collapse on foreigners. But the report of the Special Investigation Committee silenced these voices. As long as powerful parts of the Greek political class are unwilling to admit to past failures it might prove difficult to deal with the consequences: the profound lack of trust between Greece and its creditors.

“This is all the fault of foreigners!” In Iceland, this was a common first reaction among some politicians and political forces following the collapse of the three largest Icelandic banks in October 2008. Allegedly, foreign powers were jealous or even scared of the success of the Icelandic banks abroad or aimed at taking over Icelandic energy sources. In April 2010 the publication of a report by the Special Investigation Committee, SIC, effectively silenced these voices. It documented that the causes were domestic: failed policies, lax financial supervision, fawning faith in the fast-growing banking system and thoroughly reckless, and at times criminal, banking.

As the crisis struck, Iceland’s public debt was about 30% of GDP and it had a budget surplus. Though reluctant to seek assistance from the International Monetary Fund (IMF) the Icelandic government did so in the weeks following the collapse. An IMF crisis loan of $2.1bn eased the adjustment from boom to bust. Already by the summer of 2011 Iceland was back to growth and by August 2011 it completed the IMF programme executed by a left government in power from early 2009 until spring 2013. Good implementation and Iceland’s ownership of the programme explains the success. For Ireland it was the same: it entered the crisis with strong public finances and ended a harsh Troika programme late 2013. Ireland's growth in 2014 was 4.8%.

For Greece it was a different story. From 1995 to 2014 it had an average budget deficit of 7%. Already in 1996, government debt was above 100% of GDP, hovering there until the debt started climbing worryingly in the period 2008 to 2009 – far from the prescribed Maastricht criteria of budget deficit not exceeding 3% and public debt no higher than 60% of GDP. But Greece's chronically high budget deficit and public debt had one exception: both figures miraculously dived, in the case of the deficit number to below the Maastricht limit, to enable Greece to join the Euro in 2001.

Greece had an extra problem not found in Iceland, Ireland or any other crisis-hit EEA countries. In addition to dismal public finances for decades there is the even more horrifying saga of deliberate hiding and falsifying economic realities by misreporting the Excessive Deficit Procedure (EDP) and hiding debt and deficit with off market swaps.*

This is not a case of just fiddling the figures once to get into the Euro but a deceit stretching over more than ten years involving not only the National Statistical Service of Greece (NSSG) but the Greek Ministry of Finance (MoF), the Greek Accounting Office (GAO) and other important institutions involved in the compilation of EDP deficit and debt statistics – in short, the whole political power base of Greece’s public economy.

2004: the first Greek crisis of unreliable statistics
The first Greek crisis did not attract much attention although it was indirectly a crisis of deficit and debt. It was caused by faulty statistics, already unearthed by Eurostat in 2002. Eurostat’s 2004 Report on the revision of the Greek government deficit and debt figures rejected the original figures put forward by the Greek authorities. After revision the numbers for the previous years looked drastically different – the budget deficit, which should have been within 3%, moved shockingly:

The institutions responsible for reporting on the debt and deficit figures were NSSG, the MoF through the GAO as well as MoF’s Single Payment Authority and the Bank of Greece. Specifically, NSSG and the MoF were responsible for the deficit reporting; the MoF was fully responsible for the debt figures.

Eurostat drew various lessons from the first Greek crisis. Legislative changes were made to eradicate the earlier problems – not an entirely successful exercise as could be seen when the same problems re-surfaced. But the most important result of the 2004 crisis was a set of statistical principles known as the European Statistics Code of Practice, which was adopted in February 2005 and revised in September 2011 following the next Greek crisis of statistical data. Unfortunately, NSSG drew no such lessons.

2009: the second Greek crisis of unreliable statistics

Following the 2004 report, Eurostat had NSSG in what can best be described as wholly exceptional and intensive occupational therapy. Of the ten EDP notifications 2005-2009 Eurostat expressed reservations about five of them, more than for any other country. No country other than Greece received "methodological visits" from Eurostat. The Greek notifications which passed did so only because Eurostat had corrected them during the notification period, always increasing the deficit from the numbers originally reported by the Greek authorities.

But in spite of Eurostat’s efforts the pupil was unwilling to learn, and in 2009 there was a second crisis of statistics. In January 2010, a 30-page report on Greek Government Deficit and Debt Statistics from the European Commission bluntly stated that things had not improved. In fact what had been going on at Greek authorities had no parallel in any other EU country.

This second crisis of Greek statistics in 2009 was set off by the dramatic revisions of the deficit forecast for 2009. As in 2004, this new crisis led to major revisions of earlier forecasts: the April forecast was revised twice in October. What happened between spring and October was that George Papandreou and PASOK ousted New Democracy and prime minister Kostas Karamanlis from power. The new government was now beating drums over a much worse state of affairs than the earlier data and forecast had shown.

After first reporting on October 2nd 2009, NSSG produced another set of figures on October 21st which revised the earlier reported deficit for 2008 from 5% of GDP to 7.7% and the forecasted deficit for 2009 from 3.7% of GDP to 12.5% (as explained in footnote, numbers for current year are a forecast, whereas numbers for earlier years should be actual data).

This was not all. In early 2010, Eurostat was still not convinced about the actual EDP data from the years 2005 to 2008. The earlier 2009 deficit forecast of 12.5% had risen to an actual deficit of 13.6% by April 2010. The final figure was confirmed as 15.4% in late 2010.

The European Commission's report detected common features with events in 2004 and 2009: a change of government. In March 2004, Kostas Karamanlis and New Democracy came to power, ending eleven years of PASOK rule; in October 2009, George Papandreou and PASOK won back power. The EC noted that in both cases:
substantial revisions took place revealing a practice of widespread misreporting, in an environment in which checks and balances appear absent, information opaque and distorted, and institutions weak and poorly coordinated. The frequent missions conducted by Eurostat in the interval between these episodes, the high number of methodological visits, the numerous reservations to the notifications of the Greek authorities, on top of the non-compliance with Eurostat recommendations despite assurances to the contrary, provide additional evidence that the problems are only partly of a methodological nature and would largely lie beyond the statistical sphere.
In other words, the problem was not statistics but politics. As politics is well outside its remit, Eurostat could not get to the core of the problem:
Though eventually an overall level of completion was achieved, given that Eurostat is restricted to statistical matters in its work the measures foreseen in the action plan were mainly of a methodological nature, and did not address the issues of institutional settings, accountability, responsibility and political interference.
Political interference could be deduced from the fact that reservations expressed by Eurostat between 2005 and 2008 on specific budgetary issues, which had then been clarified and corrected, resurfaced in 2009 when earlier corrections were reverted and the figures were once more wrong.

Good faith versus fraud

The EC's 2010 report identified two different but in some cases linked sets of problems. The first was due to methodological weaknesses and unsatisfactory technical procedures, both at the NSSG and the authorities that provided data to the NSSG, in particular the GAO and the MoF.

