More on the Greek Banking Calamity
Rumors have been making their way over the wires on Tuesday that the four largest Greek banks will receive € 18 billion in the form of 'EFSF bonds' on Friday in a first tranche of the recapitalization effort that is part of Greece's latest bailout deal. The report was updated several times during the day, until Friday had morphed into 'perhaps Wednesday'. Below is an excerpt of the report as it appeared at Reuters:
„Greece's bank stability fund approved an 18 billion euro ($22.96 billion) injection to rescue its four largest banks on Tuesday, and an official said they would get the urgently needed funds as soon Wednesday.
Bankers say the recapitalisation will allow them to again receive funding from the European Central Bank (ECB), which cut off some Greek banks last week because they lacked enough capital to be considered solvent.
Huge losses from a sovereign debt swap in March nearly wiped out the capital of Greece's systemically important banks and Greek authorities are scrambling to wrap up a bridge recapitalisation to help them cope with a cash crunch.
The Hellenic Financial Stability Fund (HFSF) said it had approved an agreement to release the funds, which will come in the form of notes issued by the euro zone's financial rescue fund, the European Financial Stability Fund (EFSF). The HFSF statement said the deal would be presented to the Greek banks for signing on Wednesday, and an HFSF official said the funds would be released as soon as it was signed.
Recapitalising Greece's limping banks is a vital part of the 130-billion-euro EU and International Monetary Fund bailout Greece agreed in March to stave off national bankruptcy.
But with Greece lacking an elected government after an inconclusive vote on May 6, implementation of the deal is largely on hold. With details of the overall 50-billion euro recapitalisation plan for the banks still unresolved due to political deadlock, authorities have come up with an interim solution to keep the four biggest banks afloat until a new government is formed to finish the framework.
Greece will hold a repeat election on June 17, and opponents of the March bailout agreement have surged in opinion polls, alarming European leaders who say that if the bailout is rejected at the ballot box Greece could face swift bankruptcy and economic collapse.
Greeks have been withdrawing their funds from banks for months, and the pace has picked up dramatically since the May 6 vote. That has forced Greek banks to cover their funding gaps by tapping liquidity from the ECB and the Greek central bank's more expensive emergency liquidity assistance (ELA) window against collateral.
They already had borrowed 73.4 billion euros from the ECB and another 54 billion from the Bank of Greece via ELA, based on the most recent data as of January.
Together, the sums translate to about 77 percent of the banking system's household and business deposits, which stood at about 165 billion euros at end-March.
Last week the ECB suspended some Greek banks from its funding operations because their capital was too low, forcing them to migrate to higher-cost funding at the Bank of Greece's ELA facility.“
Evidently the ECB has stopped its open market operations with Greece's banks due to their lack of acceptable collateral some time ago already. This has left the ELA ('emergency liquidity assistance') program as the sole funding tool, which is administered by the national central banks (NCB's) in the euro system and requires the ECB's placet. As might be imagined, the collateral eligibility criteria for the ELA program are significantly below the already quite generous rules employed at the central ECB level.
For instance, Ireland's central bank last year famously lent its insolvent banks some €58 billion upon the issuance of 'IOU's' by the banks. We don't know what kind of collateral the Bank of Greece is accepting in these operations, but to be safe one should probably assume the worst. In fact, we think it is almost certain it is getting bank IOU's as well (see also further below).
The above is highly significant if it is true. As David Zervos, head of Global Fixed Income Strategies at Jefferies related in a recent missive, the ECB used its power over the granting of ELA to essentially blackmail the Irish government into bailing out its banks. Of course this was all done in a very polite, gentlemanly manner, by pointing out that Ireland's clearly insolvent banks were coming close to violating the rules. Yes, there are rules at Europe's money printing central command station! These are apparently invoked 'as needed'.
The rule violation would have occurred in this instance if an idea the Irish government was toying with at the time – namely to let the senior bondholders of the defunct Irish banks eat some of the losses they so richly deserved – had been put into practice. Then, so the ECB's argument went, the institutions concerned could no longer be regarded as 'sound'. The rules say that the ECB must object to the extension of ELA if the recipients can no longer be deemed 'sound'. So there!
