The events of the last few days, present us with a worrying path towards Euro disintegration. This post presents in summary what is happening and possible options for the Greek government and the Eurogroup. I need to stress that this does not need to happen and that there is time for all parties to reach a negotiated solution. In this Varoufakis is not to blame as the Greek government is very willing to reach a compromise. It is Germany which needs to consider whether the following sequence needs to play out in this way.
Up till 26.1.15 (the day after the Greek election) Greece was receiving funding primarily from the Troika (represented here by a nice set of IKEA scissors), to a small degree by markets (there were a couple of test sales of Greek bonds in 2014) and the ECB was supporting the Greek banking system, accepting Greek bonds as collateral (via a waiver to the normal rules for collateral).
After the election and the decision of Syriza (it was elected to do this) not to continue with the Troika agreed programme, Greece is not due to receive more funds from the Troika, nor is it currently likely to borrow in the markets (spreads have shot up since the election). This meant that the only interim avenue for funding would be via Greek commercial banks buying Greek sovereign debt and depositing it with the ECB/BoG as collateral for liquidity support.
On 4.2.15 Draghi closed this avenue of funding by withdrawing the ECB waiver that allowed the low-rated Greek bonds to be accepted as collateral. This leaves the Greek government with only one option of borrowing: through its banking system by drawing liquidity from the Bank of Greece via the ELA. The ELA is available as the ECB collateral rules do not apply.
How secure is this avenue for funding? Can Greece rely on the ELA for back-door financing via its banking system (and ultimately the ECB) if all other funding avenues are unavailable indefinitely? This is where things get dangerous. The ECB (see earlier posts for explanations) can control the extent (in time and value) of the ELA and if the BoG authorises liquidity support for the sole purpose of funding government expenditure through commercial channels, then the ECB is likely to want to shut the ELA down.
What are the options for the Greek government if that happens? Sadly, there are not many options. It can choose to selectively default on internal or external debt (or both). Or it can pressure the BoG to ignore the ECB and continue with ELA support. In the former case, we need to consider the consequences of default within the Eurozone (this will be the content of a future post). In the latter case, we need to consider the tools the ECB has for shutting down unauthorised ELA. The only way it can do this (barring being persuasive) is to order the other NCBs in the Eurosystem to stop lending to the BoG. This effectively (and immediately) segregates the BoG from the Eurosystem (see earlier posts) and brings the Grexit scenario into fruition. The consequence will be a Greek Euro and the old Euro, with fluctuations in their relative values. This is not a scenario we wish to see in practice.
I hope all the above demonstrates why a solution to Greece’s funding needs has to be found. No-one can afford an ECB/NCB conflict scenario. So I would urge Dr Schaeuble to realise things have changed and start thinking how to resolve this sensibly.