The second set of problems stemmed:
from inappropriate governance, with poor cooperation and lack of clear responsibilities between several Greek institutions and services responsible for the EDP notifications, diffuse personal responsibilities, ambiguous empowerment of officials, absence of written instruction and documentation, which leave the quality of fiscal statistics subject to political pressures and electoral cycles
Eurostat’s extra scrutiny and unprecedented effort had clearly not been enough:
even this activity was unable to detect the level of (hidden) interference in the Greek EDP data. In particular, after the closure of the infringement procedure at the end of 2007, Eurostat issued a reservation on the quality of the Greek data in the April 2008 notification and validated the notifications of October 2008 and April 2009 only after it intervened before and during the notification period to correct mistakes or inappropriate recording, with the result of increasing the notified deficit in both instances. As an example, Eurostat's methodological missions in 2008 resulted in an increase of the 2007 deficit figure notified by the Greek authorities, from 2.8% to 3.5% of GDP.
The EC's report further pointed out that:
on top of the serious problems observed in the functioning of other areas involved in the management of Greek public revenues and expenditures, that are not the object of this report, the current set-up does not guarantee the independence, integrity and accountability of the national statistical authorities. In particular the professional independence of the NSSG from the Ministry of Finance is not assured, which has allowed the reporting of EDP data to be influenced by factors other than the regulatory and legally binding principles for the production of high quality European statistics.
The EC concluded that there was nothing wrong with the quality assurance system in place at Eurostat. The shortcomings were peculiar to Greece:
The partners in the ESS (European Statistical System) are supposed to cooperate in good faith. Deliberate misreporting or fraud is not foreseen in the regulation.
And the rarity of revisions of such magnitude was underlined:
Revisions of this magnitude in the estimated past government deficit ratios have een extremely rare in other EU Member States, but have taken place for Greece on several occasions.
The EC's report spells out the interplay between authorities, dictated by political needs. Against these concerted actions by Greek authorities, the efforts of European institutions were bound to be inadequate. “The situation can only be corrected by decisive action of the Greek government,” the report said.

The Goldman Sachs 2001 swaps – part of the Greek statistics deceit saga

In early 2010, international media was reporting that Greece had entered into a certain type of swap – off market swaps – with Goldman Sachs in 2001 in order to bring its debt to a certain level so as to be eligible for euro membership

In Council Regulation (EC) No 2223/96 swaps were classified as “financial derivatives,” with a 2001 amendment making it clear that no “payment resulting from any kind of swap arrangement is to be considered as interest and recorded under property.” However, at that time off market swaps were not much noted. By the mid-2000s it became evident that the use of off market swaps could have the effect of reducing the measured debt according to the existing rules. Eurostat took this into account and issued guidelines to record off market swaps differently from regular swaps. Further, Eurostat rules specify that when in doubt national statistical authorities should ask Eurostat.

In 2008, Eurostat asked member states to declare any off market swaps. The prompt Greek answer was: "The State does not engage in options, forwards, futures or FOREX swaps, nor in off market swaps (swaps with non-zero market value at inception)."

In its Report on the EDP Methodological Visits to Greece in 2010, Eurostat scrutinised the 2001 currency off-market swap agreements with Goldman Sachs, using an exchange rate different from the spot prevailing one that the Greek Public Debt Agency (PDMA) had made with the bank. It turned out that the 2008 answer was just the opposite of what had happened: the Greek state had indeed engaged in swaps but kept it carefully hidden from the outer world, including Eurostat.

After having been found to be lying about the swaps, Greek authorities were decidedly unwilling to inform Eurostat about their details. Not until after the fourth Eurostat visit, at the end of September 2010 - after Andreas Georgiou took over at ELSTAT - did Eurostat feel properly informed on the Goldman Sachs swap.

The GS off market swaps were in total thirteen contracts with maturity from 2002 to 2016, later extended to 2037. As Eurostat remarked, these transactions had several unusual aspects compared to normal practices. The original contracts have been revised, amended and restructured over the years, some of which have resulted in what Eurostat defines as new transactions.

The GS swaps hid a debt of $2.8bn in 2001; after later restructuring the understatement of the debt was $5.4bn. The swap transaction, never before reported as part of the public accounts, was part of the revisions in the first ELSTAT reporting after Georgiou took over. This actually increased the deficit by a small amount for every year since 2001, as well as increasing the debt figure.

The swap story is a parallel to the Greek data deceit in the sense that it was not a single event but a deceit running for years, involving several Greek authorities. Taken together, both the swap deceit and the faulty reporting of forecasts and statistics by Greek authorities show a determined and concerted political effort to hide facts and figures, which did not change when new governments came to power.

A thriller of statistical data and mysteriously acquired emails

The Greek economy deteriorated drastically following the financial crisis in 2008. Public debt was at 129% of GDP by the end of 2009. The country effectively lost market access in March 2010. With an agreement signed on May 2nd, 2010, Greece became the first Eurozone country to be bailed out. The messy statistics made the negotiations tortuous.

After the appalling failures, misrepresentations and direct manipulation of figures for political purposes, things turned for the better when Andreas Georgiou took over as president of the newly established ELSTAT in August 2010. However, not everyone in the Greek political system celebrated the fact that ELSTAT was now operating strictly to ESS standards.

By the time Georgiou took over most of the corrections of earlier figures had already been done under the auspice of Eurostat. There was however the last set of corrections of deficit and debt figures. As pointed out earlier, the GS off market swaps were included for the first time, changing figures for earlier years, and the actual deficit figure for 2009 was yet again revised upward in the first set of data delivered by Georgiou.

The adoption of the new statistics law in March 2010 made ELSTAT independent of the MoF, although its board was politically appointed in addition to a representative from the employees’ union. This might not have been a problem if the board had understood the European Statistics Code of Practice in the same way as Georgiou.

Georgiou emphasised the independence and accountability of ELSTAT, and thought the board should be involved only with the broader issues, not the statistical production process. But the board felt, among other things, that it should vote on and approve the statistics and saw Georgiou as being manipulative, wanting to rule over the statistics. Three of the members of the new board, set up in August 2010 – ELSTAT’s vice president Nikos Logothetis, Zoe Georganda and Andreas Philippou – had applied for the position of president of ELSTAT, which possibly did not make things easier.

The breakdown of trust happened at a meeting with the presidium of the employees’ union on 21st October 2010, after Georgiou had been in office less than three months. At this meeting, the presidium showed Georgiou a document – a legal opinion from Georgiou’s lawyer, with whom Georgiou had been in touch via his private email account, on issues related to the law on ELSTAT that was in the process of being changed. Georgiou realised that someone had unauthorised access to his account. He later discovered that another member of the board, Zoe Georganda, possessed an email Georgiou had exchanged with Poul Thomsen, head of the Greek IMF mission.

Georgiou brought the case to the police, who discovered that Nikos Logothetis had been entering Georgiou’s account from the first day Georgiou took up his position at ELSTAT. When the police did a house search, Logothetis was actually at his computer, logged into Georgiou’s account. After less than six months in office Logothetis resigned from the ELSTAT board in February 2011 as criminal charges, based on his hacking into Georgiou’s account, were brought against him.

Logothetis has denied accessing the account and claims instead that various leading European statisticians framed him. His case is pending in court. But in spite of being charged with unauthorised access to Georgiou’s account, Logothetis has repeatedly been called in as an expert witness in parliament in the cases against Georgiou and his two colleagues.

When revising wrong statistics is treason

In September 2011, Antonis Samaras, the newly elected leader of New Democracy and minister for culture, gave a speech at the Thessaloniki International Expo in which he attacked George Papandreou, accusing him of manipulating statistics on coming to power in autumn 2009. Samaras claimed that Papandreou had done this to discredit Kostas Karamanlis, who had lost the election that brought Papandreou to power and whom Samaras had succeeded as party leader. This speech proved fateful, not for Papandreou but for ELSTAT’s president Andreas Georgiou.

