Monday 18 February 2019

Victims of fiasco include independence of the ECB

On two out of three critical points Athens government is more in line with economic orthodoxy than its creditor counterparts

The Eurogroup president, Jeroen Dijsselbloem, has been offering free advice to Greek voters on today's ballot, not part of his job description
The Eurogroup president, Jeroen Dijsselbloem, has been offering free advice to Greek voters on today's ballot, not part of his job description
Colm McCarthy

Colm McCarthy

Central banks were created to ensure financial stability, particularly to prevent fatal depositor runs against banks which might otherwise survive. They ensure survival through furnishing banks under stress with emergency liquidity and central banks can create the needed liquidity at will.

Over time, they acquired other functions and goals, but the prevention of avoidable bank closures remains a key central-banking function. Last year, the ECB participated in an asset quality review and stress tests on 123 European banks for whose supervision it is now responsible.

The four main Greek banks, having raised new equity capital to the tune of €8 billion, were deemed to be sound, some better than others, but all four were eligible for support on the basis of presumed solvency. Those banks have been closed all week because the ECB decided to close them.

Last Sunday, responding to concerns about the finances of the Greek government rather than the Greek banks, the ECB placed an arbitrary ceiling on support to those banks, none of which it has yet deemed insolvent, knowing that the continuing depositor run would force their immediate closure.

The panic queues in Athens have formed mainly at banks and filling stations. The managing director of Hellenic Petroleum, the main retailer of autofuels, tried to calm things, assuring people over the airwaves that stocks were adequate and that the tankers would keep rolling.

The European Central Bank, sheltering behind undisclosed rules about liquidity provision, declined to offer any such assurance and closed down the Greek financial system. In a remarkable piece of chutzpah, its press release also announced that "ECB will work closely with Bank of Greece to maintain financial stability". How precisely does the ECB define financial stability in a country where the financial system has been shut down?

The five-year fiasco over Greece, whose most farcical instalment is today's referendum on a proposal already withdrawn by the creditors, is claiming victims beyond Greece. The most notable casualty is the supposed independence of the European Central Bank. It was open to the ECB, without breaking any rules, to do what Hellenic Petroleum did: reassure the public and avoid needless disruption to an economy already on the ropes. Thankfully, the ECB is not in charge of the filling stations.

What would people think of Hellenic Petroleum had it announced: "We are closing all filling stations immediately and for an indefinite period. We are working closely with the Department of Energy to maintain stability in fuel supply"?

There was no obligation on the ECB to close down the Greek financial system on Sunday last: it was free to announce continuing liquidity support and to end the deposit run. The governing council chose not to do so and cannot now complain if it is seen to have yielded to creditor pressure.

The bank closure came on June 29, three years to the day since the famous Euro-summit declared: "We affirm that it is imperative to break the vicious circle between banks and sovereigns." This was the same Euro-summit which, during the acute phase of the 2012 sovereign debt crisis, produced the 'game-changer' commitment about re-capitalising Irish banks. We know how that played out.

The European politicians and the European Commission, as managers of the crisis response, have little credibility left to lose. They appear content to establish that they are more competent than the Greek government, not an exacting standard, with the commission president Jean Claude Juncker whingeing that he feels 'betrayed', poor thing.

The Eurogroup president, Jeroen Dijsselbloem, has been offering free advice to Greek voters on today's ballot, not part of his job description.

Until Sunday, the ECB, despite numerous missteps, had managed to stand aside from the blame game over Greece. Nobody comes well out of this omnishambles, but the ECB has again managed to stoke, rather than staunch, a run on member-state banks as it did in Ireland in 2010. This time, the run is on banks which it supervises and which it regarded as solvent. If they were okay last year, they are shattered now and may need another re-capitalisation before they can reopen. As the Lex column in the Financial Times noted during the week, it is difficult to make people feel sympathy for banks, any banks, but the ECB has managed it.

The other major reputational casualty has been the International Monetary Fund. In May 2010, the fund, against the judgement of some of its in-house experts, went along with the fateful first bailout of Greece's creditors, having re-written its own rules to do so. The fund finally conceded during the week that the Greeks need further debt relief. Had it heeded its own best instincts when the Greek crisis first emerged early in 2010, it might have saved the eurozone, and itself, a great deal of grief.

For a worldwide organisation to find itself lending huge amounts to wealthy European countries as a junior partner in the Troika was a strategic error, not just because the programmes were ill-designed but because the eurozone had the resources and the incentive to sort out its own problems. There was more urgent work for the IMF elsewhere and the debacle in Greece may well see the end of the Troika and an IMF retreat from European entanglements. When Ms Lagarde's term ends next year, it is difficult to see how the practice of always handing the top IMF job to a European can be continued.

For European leaders to blame the inexperience of the Syriza-led government for the current appalling mess is largely beside the point. It may indeed have been poor at diplomacy and too given to brinkmanship. But on two critical points (out of three), it has been more in line with economic orthodoxy than its creditor counterparts. The three key issues are how to deal with the debt overhang, where to set the deficit target in the shorter term, and economic reform.

The Debt Overhang

Even though Greece's official loan terms have been extended and interest rates reduced, the nominal debt burden is too big for the markets, where Greek bonds trade at 50 cents on the dollar. Or rather, they would, if the Athens Stock Exchange was open. A cut in headline debt would help confidence and a return to the markets, even if it did not cut the annual interest bill very much - this bill is maybe-manageable if the economy starts to recover. Syriza is correct on this one and enjoys endorsement from various economic luminaries of impeccable right-wing credentials. Plus the IMF.

Cutting the Budget Deficit

The economy has been flattened and it makes no sense, according to either Syriza or aforementioned luminaries, to tighten too quickly.

Economic Reform

The Greek economy needs comprehensive reform. It is riddled with corruption, oligarchy, weak tax collection and ineffective public administration. Syriza has shown the same clientelist reluctance as its predecessors to face the music.

The basis for a deal is a serious reform programme in exchange for a write-down (partly symbolic) in headline debt and a pause for a few years in budget tightening. If Syriza or an alternative cannot commit to reform, the creditors are undeservedly off the hook and the Greek economy doomed to further avoidable dislocation.

Sunday Independent

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