Greece: Wishful Thinking Juxtaposed by Resignation
Greek prime minister Papademos has given an interview to the FT, in which he proclaims that Greece is 'halfway to recovery' and that the Greek citizenry's capacity to endure suffering is indeed endless. Meanwhile, should it turn out that Greece's citizens are after all not willing to endure 'austerity forever' in order to keep the country's creditors whole, it won't matter, because democratic choice on the issue has apparently been suspended. So Papademos says, anyway.
“In an interview with the Financial Times, Mr Papademos expressed confidence that Greece’s downward economic spiral would prove temporary. “I am convinced that we are more than halfway along the path to economic recovery – although the fiscal consolidation process will last longer,” he said. “Positive growth rates should be achieved within less than two years,” he said.
Mr Papademos’s defiance comes in spite of widespread fears outside Greece that its economic situation makes exit from the eurozone a distinct possibility. He admitted that Greece might need more outside support if it was unable to return to financial markets by 2015. [that seems a near certainty, ed.]
However, Mr Papademos argued that implementing the agreed reform programme, and extra measures to boost growth, would turn a vicious downward spiral of fiscal austerity and economic contraction into “a virtuous circle of structural reform, increasing activity and faster fiscal consolidation”.
Full implementation of the programme should also eliminate the possibility of another government debt restructuring, Mr Papademos said. “We will do whatever is needed to ensure that this was the last restructuring of Greek sovereign debt.”
Greek leaders are going ahead with national elections in late April or early May – a decision criticised by Germany. However, the former European Central Bank vice-president, who took over as caretaker prime minister in November, said reforms would continue under any government.”
Mr Papademos said: “Almost all opinion surveys have systematically indicated that a large majority of the people – I have seen figures ranging between 70 per cent and 80 per cent – very much support Greece’s continuing participation in the euro area and this implies that, despite the sacrifices and the short term adjustment costs, they are willing to do what has to be done in order for the country to remain in the euro.”
So let's see: elections or no elections, no-one is going to challenge or attempt to alter the austerity policy? We agree of course that Greece was and remains in urgent need of economic reform. Whether it will be possible to keep the the program on track against growing political pressures is however a different matter. Papademos is quite correct that most Greeks want to keep the euro as their currency. Anything is better than the perennially devaluing drachma. This does however not automatically imply that most Greeks are automatically also d'accord with being taxed to death and with renouncing the many free goodies that the government can no longer afford to provide.
One should also not completely dismiss the idea that an economic recovery could be in train soon. A lot of malinvested capital has been liquidated in the downturn already and as we have pointed out previously, there are in fact subtle improvements in a number of relevant indicators – which have been overshadowed by the head-line grabbing GDP contraction last quarter.
The main question is this: will the putative recovery become strong and tangible enough before the Greeks become desperate enough to decide to put a stop to the austerity program? Let us not forget, the parties that are most likely to do best in the upcoming election (mostly the radical left) all want to put a stop to the program – at least that is what they have said.
Meanwhile, on the very same day, the FT published an article on the IMF's current views on Greece's bailout. These indicate that the IMF expects Greece to default all over again shortly. The fund seems to be preparing for the day when it finally stops throwing good money after bad.