A few days after Samaras’s speech, Georgiou was called to the parliament to explain why he had ignored national interests and revised the figures upwards. Georgiou referred to the ESS Code of Practice but gained little understanding. Instead he was accused of inflating the 2009 figures under instruction of Eurostat to push Greece into the Adjustment Programme. This ignored the fact that the main corrections had been done before Georgiou took over at ELSTAT.

It is important to keep in mind the context for the 2009 deficit: there was the forecasted deficit of 3.9%, put forth by the MoF and reported by NSSG in April 2009, and then the estimate of the actual 2009 deficit of 13.6%, as reported by NSSG in April 2010. All of this had happened before Georgiou took over at ELSTAT in August 2010, after which the final adjustment from 13.6% to 15.4% was made.

The accusations against Georgiou also ignored the fact that Greece had entered the Adjustment Programme three months before he took over at ELSTAT and also that the Greek statistical data had been found to be wrong prior to 2000, up to 2004 and then again up to end of 2009. Political figures on left and right of the political spectrum united against the ELSTAT president as if the only reason for the country’s high debt and deficit were statistics. The Greek Association of Lawyers accused Georgiou of high treason.

Around the time of the hearing in parliament in September 2011, a prosecutor took up the case against Georgiou and two ELSTAT managers and eventually pressed criminal charges in January 2013. In accordance with due process, an investigating judge began a more thorough investigation but at its conclusion, almost two years later, in August 2013 recommended that the case be dropped as nothing was found to merit taking the case further. Following interventions by politicians the case was kept open by the judicial system.

Twice again—in 2014 and 2015—prosecutors proposed that the case be dropped, always followed by interventions from nearly all sides of the political spectrum, which insisted on charges of false statements on the 2009 deficit and debt, and breach of faith against the state/causing the state damages be sustained and that the case be taken to trial. As the punishment should be relative to the damages, calculated to amount to €171bn, this would effectively have amounted to a prison sentence for life.

The charges against Georgiou and the two ELSTAT managers for allegedly making false statements on the 2009 statistics and breach of faith have recently been dropped. However, charges against Georgiou, inter alia for alleged violation of duty by not bringing the 2009 figures to the former board for voting, are being upheld. Some members of that former board still insist that the actual deficit figure of 2009 turned out to be identical to the planned deficit figure for 2009 of 3.9%, put forward in April 2009

Truth commissions and ELSTAT

One of the measures agreed on by the Eurogroup and Greece after the fateful Euro Summit July 12, “(g)iven the need to rebuild trust with Greece,” was “safeguarding of the full legal independence of ELSTAT.”  This reflects the fact that ELSTAT’s independence is still not secured and ELSTAT’s president still under attack.

The Greek parliament has set up two committees to investigate the past. One is the Parliamentary Truth about the Debt Committee, which was set up in April 2015, with members chosen by the Syriza president of the Greek parliament Zoe Konstantopoulou. The other, a Parliamentary Investigative Committee made up of members of parliament and normally referred to as the Investigative Committee about the Memoranda, is scrutinising how Greece got into the two Memoranda of Understanding with international partners, in 2010 and 2012, in the context of adjustment programs.

The two committees both seem to be in denial regarding the swaps and the faulty statistics. Both uphold blaming and shaming Georgiou and the two ELSTAT managers. In the Truth about the Debt Commission’s preliminary findings the earlier claims against Papandreou’s government are again taken up:
George Papandreou’s government helped to present the elements of a banking crisis as a sovereign debt crisis in 2009 by emphasizing and boosting the public deficit and debt.
And the Commission concludes:
Greece not only does not have the ability to pay this debt, but also should not pay this debt first and foremost because the debt emerging from the Troika’s arrangements is a direct infringement on the fundamental human rights of the residents of Greece.Hence, we came to the conclusion that Greece should not pay this debt because it is illegal, illegitimate, and odious.

A former director of the national accounts division at NSSG and now at ELSTAT (but heading a different division), Nikos Stroblos, who has accused Georgiou and the two others of manipulating statistics on instructions from Eurostat, is one of the contributors to the preliminary report of the Truth about the Debt Committee and has given evidence to the Investigative Committee on the Memoranda.

As recently as June 18, Nikos Logothetis - he of the aforementioned email hacking - testified before the Committee about the Memoranda, claiming that the deficit figures for 2009 and 2010 had been deliberately and artificially inflated. He called Georgiou a “Eurostat pawn” who had used tricks to increase the deficit figure.

Remarkably, the Greek parliament has never questioned anyone on the tricks and manipulations going on at ELSTAT and other public institutions involved in reporting wrong data from before 2000 until 2010.

International support for ELSTAT managers

Contrary to the sustained attacks at home, Georgiou and the two managers have enjoyed the support of Eurostat, European and international associations of statisticians, reflecting the fact that under Georgiou ELSTAT’s reporting has fully complied with Eurostat standards.

In late May this year, the European Statistical System (ESS)  published a statement expressing concern regarding the situation in Greece:
the statistical institute, ELSTAT, as well as some of its staff members, including the current President of ELSTAT, continue to be questioned in their professional capacity. There are ongoing political debates and investigatory and judicial proceedings related to actions taken by ELSTAT and to statistics which have repeatedly passed the quality checks applied by Eurostat to ensure full compliance with Union legislation.
On June 12 2015 the International Statistical Institute (ISI) published its fourth statement regarding the situation in Greece, welcoming the proposal from the Greek Appeals prosecutor that judicial authorities drop the investigation into claims that the current head of ELSTAT, Andreas Georgiou, inflated the country’s public deficit figure for 2009. ISI pointed out that according to the prosecutor the probe into Georgiou and the two managers had not delivered any evidence suggesting that the three had manipulated the figures. ISI repeated its statement from 2013:
the charges against Mr. Georgiou and two of his Managers of exaggerating the estimates of Greek government deficit and debt for the year 2009 are fanciful and not consistent with the facts’… The ISI expresses the hope that justice will prevail in this case and that the threat of prosecution will finally be lifted from Mr Georgiou and his Managers.
These recent statements on ELSTAT, and the reiterated requirement for ELSTAT independence in the Euro Summit’s statement of July 12th 2015, show that political pressure on ELSTAT is still palpable.

The lethal blend of “unhealthy politeness” and “excessive deference”

The lack of scrutiny, as demonstrated in the saga of the faulty Greek statistics, can partly be blamed on the European powers. True, both Eurostat and then the European Commission did exhume the ELSTAT failures and misreporting; but that it could happen in the first place is also due to failures at the European level.

When the European Union created a single currency the Euro countries in effect embarked on a journey all on the same ship. By now, it is evident that the crew - the European authorities - did not have the necessary safety measures to keep discipline among the passengers. Nor have the passengers kept an eye on each other. In the summer of 2011, Mario Monti, sorely tried by his experience as EU Commissary, formulated what had gone wrong:
At the root of the eurozone crisis lies of course the past indiscipline of specific member states, Greece in the first place. But such indiscipline could simply not have occurred without two widespread failings by governments as they sit at the table of the European Council: an unhealthy politeness towards each other, and excessive deference to large member states.
A successful monetary union demands more than the countries being just fair-weather friends. The crisis countries, most notably Greece, can only learn from the past if they understand what happened. In Greece these failures were, among others, the basic function in a modern state of truthfully reporting statistics.

