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Monday, August 10, 2015

Why Schauble wanted to force Greece out of the ECU ASAP

This was a great post I stumbled across a few days ago:

Mean Squared Errors - Schauble's ticking clock. Sorry, but it's such an interesting (and snarky) post that I have to quote it in its mostirety:
As we've learned over the past two months, the Troika's biggest stick is the ability (and willingness) of the European Central Bank to cripple the banking system of a Eurozone member state by denying it liquidity.

Now, for a central bank to deliberately destabilize a financial system under its care is, as far as I can tell, unprecedented in the history of modern central banking. And it is unimaginable that the countries composing the Eurozone would have signed up in the first place if the ECB "charter" had explicitly given the central bank the role of "enforcer" of the terms of the growth-and-stability pact (or of pretty much anything else). So the ECB's actions would have been jaw-dropping enough under the original rules of the Eurozone. But the reality is worse.

In 2013, the European Commission designated the ECB to be the authoritative bank regulator for the Eurozone. (1) The ECB is the entity charged with determining whether a particular bank is solvent. It is also charged with the responsibility to take early action to force the resolution of insolvent (and likely-to-become insolvent) banks in such a way as to preserve the smooth functioning of the financial system of the Eurozone and of each member state.

It's hard to avoid the conclusion that, if Greece's banks are in such trouble that the ECB is remotely justified in refusing to provide liquidity support, that the ECB is also, in its role as bank regulator, obliged to shut those banks down and see that they are rapidly restructured and recapitalized.

In other words, the ECB is explicitly required by its own enabling legislation to prevent the state of affairs which it deliberately created in Greece.

So what happens in 2016?

On January 1, the final piece of the Eurozone banking union puzzle falls into place: the responsibility for structuring bank resolution programs will shift from national resolution authorities to a Eurozone-wide Single Resolution Mechanism (SRM), backed by a Single Resolution Fund (SRF). The goal of this institution is to break, one and for all, the link between the solvency of any particular national government and the stability of its banking system. In other words, its purpose is to take away the very leverage the Troika has been using to force concessions from the Greek government -- the threat that "insolvent government = banking system collapse."


What does this mean for Greece? A couple of things. First, it gives the Greek government a way to force the "are they solvent or aren't they" issue. If the Greek national authorities declare one or more banks to be in danger of insolvency, they can ask the SRM to help create a resolution plan. The ECB could prevent this, but only by explicitly declaring said banks not merely solvent, but safe.

Second, the existence of the SRF, even in its initial "compartmentalized" form, drastically reduces the uncertainty associated with declaring a Greek bank insolvent. Under current rules, it's not 100% clear that the ECB is required to provide financial support to make an orderly resolution feasible. (I would argue that it's strongly implied, but given the ECB's demonstrated willingness to ignore its responsibilities when it come to Greece, I certainly wouldn't rely on it.) The responsibilities of the SRF are indisputable.

So: it is settled EU policy that the insolvency of a particular Eurozone government shall not destabilize the financial system in that or any other Eurozone country. And, to that end, financing bank resolutions is a responsibility of the Eurozone banking system as a whole, not of individual Eurozone governments. Good. But it's hard not to suspect that some in the EU, in writing and blessing these rules, had in mind a silent caveat: "except for Greece."

In fact, it's not hard to imagine what might happen if the first use of the SRF were to recapitalize, say, Alpha Bank. The German press, among others, would take a sudden interest in the SRM and the SRF, and might not be inclined to accept the notion that compulsory payments to a governmental entity are, in some fundamental sense, not "taxes." And somebody, somewhere will accuse the Merkel government (with some justice) of having signed on to a stealth transfer union, which is "bailing out" Greek banks. Hijinks ensue.

How could EU policymakers have convinced themselves that that the SRM would never be applied to Greece? My personal guess would be that it involved the same form of self-deception entailed in all games of "kick the can down the road," the expectation -- born more of wishful thinking than of reason -- that, somehow, these things will work out before the moment of truth arrives.

But now the moment of truth is awfully near.

All of which might help to explain Wolfgang Schäuble's evident desire to push Greece out of the Eurozone as quickly as possible. There's a ticking clock: in five months, it becomes a whole lot harder for the Troika to hold the Greek banking system hostage, and the consequence of trying -- the activation of the SRM to recapitalize insolvent Greek banks -- could have interesting political repercussions in Germany and elsewhere.
But I think we can expect the ECB will indeed explicitly ignore its own legislation when it comes to Greece or democracy or mainstream economics. Which, of course, will pooch the entire reason for an SRM and make peripheral banks a ticking time-bomb again.

But that's the way Europe is run.

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