Of course the end result of the Irish intervention was that Ireland's government first had to lie about why it went ahead with the bank bailout, and then had its lie exposed in the most interesting fashion: the exact opposite of what it said would happen if it didn't bail out bank bondholders happened precisely because it bailed them out.
By bailing out the banks, the Irish government was eventually forced to seek a bailout itself, although it had asserted that the main reason why it had to bail out bank bondholders was that this was the only way to ensure that the government would be able to continue to fund itself in the markets!
We noticed with some interest that the ECB cut off direct funding of several more Greek banks a little while ago as they ran out of eligible collateral. However, recently the first rumblings could be heard about a potential end to ELA financing as well. As German news magazine 'Der Spiegel' reported a few days ago:
„When the head of Greece's central bank, George Provopoulos, recently met with his European counterparts, the session turned into a confession. His fellow Greeks had just withdrawn €800 million ($1.022 billion) from their bank accounts, within just a few days. Consequently, at a meeting of the Governing Council of the European Central Bank (ECB) last Tuesday, Provopoulos had to ask for money — once again.
Most Greek banks are currently cut off from the usual ECB lines of credit. They no longer have sufficient collateral. A number of banks are even currently operating without sufficient capital as a risk buffer for their activities. Indeed, Provopoulos had to accept last week that yet another crop of Greek banks were branded as unfit for ECB refinancing.
These zombie banks are being kept alive with help from the so-called Emergency Liquidity Assistance (ELA) — a rescue aid program managed by Provopoulos. At every session of the Governing Council, he has to have these special allocations approved.
For the time being, he has succeeded. Last Tuesday, the ceiling for the amount of aid that Provopoulos is allowed to give his banks was even raised again, from roughly €90 billion to €100 billion. But the Council is harboring increasing doubts about this permanent subsidy.
The central bankers are caught in a moral conflict. Cutting off the flow of money would have disastrous consequences: Greece would quickly run out of money. The population would soon not even have enough cash to pay for its daily purchases.
The entire country essentially depends upon life support from the ECB. At the same time, the risks are mounting on the central banks' balance sheets. Already back in February, Greek banks had accumulated more than €106 billion of debt alone in the TARGET2 internal payment system of the euro zone's central banks.
But the central bankers are particularly annoyed as they once again have to play the role of major bankroller because the political system is failing to address the problem. Indeed, in the Greek election circus, it looks like the issue of urgent reform of the country's ailing banks may be given short shrift.
Nevertheless, funds are available: The most recent bailout package for Greece includes €50 billion to recapitalize the financial sector. The euro partners have even already transferred half of this money to Greece.
The legal conditions for the bailout have not been clarified, though. Originally, private banks were supposed to raise roughly 10 percent of their recapitalization from private investors, or run the risk of being nationalized. Investors are, however, hard to find. So this uncomfortable issue has been sidelined in the election campaign.
By the end of last week, not even an initial bridge financing of €18 billion had flowed to the banks — funds which the interim government under Loukas Papademos had approved in a rush before the election on May 6.
„According to an analyst with the Moody's rating agency, the Greek banks have in the meantime become "economically insolvent," and thus urgently rely on assistance from the rescue fund. Even former model institutions, such as the country's largest lender, the National Bank of Greece, which posted earnings of €1.6 billion in 2007, are fighting for their survival.
Greek banks may have never indulged in high-stakes gambling on the US real estate market, but after they entered the euro zone, they aggressively expanded their lending operations. Now, they are threatened with massive defaults. Furthermore, the country's financial elite is closely linked to the political arena. At the beginning of the crisis, this prompted the banks to purchase huge amounts of sovereign bonds. The partial debt waiver by private investors a few weeks ago suddenly took an enormous bite out of the banks' remaining capital reserves. This so-called haircut cost the country's four largest banks alone €24 billion.
To make matters worse, nervous customers have been pillaging their bank accounts since the beginning of the crisis. The banks have already lost one-third of all their deposits.
Some of Europe's central bankers are nevertheless no longer willing to allow themselves to be endlessly tapped for cash. Belgian Luc Coene has already openly warned that even the ELA payments must "absolutely" be stopped if the Greek banks are actually hopelessly bankrupt, and not merely illiquid.