Truth or politically suitable truth

In December 2008, while Iceland was still in shock after the banking collapse, its parliament set up a Special Investigation Committee, SIC, which operated wholly independently of parliament. The three SIC members were Supreme Court Justice Páll Hreinsson (the chairman), Parliament’s Ombudsman Tryggvi Gunnarsson and lecturer in economics at Yale University Sigríður Benediktsdóttir. Together, they supervised the work of about 40 experts. Their report of 2600 pages was published on April 10th 2010.

The report buried politically-motivated explanations of the collapse being caused by foreigners and instead recounted what had actually happened, based on both documents and hearings (private, not public hearings). One benefit of the SIC report is that no political party or anyone else can now tell the collapse saga as suits their interest: the documented saga exists and this effectively ended the political blame game. Importantly, the report points out lessons to learn.

Sadly, nothing similar has been done in Greece. The two committees set up by the Greek parliament do not seem entirely credible, because the allegations of ELSTAT misconduct and manipulation under Georgiou are being recycled. Further, their scope seems myopic, as no effort is made to explain what went on at the institutions that from before 2000 until 2010 were reporting faulty statistics and forecasts and lying about the GS swaps.

All of this taken together shows a political class, including within Syriza, not only unwilling to face the past but actively fighting any attempt to clarify things in a battle where even national statistics are a dangerous weapon. The fact that leading Greek political powers are still fighting the wrong fight on statistics is unfortunately symptomatic of political undercurrents in Greece. And this, in part, explains why the Troika and the EU member states find it so hard to trust Greece.

*A note on EU statistics: twice a year, before end of March and August, statistical authorities in the EU countries report forecasts of debt and deficit numbers for the current year, i.e. what the planned deficit and debt is and then statistical data for earlier years, i.e. the real debt and deficit, according to strict Eurostat procedure, in order to produce comparable statistics. This reporting, called Excessive Deficit Procedure (EDP) is published by Eurostat in April and October every year.

_________________________________________________________________________________ Sigrún Davídsdóttir is an Icelandic journalist, broadcaster and writer. Her coverage of Iceland's financial crisis and subsequent recovery can be found at her Icelog. Together with Professor Þórólfur Matthíasson she has earlier written at A Fistful of Euros on what Icelandic lessons could be used to deal with the Greek banks. 

Image from Jubilee Debt Org.

Thursday, 23 July 2015

When reason departs

In my last post, I pointed out that Greece's current depression is by no means the worst since World War II, as is often stated, and that the US's Great Depression was not the worst depression in history either. For reference, I'm putting up Tony Tassell's chart again.

I'm frankly appalled by the comments on that post. The arguments used to justify the prevailing views amount to the following.

1. The other countries in the list aren't rich Western countries, so they don't count.


2. Depression in a time of war isn't really depression.

I doubt if the people of Syria would agree with this.

However, in support of this point (and taking into account point 1), Christos Savva kindly provides this chart:

What this chart shows us is that the two World Wars were bad for the GDP of Western countries, and REALLY bad for the GDP of the countries on the losing side. So if you want to avoid a really bad depression, make sure you always win wars. Unless you are America

So, if we remove non-Western countries (point 1) and countries involved in wars (point 2), we are left with - what? Oh look, Greece and the US. Or, in Chart 1, just Greece (since the depressions in the Baltics and Bulgaria happened before they joined the rich Western European club). How remarkable.

But what is all this about "war doesn't count"? Seriously, Point 3 was actually made in a comment on my last post (though I am paraphrasing, of course):

3. Depressions caused by political decisions are worse than depressions caused by wars. 

Presumably this means "morally worse", not actually worse. GDP falls are clearly far greater when war is involved.

I find this morally inexcusable. War is a political decision. How is a political decision that results in depression worse than a political decision that results in war?

Wars cause depression through killing people and destroying property. "Political decisions" that cause depression also kill people and destroy property, just more slowly and with lots of excuses about "this will be good for you in the long run". And all too often, depression leads to war, just as war causes depression.

So we should rewrite point 3 thus:

 3. Depressions caused by some political decisions are worse than depressions caused by other political decisions. Even when they aren't.

But this is utterly illogical. Reason seems to have departed. 

"Ah well," say some commenters, "the US's Depression was the longest and deepest PEACETIME depression". (Though Greece may overtake it soon.)

But what does "peace" mean, when banks are used as weapons? What is the difference between imposing sanctions on Russia, which restrict financial and trade flows, and forcing closure of Greek banks and imposition of capital controls, which restrict financial and trade flows? Both are a form of siege. Using military force to cut supply lines or seize resources is an outright act of war - though we often turn a blind eye even to this, as we did in Czechoslovakia in 1968 and Weimar in 1923. Sanctions are economic warfare, though we like to pretend we are not actually at war with the countries concerned. But restricting liquidity to Greece's banks is a peacetime activity, apparently. I'm sorry, but I see little difference. The effects are the same.

If Greece's depression is in "peacetime", would someone please define "peace"?

Wednesday, 22 July 2015

Not such a Great Depression

We're used to hearing that the current Greek depression is the longest and deepest since World War II, aren't we? And that the worst depression in history was the US's Great Depression?

Via the FT's Tony Tassell comes this chart:

Looks like the fall of the Iron Curtain, the collapse of the Soviet Union and the first Gulf War did far more damage. Not to mention the numerous wars and crises in Africa. The current Greek depression just about makes it on to the bottom of this chart, and the other recent EU disasters don't even figure. 

I can't imagine what it is like to live through a GDP collapse of nearly 80%. But there are people alive today in Georgia and Iraq who remember that dreadful time all too well. And the appalling collapse suffered by Latvia in 1990-3 made their 2009 recession seem mild by comparison, even though it was the deepest of any country in the EU at that time. 

Nor are these all depressions of the past. Halfway up this chart is Syria, which has suffered a GDP collapse of 50% in the last five years - and we aren't talking about that, though we notice the refugees streaming into Turkey, Egypt and (of all places) Greece, and we don't know what to do about them. 

Now look at this chart:

Yes, that's right. Greece's depression is of a similar depth to the US in the 1930s, and on present trend will last longer. Recent developments may mean it deepens further, too. It may even catch up with Syria.

The next time someone claims the "mother of all depressions" was the US in the 1930s, will someone please show them Tony Tassell's chart?


Monday, 20 July 2015

The Great Greek Bank Drama, Act II: The Heist

The banks are re-opening, though just for transactions, so people can pay their bills and their taxes, pay in cheques, that kind of thing. The cash withdrawal limit has been changed to a weekly limit of 420 EUR per card per person, enabling households to manage their cash flow better. But the capital controls remain: money cannot leave the country without the agreement of the Finance Ministry. And the banks remain short of cash: although the ECB has raised the funding limit by 900m EUR, that only amounts to about 80 EUR per Greek so won't go very far. But the tourist season is in full swing, and tourists have been advised to bring cash into the country rather than using ATMs in Greece. On balance, therefore, Greece's monetary conditions should be easing.