"On Friday, after much of Europe shut down for the week, the International Monetary Fund issued its 231-page report on Greece’s new €174bn bailout, which seems to struggle to keep an optimistic tone about Athens’s ability to turn itself around over the course of the rescue plan.But the IMF report is worth scrutinising for reasons beyond its gloomy prose: If there’s anyone who might force eurozone leaders back to the drawing board once again, it’s the IMF, which essentially pulled the plug on the first €110bn Greek bailout early last year when it became clear it wasn’t working.Signs that the IMF is on a bit of a hair trigger litter the new report.The fund notes that more austerity measures totalling 5.5 per cent of economic output – or about €12bn – must be found in the next three months to close gaps in Greece’s budget for next year and 2014. Without those cuts, the IMF warns, it’s ready to withhold its very first quarterly aid payment in three months’ time: “Identification and, where possible, enactment of these measures will be a requirement to complete the first review and continued Fund support.”The report also makes clear that if Greece falls off the wagon in any way, the IMF is not going to pick up the tab any more. Instead, it will either be up to Athens to restructure its debt yet again or for eurozone lenders to put up even more money. The report seems to give a very strong hint that the fund wants European Union leaders to prepare for that eventuality very quickly.”[…]Reading between the lines, it looks like the IMF is saying there’s a pretty good chance of things going badly quickly, so EU leaders should be getting ready for another default.The reason for the IMF’s skittishness is the fact that it’s already way out on the limb with Greece. It’s own internal rules only allow it to annually lend a single country 200 per cent of its “quota”– essentially an estimate of a country’s size in relation to the global economy – with a total limit of 600 per cent. The new bailout is 2,160 per cent of Greece’s quota.
It turns out the IMF is also a tad more realistic about the political challenges posed by the bailout/austerity program than Papademos. From the report's conclusion:
“Even with these assurances and undertakings of the authorities, it should be stressed that programme implementation risks are likely to remain very high. The necessary level of ambition embedded in the programme will continue to test political and social resolve, and even with political resolve, the breadth of the reform agenda may test the authorities’ administrative capacity.”
Yes, it is absolutely certain that Greece's 'political and social resolve' will be 'tested' - most likely to the breaking point. As we have often pointed out, it is not so much 'reform' as such that is the problem. The problem is that there seems to be no light at the end of the tunnel. Greece's citizens have yet to see anything positive emerge from the austerity program. Granted, even if the government had been more diligent in implementing reform it would have taken some time for this to bear fruit. However, it has definitely not displayed enough diligence on that point (except in the short time periods just before Greece was about to careen toward a 'disorderly' default), and it may not even be capable of doing so, given Greece's sclerotic bureaucratic apparatus with its broken lines of communication.
LTRO 'Exit Plan' Mooted
In this context it is quite amusing that the debate over the 'LTRO exit plan' continues to heat up a mere three weeks after the second tranche of the ECB's long term bank funding program has been put into place. It is of course a positive development that such a debate actually exists. However, it doesn't make it any less risible. 'Exit plan'? There will probably never be an 'exit', because as soon as one is attempted, the crisis will likely return in even greater force than before. It is in the very nature of an inflationary monetary system that it must keep inflating – it's either that, or it breaks down very quickly.
“European regulators are calling for the eurozone’s banks to come up with an exit strategy for the LTRO, as they warn that the three-year funding will not be rolled over and worry about the growing encumbrance of the banking system balance sheet.According to two European bankers, the German regulator along with others is now asking banks to either pay back the LTRO funds ahead of schedule, deleverage, consolidate with healthier banks or access wholesale funding through the public markets.“The regulator’s message is clear – take as much as you want out of the LTRO but you must demonstrate a funding plan and rolling over the LTRO is not an option,” said a banker. “It’s a great time for banks to be doing deals. There’s ample liquidity in the market and investors are calling out for bonds to be sold, which will allow banks to get their balance sheets in order.”Bundesbank president Jens Weidmann echoed various European regulators’ calls for banks to wean themselves off the ECB funding lifeline last week.”