Gee, Luc, do you perhaps think they may no longer be 'sound institutions'? What part about 'economically insolvent' did the rest of the ECB's board members not understand? Of course in today's world 'economically insolvent' banks are quite often still 'politically solvent'.
The above morsels illustrate the perversity of the modern-day fractionally reserved banking system with its unlimited central bank backstop like few others we have come across. It is really the ultimate in 'extend and pretend' schemes – nothing else comes even close.
Greece's biggest banks, their decline in market cap and the loss of deposits since January 2010 (evidently the past several weeks of withdrawals are not yet visible on this chart) – click chart for better resolution.
Evidently Lucas Papademos had the wits to quickly approve the €18 billion in EFSF funds for the banks shortly before he retired from politics. Presumably he guessed that even more trouble was looming for the banks after the election.
However, the piece de resistance is the final paragraph of the Spiegel article:
The banks have simply submitted massive quantities of their own bonds to the central bank — after the government stamped them with a state guarantee.
But what will this guarantee still be worth if Greece becomes insolvent? The dubious bank bonds along with Greek government bonds make up roughly 60 percent of the collateral that Greek banks have supplied to obtain cash injections.
At least the worrisome bank bonds will be on the agenda of the next ECB Governing Council session. The fact of the matter is that this bizarre practice was slated to be phased out by mid-2012 for countries that receive aid from the euro rescue fund. For the time being, though, nobody is talking about that plan.
Well there you have it…'bank bonds' with a 'state guarantee' – bonds issued by Greek banks and guaranteed by the Greek State! And they still have €165 billion in deposits? You may think that if that's true then there must be a lot of 'dumb money' in Greece, but the tax payers elsewhere in the euro area are really the dumbest of all, because they and every user of the euro are going to pay for this calamity in the end.
As we often say: you couldn't make this up.
How It All Hangs Together
Some time ago we offered our readers a pdf file for download which contained an economist's discussion of the TARGET system way back in 1999, just prior to the introduction of euro banknotes. It was seen as a potentially disruptive mechanism that could eventually rip the currency union apart. For those who haven't had the time to study this fairly weighty tome in detail, here is a brief overview of how it works and what it unfortunately doesn't have: namely a settlement procedure.
The US Federal Reserve System's structure is fairly similar in principle to that of the euro system – instead of national central banks it has the 12 district reserve banks and the board of governors at the center. Also, the FRB of New York holds a special place in the system, as it is responsible for its open market operations.
This system has grown out of the Fed's predecessor system, the national banking system with its central reserve banks of different sizes (central reserve city in New York, reserve city banks in all other cities with populations exceeding 500,000 and the reserve country banks elsewhere). Payment imbalances arise between the district reserve banks as well – and they are settled once a year by transferring gold certificates between them. This is precisely the type of settlement procedure that is lacking in the euro system.
The euro system's TARGET 2 system has become a symptom of the ongoing deposit flight from the periphery, as well as the surreptitious financing mechanism for ongoing current account imbalances the private sector no longer wishes to fund.
ELA funding also shows up in TARGET-2 imbalances: say a Greek depositor sends money to a bank in Germany in order to protect himself against the possible return of the drachma. The bank concerned will ask the Bank of Greece to replace the funding it lost with ELA funds and present an IOU to obtain them. The bank of Greece in turn gets basically unsecured credit from the ECB, which is reflected in its TARGET-2 liabilities. The German bank that receives the deposit hands its excess reserves to the Bundesbank, which in turn deposits them with the ECB. Thus the Bundesbank's TARGET-2 claims keep rising (and are partly offset on the liabilities side of its balance sheet by excess reserves due to German commercial banks). So the Bank of Greece owes money to the ECB, while the BuBa has a claim to money from the ECB. As we have pointed out previously, any future losses arising from this arrangement are independent of the size of the claims individual NCB's like the BuBa may have: losses will be calculated according to the capital key (the BuBa will still end up with the bulk of such putative losses of course).
While officially we are always told that the TARGET2 imbalances pose no problem as there is 'collateral' offsetting them in the system, one wonders how that is going to work out considering that a good chunk of the collateral consists of 'bank bonds' issued by 'economically insolvent' banks that are 'guaranteed' by an insolvent government. We would venture to guess that there actually will be significant losses.