But there is another tranche of bailout conditions to be agreed by the Greek Parliament by Wednesday 22nd July:
  • the adoption of the Code of Civil Procedure, which is a major overhaul of procedures and arrangements for the civil justice system and can significantly accelerate the judicial process and reduce costs; 
  • the transposition of the BRRD with support from the European Commission.
The first of these is relatively uncontroversial, though a tall order to implement at the speed that the creditors demand. But the second has serious implications for Greek banks and their customers, especially in the light of this part of the bailout agreement:
Given the acute challenges of the Greek financial sector, the total envelope of a possible new ESM programme would have to include the establishment of a buffer of EUR 10 to 25bn for the banking sector in order to address potential bank recapitalisation needs and resolution costs, of which EUR 10bn would be made available immediately in a segregated account at the ESM. 
The Euro Summit is aware that a rapid decision on a new programme is a condition to allow banks to reopen, thus avoiding an increase in the total financing envelope. The ECB/SSM will conduct a comprehensive assessment after the summer. The overall buffer will cater for possible capital shortfalls following the comprehensive assessment after the legal framework is applied.
Back in the autumn of 2014, the ECB & EBA conducted stress tests on European banks, including all four of Greece's large banks (which together make up about 90% of its banking sector). The Greek banks at that time passed the stress tests and were deemed solvent. They are now supervised not by Greek regulatory bodies, but directly by the ECB under the Single Supervisory Mechanism (SSM).

Yet now, eight months later, sufficient damage has apparently been done to Greece's banks to render them collectively insolvent. What on earth has gone wrong?

Greece's banks have suffered a continual deposit drain since the beginning of the year. This is how they became dependent on emergency liquidity assistance (ELA) funding from the Bank of Greece. But liquidity shortfalls do not cause insolvency unless they are covered by means of asset fire sales. In this case, the liquidity drain was until 28th June covered by ELA. Collateral has to be pledged for ELA funding, and Greek banks consequently found their balance sheets becoming more and more encumbered. To make matters worse, the ECB recently increased collateral haircuts for Greek banks. Now the banks are reopening, it is not clear how much collateral they have left for ELA funding. Whether the ECB will relax collateral requirements to allow a wider range of assets to be pledged remains to be seen. It is probably conditional on good behaviour by the Greek sovereign.

But it is not the funding side of Greek banks that is the real problem. It is the asset base.

Greece went into recession in Q4 2014 (yes, BEFORE Syriza came to power). Since then, there has been a considerable fall in output caused mainly by lack of confidence. On top of this, the Greek sovereign has been running substantial primary surpluses all year in order to maintain payments to  creditors in the absence of bailout funding. It has done this not by collecting more taxes but by a considerable squeeze on public spending: this has mainly taken the form of delaying payments to the private sector. Additionally, the private sector itself has cut back spending and investment. The result is that real incomes have tumbled, unemployment has risen and loan defaults have increased. Non-performing loans in the Greek banking sector were already high at the beginning of the year but are now believed to have risen substantially. This is the principal cause of the possible insolvency of Greek banks.

So the bailout plan includes recapitalisation of the banks using a loan from the European Stability Mechanism. This loan would be repaid from sales of sequestered assets in the privatisation fund that also forms part of the bailout agreement (my emphasis):
  • to develop a significantly scaled up privatisation programme with improved governance;  valuable Greek assets will be transferred to an independent fund that will monetize the assets through privatisations and other means. The monetization of the assets will be one source to make the scheduled repayment of the new loan of ESM and generate over the life of the new loan a targeted total of EUR 50bn of which EUR 25bn will be used for the repayment of recapitalization of banks and other assets and 50 % of every remaining euro (i.e. 50% of EUR 25bn) will be used for decreasing the debt to GDP ratio and the remaining 50 % will be used for investments. 
So, let's put this jigsaw puzzle together.

1. Greek banks are currently reopening for transactions only. The cash withdrawal limit is likely to remain in place for the whole of the summer, effectively limiting Greeks' ability to hoard physical cash, and the capital controls that prevent money being moved outside the country will also remain in place.

2. The Greek government is required to fast-track through legislation to implement the European Bank Resolution & Recovery Directive in Greece. Once implemented, bank resolutions will involve bail-in of unsecured creditors.

3. In the autumn, the ECB/SSM will conduct another asset quality review of Greek banks to determine their solvency. Most estimates of the expected capital shortfall seem to be of the order of 15bn EUR without including deferred tax assets (DTAs), a form of capital extensively used in Greek banks that the ECB has already indicated it intends to phase out. If the ECB excludes DTAs from the CET1 definition, the bill would be at least double that.

4. Once the outcome of the asset quality review is known, the Greek banks will be recapitalised by the ESM. This implies use of the ESM's direct recapitalisation facility, which will not be available until January 2016. The banks would be supported by ELA until then, but the cash withdrawal limit and capital controls would remain in place to prevent cash hoarding and capital flight. So Greeks face the prospect of continuing restrictions on access to and use of funds for at least the rest of the year.

There are two significant implications of using the ESM's direct recapitalisation facility.
Firstly,  ESM recapitalisation is de facto nationalisation of the banks by Greece's Eurozone creditors, bypassing the Greek sovereign. Once the banks were recapitalised and - presumably - relieved of their non-performing loans, they would be sold back to the private sector. The proceeds of their sale would go to pay back the ESM loans. The asset privatisation fund therefore implicitly includes all the Greek banks. Not many people seem to have understood this.

Secondly, the ESM's direct recapitalisation tool requires bail-in of 8% of liabilities. Silvia Merler at Bruegel explains what this would mean for Greek bank bondholders and depositors:
Bail-in would require full haircut of subordinated/other bonds, full haircut of senior non-guaranteed bonds and still a haircut of uninsured deposits ranging between 13% and 39% for three out of four banks. This would already bring all banks above the 4.5% CET1 threshold and two of the banks above 8% CET1. The remaining capital shortfall would be covered by the ESM and Greece together, but the Greek contribution could be suspended. The ESM would effectively play only a very limited role.
Silvia discusses an alternative, ESM direct recapitalisation with bail-in according to amended State Aid guidelines, which would mean bail-in of junior bondholders only:
The amended State aid guidelines require only bail-in of junior debt in the transition to the Bank Recovery and Resolution Directive (BRRD). After a 100% haircut on subordinated/other non-senior debt, the banks’ CET1 would still be below 4.5% in some cases. Under the ESM direct recap’s priority ranking, Greece needs to bring the banks to 4.5% CET1 before the ESM steps in and take them to 8%. With a conservative DTAs assumption, the contribution to reach 4.5% could be substantially bigger than the ESM contribution for those banks that are less capitalised and that do not have much bail-in-able junior debt. However, this contribution could be suspended by mutual agreement in light of the fiscal situation of Greece. If so, the ESM would play a more meaningful role.
 I'm afraid I don't think this second alternative is likely. The creditors are in no mood to cut Greece any slack, and the fact that steps are being taken to ensure that deposits don't leave the banking system in any quantity suggests that the intention is to bail them in. If I am right, then the potential economic outcome is terrible for Greece.

The last time uninsured deposits were haircut was the resolution of Cyprus's two failing banks in 2013. On that occasion, a reasonably large proportion of the cost was borne by foreign depositors, principally Russians, although Cypriot businesses, institutions and households also took a hit. One interesting effect of the Cyprus bail-in was that non-performing loans increased: people whose deposits were frozen were too angry to service their loans. The economic consequence of the Cypriot bank failures, including deposit bail-in, was a fall in GDP of around 6%:

But the situation in Greece is very different. Most large depositors have removed their money already. The remaining uninsured deposits - about 30% of the deposit base - are mainly the working capital of Greek businesses. Bailing these in would be far more destructive for the Greek economy than the bail-in of large depositors was for Cyprus. It is hard to put a figure on exactly what the GDP fall would be, but we should expect it to exceed the Cypriot fall by quite a bit. And this is on top of the 25% fall in GDP Greece experienced 2010-14, and a further projected 2-4% fall in GDP as a direct consequence of the output fall in the first six months of this year, and a planned fiscal tightening of 3% of GDP, and who knows how much of a collapse in the remainder of the year if cash withdrawal limits and capital controls remain in place as I expect.