“The ECB’s liquidity provision cannot replace the fiscal responsibility of member states if some of the weaker banks should turn out insolvent,” he said. “It is not up to the ECB to keep weak banks in business.” He added that the ECB should provide sufficient liquidity to banks but only to those that are solvent and provide adequate collateral.Weidmann makes an excellent point of course – it should definitely not be the ECB's business to keep insolvent banks afloat and provide the euro area's fiscally challenged governments with an excuse to reduce their efforts to bring their houses in order. However, the assumption that the crisis-stricken overleveraged fractionally reserved banking system will become capable of standing on its own feet again is probably going one bridge too far. It would be fine if market forces were allowed to operate freely and weed out the insolvent zombie banks. However, this could only happen if the authorities were prepared to allow a massive deflation of the money supply to occur and watch as possibly hundreds of banks go under – taking their extant deposit liabilities with them to 'money heaven' in the process.This just isn't going to happen, no matter how conservative the views of Germany's central bankers are. The conclusion must be that all this 'exit talk' is in the end just hot air.Meanwhile, the IFR article also makes clear that asset encumbrance remains a major problem associated with the ECB's extension of long term funding. The numerous other funding options the banks had to resort to when interbank funding markets seized have also contributed to this problem. Among these we find the pledging of 'covered bonds' and the overcollateralization routinely demanded by private funding sources in the repo market in view of the crisis. According the Barclay's, the asset encumbrance problem continues to fester and since the ECB of course also demands adequate collateral for its funding programs, it has actually become a great deal worse.This in turn makes it less likely that banks will be able to access unsecured funding by means of issuing bonds. In fact, current holders of bank debt are increasingly uneasy over the collateral encumbrance situation, as fewer and fewer tangible assets remain with the banks that creditors could lay claim to in the event of bankruptcies.“The way in which banks access the ECB – pledging collateral in return for funding – fits into a broader trend of banks encumbering their assets via repo, collateral swaps and covered bonds,” Barclays research said.The analysis highlights the situation in the covered bond market in 2011, where secured funding accounted for 40% of debt issuance, and now several banking systems have encumbered more than 15% of their balance sheets to obtain ECB funding.Rating agencies such as Fitch have also begun monitoring the situation closely over the past year. According to a Fitch analyst, investors are anxious about where they stand on senior unsecured debt, which is driving the price of unsecured funding higher. “There is definitely a lack of clarity on how much of banks’ balance sheets are encumbered by ABS, senior, covered and derivatives,” he said.(emphasis added)Perversely, by exacerbating the collateral shortage problem, it has actually become a central feature of the ECB's long term funding programs that an 'exit' from them will be extremely difficult to achieve. As Barclay's remarks further, for many banks unsecured funding will remain either unobtainable or will be available only at costs that completely undermine their business model. Senior bondholders don't like to become subordinated creditors and the crisis in euro-land has evidently created a great many involuntarily subordinated creditors already. They are certainly not going to want to add positions harboring a similar danger.“Barclays shared Fitch’s view and explained that bondholders faced increasing subordination from this balance sheet encumbrance, reinforced by depositor preference laws (in some countries) and imminent legislation on bail-in bonds.“Combining these factors suggests that unsecured funding cost for banks will remain high – potentially too high for some business models to make economic sense,” according to Barclays.”(emphasis added)A number of banks have been commenting on the 'exit strategy' debate in recent days. Not surprisingly, they are for the most part slightly bewildered by the fact that this debate has already begun.“Assuming these rumours are true, it seems totally inconsistent just when the market is getting going to be telling people that the support provided is not really on offer for as long as first suggested,” said Mauricio Noe, head of covered bond origination at Deutsche Bank.“We’ve finally got the bazooka we need and the suggestion is they might already be talking about a time when it won’t be there.”Barclays also viewed the warnings as premature, saying: “The time for tightening the screws at the ECB has definitely not come yet, and even an exit strategy debate appears somewhat premature.”(emphasis added)This is a diplomatic way of putting it ('the debate seems premature'). Again, we wouldn't take this 'exit strategy debate' very seriously anyway. Jens Weidmann needs to keep up his image as a responsible and conservative central banker and he wasn't particularly happy with the ECB's interventions in the first place. However, he must expect to be outvoted at the ECB's governing council. The faction of ECB 'hawks' will soon gain a new member with Yves Mersh, which may strengthen its hand a little bit. The fact remains though that the ECB regards it as part of its often cited 'remit' not to allow a deflation to occur under any circumstances. We remain fairly confident that in light of this fact the LTROs will be rolled over forever and ever. In fact we wouldn't be surprised at all if funding provided by the ECB were to continue growing mightily in the years ahead – assuming that the euro and the ECB actually have a future, which is by no means certain.