Via the German site 'Querschüsse' we bring you the most recent updates of the TARGET-2 imbalances below. Note here that system-wide data are only available as at the end of March, while several individual NCB's have reported their data up to the end of April.
TARGET-2 balances: the BuBa versus the NCB's of the 'PIIGS' - click chart for better resolution.
TARGET-2 balances in the euro area: the biggest creditors and the biggest debtors. DNFL = Germany, Netherlands, Finland and Luxemburg, 'PIIGSBF' = 'PIIGS' plus Belgium and France - click chart for better resolution.
The Bank of Greece isn't exactly in a rush to keep people in the loop. Its balance sheet was most recently published in January (pdf). This contrasts with the Fed's weekly updates. For a laugh, check the bank's capital position. The bulk of it consists of a 'special reserve' of € 507 million stemming from the 'revaluation of buildings and land'. Most of its assets meanwhile consist of advances to credit institutions, most of which are in the form of ELA (and consequently collateralized with nothing much), while it sported a TARGET-2 liability of €107 billion as of January (this had come down a little bit by March, but it is almost certain to have ballooned in recent weeks). For a tiny country like Greece this is actually quite a stunning amount.
Note that in January, advances to credit institutions stood at about €71 billion, but according to the 'Spiegel' article, the Bank of Greece just had its ELA 'ceiling' increased to €100 billion, so one can infer that things have really deteriorated badly in recent weeks.
Also, the BuBa's TARGET-2 claims have increased from €615 billion in March to over €642 billion in April, although the main culprit behind the increase in April appears to have been Spain.
Greece's TARGET-2 liabilities as of March. Recall that as of March, the world was still looking fine. Stock markets were making new highs for the move, and Greece had just been 'saved' again by the PSI deal and the second bailout. We suspect the April and May data will reveal a rather disconcerting deterioration - click chart for better resolution.
The BuBa's TARGET-2 claims as of April - click chart for better resolution.
TARGET-2 liabilities of Spain as of April – these have grown at warp speed since the beginning of the year - click chart for better resolution.
So what would happen if Luc Coene has his way and ELA is 'absolutely' no longer extended to Greece's insolvent banks? After all, if the ECB states that Greek banks are no longer 'sound', then it's game over. In that case, the Greek banking system would go from 'economically insolvent but politically solvent' to de facto and de iure insolvent in a single step. As happened in Argentina when IMF funding ran out, it would no longer be possible to pay the claims of depositors and savers. Greece's banks would go on an extended 'holiday'.
However, the bank run in Greece is unlikely to stop prior to the election, since the writing has been clearly on the wall since the last one. As long as Alexis Tsipras and SYRIZA are still thought to be capable of winning the election (notwithstanding more recent polls that seem to show growing support for the conservative New Democracy party), anyone leaving money in a Greek bank is an incurable optimist. We have all heard about the run on deposits on Monday of last week, but ever since, a cloak of silence has descended over the issue.
Presumably the run is ongoing though, hence the frequent requests for increased ELA funding. If the €18 billion in EFSF bonds are released to Greece's banks this week, a little bit of time will have been bought, as those can probably be discounted with the ECB. There may therefore be a brief return to non-ELA funding if the banks decide to use the EFSF bonds for the purpose (which seems a near certainty at this juncture).
In other words, once again a way has been found to increase the potential losses for euro area tax payers residing outside of Greece.
In this context we want to point readers to a rant by a British MP to the European parliament, who boils the whole issue down to its essential point without mincing words. The Gentleman in question is one Godfrey Bloom from Yorkshire, a UKIP MP. He seems to have received training from Nigel Farage.
This is not only quite funny, but it hits the nail on the head in every respect. In an example of random irony, the socialist from Luxemburg who vainly attempts to refute him goes by the name of 'Goebbels'.
Godfrey Bloom tells it as it is.