Silvia argues that the working capital of Greek businesses would be exempt from bail-in because of its systemic consequences:
BRRD foresees some exemptions concerning bail-in, which the ESM direct recap does not have at the moment. Article 43(3) of the BRRD directive provides four exceptions, stating that in those cases the resolution authority may exclude or partially exclude certain liabilities from the application of the write-down or conversion powers. One of these exemption is when “the exclusion is strictly necessary and proportionate to avoid giving rise to widespread contagion, in particular as regards eligible deposits held by natural persons and micro, small and medium sized enterprises, which would severely disrupt the functioning of financial markets, including of financial market infrastructures, in a manner that could cause a serious disturbance to the economy of a Member State or of the Union”. This is evidently happening at the moment in Greece, where a full-fledged bank run is being kept contained only because of capital controls (which should unquestionably qualify as a “severe disruption of the functioning of financial markets”).
I'm afraid I disagree with Silvia. The existence of capital controls eliminates contagion and makes it possible to bail-in deposits that would normally be considered to have systemic consequences. Provided that cash withdrawal limits and capital controls remain in place until bail-in, therefore, there should be no destabilising effects on financial markets or financial market infrastructures. And apparently the microeconomic foundation of the economy can be destroyed with impunity as long as financial stability is not threatened. So therefore I think that bailing-in large deposits and senior unsecured bonds as well as junior debt is exactly what the creditors have in mind.

Bailing-in the deposits of Greek corporations and sole traders would be the clearest indication so far that restoring the Greek economy is on no-one's agenda. It amounts to a massive heist of the Greek private sector's disposable income.

I suspect Alexis Tsipras realised something like this was on the agenda, since he insisted that part of the privatisation receipts must go to new investment. But would this really be sufficient to offset the losses to Greek businesses and households of such a draconian bail-in?

The more I look at it, the less benign this bailout deal appears. Indeed it looks to me as if it was set up to do considerable damage to the Greek economy. Once this becomes apparent, Greeks are surely likely to change their minds about staying in the Euro. And I'm afraid I think this is the point. One way or another, Greece is on its way out of the Eurozone.

Thursday, 16 July 2015

The Great Greek Bank Drama, Act I: Schaeuble's Sin Bin

 Greece's banks have been closed since 29th June. The closure followed the ECB's decision not to increase ELA funding after talks broke down between the Greek government and the Eurogroup.

The closure is doing immense economic damage. The cash withdrawal limit of 60 euros per bank card per day is restricting spending in the Greek economy to a trickle. Media generally focus more on the hardship that the cash limit causes for households: but far worse is the inability of businesses to access working capital and make essential payments. Businesses are failing at a rate of knots. People are losing their jobs. And bank loan defaults are rising rapidly.

The closure was, of course, the decision of the Greek government, as was the associated decision to impose partial capital controls. But it is hard to see that they had any choice. Deposits have been draining from Greek banks for months, but when talks broke down the outflows increased to a full-blown bank run. The  ECB's decision not to increase liquidity was rather analogous to refusing a blood transfusion when a patient is haemorraghing. Without additional liquidity support, the banks would quickly have bled to death.

Ordinarily, in a bank run the correct action for the central bank is to increase liquidity to accommodate the desire of the private sector to convert bank deposits into physical cash and/or move their money somewhere safer. But this is when the reason for the bank run is concerns about bank solvency. In the Greek case, the bank run was due to concerns about sovereign solvency, and in particular about the growing possibility of redenomination of deposits into a new, devalued currency. Since the reason for the bank run was political, therefore, I find it hard to criticise the ECB. It was in a cleft stick. If it increased liquidity, it was arguably supporting the Greek government. If it reduced it, it was supporting the Eurozone creditors. It therefore did neither. Maintaining ELA at its existing level was a politically neutral decision.

The real mistake was made by the Greek government. It was always obvious that the talks would be difficult, and the Greek government's "strength in weakness" approach meant that it had to allow itself to be pushed dangerously close to Grexit. Bank runs were inevitable. So allowing Greek banks to become totally reliant on a central bank controlled by Greece's Eurozone creditors - and itself a creditor - was a fatal flaw in the Greek government's strategy. It should have imposed capital controls long before. Had it done so, monetary conditions in Greece would still have been very tight but the banks could have remained open.

But the failure to impose capital controls early on was symptomatic of a much larger error. The Greek government allowed itself to drift close to the Grexit cliff edge in the belief that the Eurozone creditors would not dare push it over. On Sunday night, its bluff was called - and it had no response. It had not prepared for the possibility that it might actually have to do the unthinkable and leave the Euro.

The lack of a "plan B" meant that the Greek government was left with no choice but to cave in to its creditors' demands. I have criticised the methods used to break the Greek PM Alexis Tsipras, but the end result was inevitable. He could not accept the "temporary Grexit" plan put forward by Germany's Wolfgang Schaueble. To do so would be catastrophic for the Greek economy. "We do not have the foreign reserves for a Grexit", he explained afterwards. He is right, and those who think that Schaueble's "sin-bin" would have been better for Greece are wrong.

Greece's situation should properly be regarded as a foreign exchange crisis. It is using a foreign currency as its domestic currency, and now that the foreign issuer of that currency has turned off the taps, its only sources of currency are earnings from trade and international borrowing. Greece is of course unable to borrow on the international markets, so earnings from trade are the only possible source of currency. But Greece has a trade deficit, and it imports essentials such as fuel and some foodstuffs. So even with the banks closed and capital controls, there is still a net drain of Euros from the Greek economy.

UPDATE: Kleingut (see comments) points out that it is the current account not the trade balance that matters. This is correct. And for the last two years the current account has been in credit during the tourist season:

It is not clear whether this is sufficient to make Euro earnings positive on an annualised basis. And the wide swings in Euro income need to be buffered by reserves to avoid cash flow problems. But more importantly, it is now a racing certainty that income from tourism will fall significantly in 2015. Bookings are down by 30% despite  operators slashing prices. Even without Grexit, therefore, Greece will have a foreign exchange problem in the autumn if not before unless ELA is restored.
So the hope is that with agreement on a new bailout, the ECB will turn the ELA taps back on, easing monetary conditions and allowing discretionary cross-border trade to resume.

Schaueble's scheme would have ended this hope. Here is how it is described in the short paper leaked to the press on Saturday:
In case debt sustainability and a credible implementation perspective cannot be ensured up front, Greece should be offered swift negotiations on a time-out from the Eurozone, with possible debt restructuring, if necessary, in a Paris Club-like format over at least the next 5 years. Only this way forward could allow for sufficient debt restructuring, which would not be in line with the membership in a monetary union (Art. 125 TFEU).
The time-out should be accompanied by supporting Greece as an EU member and the Greek people with growth-enhancing, humanitarian and technical assistance over the next years. 
As always, the devil is in the detail. Greece cannot be prevented from using the Euro, either domestically or internationally. But since it cannot borrow internationally and its Euro earnings are net negative, its access to supplies of the Euro can be completely cut off.  A "time-out" would presumably be implemented by removing ELA from the banks, forcing them to relinquish their Euro reserves, and possibly also by suspending its membership of the Target2 international Euro settlement system, although as Target2 includes among its members four non-Euro users, this would be politically problematic. But removing ELA would be sufficient to exclude Greece from Euro membership.

And it would have terrible consequences. As Silvia Merler explains, ELA is a significant part of the Greek banks' liabilities:
At the aggregate level, central bank liquidity accounted for about 30% of total liabilities the Greek banking system, as of May 2015. At the level of individual institutions, ECB lending was equivalent to 21% of assets in NBG, 37% in both Alpha and Piraeus and 39% in Eurobank. 
Removing ELA would be the equivalent of a simply enormous cash margin call - and as those familiar with the fall of the American insurance giant AIG will no doubt recall, large sudden cash margin calls can break financial institutions. Suddenly removing ELA from Greek banks would undoubtedly break them. Schaueble's "time-out" means the bankruptcy of the entire Greek banking sector.

It also means the denial of cash to Greek households and the loss of household and business deposits in the inevitable bank insolvencies. So it is not just the banks who would be suddenly insolvent. It would be the whole of Greek society.

The solution to this is of course for the Greek government to seize the Greek central bank (which is currently part of the Eurosystem) and force it to replace the lost ELA with a new Greek currency. Realistically this would be a Greek Euro, not drachma. The banks could then be recapitalised by the Greek state (i.e. nationalised) using money created by the now-captive central bank, rather than international borrowing. And since the new currency would be Euro not drachma, household and business deposits would not need to be redenominated. This sounds like a plan, doesn't it?

The domestic monetary squeeze could indeed be solved by creating Greek euros. But these would not be accepted internationally, since the ECB would regard them as counterfeit money. So Greece would still have to find "proper" euros, or perhaps US dollars or sterling, to pay for its imports - and although such a tight monetary squeeze would cause a sharp fall in imports, having to curtail essential imports because of lack of foreign exchange would do the sort of damage to the economy that cutting supply lines does in a war. Countries can be broken through lack of foreign exchange. Just ask India.

There is a further problem with Schaeuble's scheme. It envisages debt restructuring in a Paris Club-type arrangement. But all of Greece's debt is Euro-denominated. Grexit, even on a supposedly temporary basis, would leave Greece with no means whatsoever of obtaining the Euros to service that debt. Here, courtesy of RBC Capital Markets, is a graphic showing Greece's repayment schedule over the next few years:

The chart shows that if Greece were completely cut off from Euro supplies, default on its debts to the ECB, the IMF and the private sector would be certain, although the Eurozone might decide to swap out the ECB's holdings with the ESM - a ruse suggested originally by the Greek government's erstwhile finance minister Yanis Varoufakis. Interestingly, though, payments to other Eurozone official creditors would not be affected provided that Greece returned to Euro membership by 2020. Schaueble's choice of 5 years is not accidental. Temporary exit would force losses on to the IMF and the private sector ahead of Eurozone official creditors. Nice.

Defaulting on payment to the IMF prevents the IMF or its partner Bretton Woods organisation, the World Bank, offering further aid. All humanitarian relief would therefore have to come through bilateral assistance from friendly countries. And this is where the geopolitics gets nasty. Russia has already offered to maintain gas supplies, and I'm sure further "humanitarian assistance" would be offered if Greece were forced into a Grexit, whether permanent or temporary. That would go down REALLY well with the USA.

But what about this Paris Club lark? If I were the Club de Paris, I wouldn't touch this with a barge pole. Greece is already in IMF arrears. It is by Club de Paris standards a rich country, so would not qualify for exceptional assistance. And its official creditors have so far shown complete intransigence as far as debt relief is concerned - yes, even the IMF, which wants everyone except itself to restructure Greece's debt. Admittedly, Schaueble suggests that Eurozone creditors might be more willing to consider debt restructuring including NPV haircut if Greece were not in the Eurozone, but as Greece would still be an EU member it's really not clear why the Club de Paris should be involved. It would risk being drawn into the Eurozone's political quagmire for no purpose.

The fact is that Schaueble's "sin bin" would be the worst possible outcome for Greece. Even a permanent Grexit including leaving the EU would be preferable, since at least then it could default on Euro-denominated debts. But it would still face a foreign exchange crunch due to its import dependence. Grexit is toxic while Greece's export sector is so weak.

Alexis Tsipras and Euclid Tsakalotos made the best decision possible in a dreadful situation. They should be commended for that. But the drama is not over yet. This show begins and ends with banks - and Greek banks are now terribly damaged. The bailout includes proposals for restructuring them which will inflict further severe damage on the Greek economy and almost certainly lead to the failure of the new program. I shall discuss this in my next post.

Friday, 10 July 2015

There are controls, and then there are controls....

Guest post by Sigrún Davídsdóttir

Now that Greece has controls on outtake from banks, capital controls, many commentators are comparing Greece to Iceland. There is little to compare regarding the nature of capital controls in these two countries. The controls are different in every respect except in the name. Iceland had, what I would call, real capital controls – Greece has control on outtake from banks. With the names changed, the difference is clear.
Iceland – capital controls
The controls in Iceland stem from the fact that with its own currency and a huge inflow of foreign funds seeking the high interest rates in Iceland in the years up to the collapse in October 2008, Iceland enjoyed – and then suffered – the consequences, as had emerging markets in Asia in the 1980s and 1990s.
Enjoyed, because these inflows kept the value of the króna, ISK, very high and the whole of the 300.000 inhabitants lived for a few years with a very high-valued króna, creating the illusion that the country was better off then it really was. After all, this was a sort of windfall, not a sustainable gain or growth in anything except these fickle inflows.
Suffered, because when uncertainty hit the flows predictably flowed out and Iceland’s foreign currency reserve suffered. As did the whole of the country, very dependent on imports, as the rate of the ISK fell rapidly.
During the boom, Icelandic regulators were unable and to some degree unwilling to rein in the insane foreign expansion of the Icelandic banks. On the whole, there was little understanding of the danger and challenge to financial stability that was gathering. It was as if the Asia crisis had never happened.
As the banks fell October 6-9 2008, these inflows amounted to ISK625bn, now $4.6bn, or 44% of GDP – these were the circumstances when the controls were put on in Iceland due to lack of foreign currency for all these foreign-owned ISK. The controls were put on November 29 2008, after Iceland had entered an IMF programme, supported by an IMF loan of $2.1bn. (Ironically, Poul Thomsen who successfully oversaw the Icelandic programme is now much maligned for overseeing the Greek IMF programme – but then, Iceland is not Greece and vice versa.)
With time, these foreign-owned ISK has dwindled, is now at 15% of GDP but another pool of foreign-owned ISK has come into being in the estates of the failed bank, amounting to ca. ISK500bn, $3.7bn, or 25% of GDP.
In early June this year, the government announced a plan to lift capital controls – it will take some years, partly depending on how well this plan will be executed (see more here, toungue-in-cheek and, more seriously, here).
Greece – bank-outtake controls
The European Central Bank, ECB, has kept Greek banks liquid over the past many months with its Emergency Liquid Assistance, ELA. With the Greek government’s decision to buy time with a referendum on the Troika programme and the ensuing uncertainty this assistance is now severely tested. The logical (and long-expected) step to stem the outflows from banks is limit funds taken out of the banks.
This means that the Greek controls are only on outtake from banks. The Greek controls, as the Cypriot, earlier, have nothing to do with the value or convertibility of the euro in Greece. The value of the Greek euro is the same as the euro in all other countries. All speculation to the contrary seems to be entirely based on either wishful thinking or misunderstanding of the controls.
However, it seems that ELA is hovering close to its limits. If correct that Greek ELA-suitable collaterals are €95bn and the ELA is already hovering around €90bn the situation, also in respect, is precarious.
How quickly to lift – depends on type of controls
The Icelandic type of capital controls is typically difficult to lift because either the country has to make an exorbitant amount of foreign currency, not likely, a write-down on the foreign-owned ISK or binding outflows over a certain time. The Icelandic plan makes use of the two latter options.
Lifting controls on outtake from banks takes less time, as shown in Cyprus, because the lifting then depends on stabilising the banks and to a certain degree the trust in the banks.
This certainly is a severe problem in Greece where the banks are only kept alive with ELA – funding coming from a source outside of Greece. This source, ECB, is clearly unwilling to play a political role; it will want to focus on its role of maintaining financial stability in the Eurozone. (I very much understand the June 26 press release from the ECB as a declaration that it will stick with the Greek banks as long as it possibly can; ECB is not only a fair-weather friend…)
Without the IMF it would have been difficult for Iceland to gather trust abroad in its crisis actions – but Greece is not only dependent on the Eurozone for trust but on the ECB for liquidity. Without ELA there are no functioning Greek banks. If the measures to stabilise the banks are to be successful then controls are only the first step.
Sigrún Davídsdóttir is an Icelandic journalist, broadcaster and writer. Her coverage of Iceland's financial crisis and subsequent recovery can be found at her Icelog, where this post first appeared. 
Together with Professor Þórólfur Matthíasson she has earlier written at A Fistful of Euros on what Icelandic lessons could be used to deal with the Greek banks. 