The recent vast expansion of ELA financing to Greek banks has also gotten the attention of the FT, which talks about 'secret bank aid' that props up the Greek banks. Well, it actually isn't a secret anymore, or never really was one. The FT does however have a point when it notes that 'the terms and conditions haven't been disclosed'. The whole procedure is in fact cloaked in the usual central bank secrecy, as the truth is deemed to be quite unpalatable. Interestingly it is the very same Luc Coene quoted above who argues for the need for secrecy:
“There has been no official announcement. No terms or conditions have been disclosed. But Greece’s banking system is being propped up by an estimated €100 billion or so of emergency liquidity provided by the country’s central bank — approved secretly by the European Central Bank in Frankfurt. If Greece were to leave the eurozone, the immediate cause might be an ECB decision to pull the plug.
Extensive use of “emergency liquidity assistance” (ELA) to help banks in the weakest economies has been one of the less-noticed features of the eurozone crisis. Separate from normal supplies of liquidity and meant originally as a temporary facility for national authorities to use when banks hit problems, ELA proved a lifesaver for the financial system Ireland and is now even more so in Greece. As such, it has given the ECB — which has ultimate control over the facility — considerable power to determine countries’ fates.
Whether that power would ever be exercised is unclear. ELA is a subject on which the ECB is deeply reluctant to provide information — even on where or when it is provided.
“You don’t say when you are in an emergency situation, because then you make the situation worse. So I really don’t see the usefulness of being more transparent,” Luc Coene, Belgium’s central bank governor, explained in a Financial Times interview this month.
The ECB’s guard slipped a little late last month. Its weekly financial statement published on April 24, showed an unexpected €121 billion increase in the innocently titled heading “other claims on euro area credit institutions,” the result of putting all ELA under the same item. By definition, €121 billion was the minimum amount of ELA being provided by the “eurosystem” — the network of eurozone central banks.
By scouring ECB and national central bank statements analysts, have since pieced together more details. Analysts at Barclays, for instance, reckon Greece is now using €96 billion in ELA, with Ireland accounting for another €41 billion and Cyprus €4 billion. If correct, total ELA in use has exceeded €140 billion — more than 10 per cent of the amount lent to eurozone banks in standard monetary policy operations.
Because of the risks of extra liquidity creating inflation, ELA in excess of €500 million requires approval by the ECB’s 23-strong governing council: its use can be stopped if two-thirds of the council oppose an application.
Importantly, the risks fall on the relevant national central bank, rather than being shared across eurozone central banks as with normal liquidity — although there would be a general hit if a country left the eurozone. However there is no theoretical limit to the amount of ELA that can be provided – and no information, for instance, what collateral recipient banks have to provide as security or what interest rate they pay. Ireland’s example shows that the supposedly temporary use of ELA, can also be prolonged.
Mr Coene said ELA had to be cut off once banks became insolvent. “It is emergency liquidity assistance – not solvency assistance,” he said. The secrecy surrounding ELA creates grey areas, however.
Last week, the ECB council excluded four Greek banks from ordinary liquidity operations — forcing them to fall back on ELA. The unofficial reason was political uncertainty over Greece’s bank recapitalisation plan after the country’s inconclusive May 6 election.
But where would the council draw the line? Mario Draghi, ECB president, would probably seek political cover before Greek ELA was withdrawn. Although the ECB’s “strong preference” was for Greece to stay in the eurozone, the country’s future was for politicians to decide, he said last week.”
Obviously, we're not quite so sure that 'all the risks fall on the relevant national central bank' if push really comes to shove. However, we can infer from the above that the ECB is getting rather uneasy over the proceedings, while the ELA can obviously be used as a means to put pressure on Greece, regardless of who wins the election. The big problem as we see it is that the flight of deposits happens right now, well before the next election. At the speed ELA to Greek banks has been growing lately we can imagine that quite a substantial amount could be at risk in he end.
Credit Market Chart Selection
Ahead of the euro-group summit, euro area credit markets have calmed down a little bit, with CDS and bond yields ticking slightly down over Monday and Tuesday. Below is a selection of the most important charts. As always, prices and price scales are color coded and readers should keep the different scales in mind when assessing 4-in-1 charts.
These pullbacks ahead of euro-group summits are something we have seen before – there is always hope that something will actually be announced that finally manages to get the cart out of the mud. No such announcement seems very likely however, given the big differences between the major players.
5 year CDS on Portugal, Italy, Greece and Spain - click chart for better resolution.