Image from WSJ. 

Thursday, 9 July 2015

Tsipras in the crucible

The atmosphere in the Greek standoff is turning ugly. On Tuesday, after new Greek finance minister Euclid Tsakalotos turned up to Eurogroup talks with nothing but hastily-drafted notes written on hotel paper, Eurozone leaders told the Greek government in no uncertain terms that if it did not produce credible proposals by Sunday 12th July Greece would be thrown out of the Eurozone. "We have a Grexit scenario prepared in detail", said European Commission president Jean-Claude Juncker.

The President of the European Council, Donald Tusk - one of the very few consistently sane and reasonable voices in this drama - said that inability to find agreement may lead to the bankruptcy of Greece and the insolvency of its banking system. And he warned that there would be serious - possibly irreparable - geopolitical repercussions for the European Union. "If someone has any illusion that it will not be so," he said, "they are naive".

Others have also warned about the geopolitical risks and the threat to the Euro project that a Grexit would create. In an interview on BBC Radio 4, the former head of the ECB, Jean-Claude Trichet, warned that Grexit would cause a "loss of credibility for Europe" and increase instability in a geopolitically sensitive region. The US has also expressed concern: on Tuesday evening President Obama telephoned both Angela Merkel and Alexis Tsipras, and today the Treasury Secretary Jack Lew warned that a deal was essential for the economic and geopolitical stability of Europe. In his Budget speech, the UK's Chancellor George Osborne described Grexit as the biggest risk facing the UK economy. And France's Prime Minister Manuel Valls, warning of geopolitical risks from Grexit, insisted that Grexit would be an indication of "impotence". "France refuses this", he said adamantly.

But despite all these warnings, Grexit now appears to be the default position of most European leaders. Eastern European leaders, particularly, are strongly opposed to any more help for Greece, while Germany would apparently consider money for humanitarian relief after a Grexit but not for debt restructuring to avoid it. France and Cyprus appear to be Greece's only friends.

Germany's position is the same as ever: no debt relief, no bridge finance, reforms must be delivered before any money is released, and the IMF must continue to be involved. If it sticks to these, Grexit is a certainty, since the IMF's involvement is incompatible with lack of debt relief. Christine Lagarde, speaking in Washington DC, reiterated the IMF's position that debt relief is required in addition to further cost cutting by Greece:
The other leg is debt restructuring, which we believe is needed in the particular case of Greece for it to have debt sustainability. That analysis has not changed. It well may be that numbers may have to be revisited but our analysis has not changed.
Lagarde's repetition of "our analysis has not changed" is clearly aimed at Angela Merkel. Continued involvement of the IMF is impossible unless the creditors agree to debt relief. Unless Merkel agrees to debt relief, she may go down in history as the German leader whose intransigence destroyed the Euro project. It is perhaps not surprising that this week there have been pieces in the German magazines Der Spiegel and Handelsblatt that are highly critical of Angela Merkel's handling of the Greek crisis. For now, she is popular - but would she remain so after a disorderly Grexit?

I fear we may soon find out. Watching Alexis Tsipras's address to the European Parliament this afternoon, I was filled with a terrible sense of foreboding. The tension in the room, the antagonistic attitude of a sizeable proportion of the audience and the angry interventions by several MEPs reminded me of the courtroom scene in Arthur Miller's The Crucible. There was little sense in evidence: fear and anger ruled the roost. One MEP even suggested that Greece needed a "General Pinochet" to take over and sort the place out. A military coup, for a country whose people remember the "colonels" with fear and loathing. What kind of union is this?

Nor is the sense that the lunatics have taken over the asylum limited to the European Parliament. Lagarde's comment a few weeks ago that there needed to be adults in the room in any negotiations was not aimed only at Greece. The Eurozone leadership is beginning to resemble the feral boys in William Golding's Lord of the Flies. Gone is any idea of working together to achieve the best outcome for everyone. The "no bailout" faction led by Germany's Schaueble is so intent on hunting down and killing the PIIG that the warnings from outsiders pass unnoticed.  It is a completely unedifying spectacle.

It cannot be stated too strongly that Grexit is NOT the best outcome. Not for anyone. It would be terrible for Greece, of course: the Greek government is very aware of that. But it would also be terrible for Europe, possibly spelling the end of the Euro and even of the European Union. What sort of message does the sight of a group of countries ganging up on a weaker one to force it out of their club send to the world? And with the current turmoil in the Chinese stock market, and the instability and conflicts along the EU's eastern border and in the Middle East, the consequences for the whole world of an economic and political disaster in the Balkans could be severe.

The Greek negotiations have become a classic "prisoner's dilemma". The best outcome FOR EVERYONE - even for those currently in favour of Grexit - is a negotiated restructuring of debt coupled with sensible and achievable reforms. But that means that everyone involved must put aside their anger, their fear and their pride so that they can cooperate. I don't see any signs of this at the moment, and I fear for Greece, for Europe and for the world.

Greece has now formally requested a third bailout, and will present its proposals to the Eurogroup tomorrow (Thursday). The letter from Euclid Tsakalotos is more conciliatory than previous letters from his predecessor Yanis Varoufakis, and offers to commence reform of tax and pensions immediately. Greece, therefore, has made the first move. It is blurring its "red lines" in an effort to seek a negotiated solution. It is now up to the creditors to respond in kind.

Donald Tusk has called a European summit for Sunday July 12th. This summit will involve the leaders of all 28 European Union nations, not just the Eurozone leaders. Given how bad relationships between the Eurozone leaders and the Greek government appear to be at the moment, this is a wise decision. I sincerely hope that there will be sufficient adults at this meeting for an agreement to be reached.

This insanity must end.