5 year CDS on France, Belgium, Ireland and Japan - click chart for better resolution.
5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns - click chart for better resolution.
Three month, one year, three year and five year euro basis swaps - a small bounce is in train here as well - click chart for better resolution.
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – pulling back as well - click chart for better resolution.
10 year government bond yields of Italy, Greece, Portugal and Spain – with the exception of Greek yields, all have pulled back - click chart for better resolution.
Finally, a chart we haven't shown before: China's exports compared to car sales. There appears to be a notable degree of correlation - click chart for better resolution.
Addendum: Euro-bond Dreams
The press has been speculating whether Germany's resistance to euro bonds may falter given the combined French-Italian onslaught in their favor that is expected at today's euro-group summit. Even the IMF and the OECD are now arguing they should be introduced.
Apparently Francois Hollande is not only pushing for euro-bonds, but also for direct lending to governments by the ECB, according to a recent Spiegel article on the topic.
We would reiterate here that Germany can not just agree to issuance of euro-bonds, even if it were not the case that Mrs. Merkel's government is staunchly opposed to them. A constitutional court verdict stands in the way as it were – as the ruling of the court on the issue clearly states that:
“[…] the German government must not accept permanent mechanisms – as opposed to the EFSF, which is temporary – with the following criteria: if they involve a permanent liability to other countries; if these liabilities are very large or incalculable; and if foreign governments, through their actions, can trigger the payment of the guarantees.”
This seems to unambiguously rule out eurobonds. However, as this Reuters article from the time the ruling was handed down notes, things are amenable to change – if the European treaties are substantially altered:
“A ruling by Germany's top court has made it virtually impossible for Berlin to sign up to joint euro zone bonds now, even if it wanted to, politicians and legal experts said on Thursday.
The Constitutional Court's stance on Wednesday included a provision blocking Germany from pooling debt with its partners — unless the current European Union treaty is changed.
The court set out its reasoning in a keenly-awaited ruling rejecting lawsuits aimed at stopping German participation in bailouts for the euro zone.
The Bundestag (lower house of parliament) is "forbidden from setting up permanent legal mechanisms resulting in the assumption of liabilities based on the voluntary decisions of other states", reads a passage of the verdict.
Many politicians and economists immediately read this as a reference to euro bonds, and constitutional experts agreed.
"I understand this passage to mean that assuming liability for the debt of other member states, and with that euro bonds in which Germany would have to vouch for another member's debt, is not currently admissible," said Ulrich Haede, professor of law at the European University Viadrina in Frankfurt/Oder.”
Given this stipulation by the constitutional court, even if Mrs. Merkel were to completely change her mind about euro-bonds in the course of today's debates, she could not possibly agree to the idea.
Prediction: absolutely nothing of substance will emerge from the summit, as always. Mind, contrary to a surprisingly large number of pundits, we don't believe in the alleged miraculous powers of euro-bonds either. They would be an open invitation for spendthrifts to spend even more – the 'tragedy of the commons' brought about by the currency union would be perfect.
However, we also don't expect any notable pro-free market reforms to be announced at the summit, as obviously quite a few of the main players have completely different concerns and are not really big believers in the market economy anyway. Especially Mr. Hollande seems to think that somehow, more debt and more money printing will be the best solution.
For a change we even find ourselves actually agreeing with Austria's minister of finance, Maria Fekter:
“Austrian Finance Minister Maria Fekter dismissed as "nonsense" French President Francois Hollande's approach to resolving the euro zone debt crisis and insisted, in a newspaper interview, on financial discipline.
"Growth financed by debt? Those are the recipes from the day before yesterday. The arguments that France's new president Francois Hollande is putting forward again are nonsense and got us into this whole mess in the first place," the Oberoesterreichische Nachrichten paper quoted her as saying.”
Of course the main fighters for fiscal discipline are those who are expected to pay for the fiscal indiscipline of others. It is not so much a matter of principle, as even most of the allegedly fiscally conservative euro area nations are drowning in debt and have disturbingly high levels of government involvement in the economy. It is rather a matter of not wanting to pay up for even bigger spenders elsewhere as well.
Charts by: Bloomberg, Der Spiegel, Querschüsse.de
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