What Would Grexit Look Like? di Charles Forelle
Once a theoretical fear of euro-pessimists, Grexit—a Greek exit from the eurozone—may be soon upon us. The euro was designed to be an irrevocable currency; there is no procedure in its rules or treaties for a country to stop using it. So precisely what would happen is highly speculative. But let’s speculate.
How would Grexit arrive?
Through the banks. There is no political or legal procedure for “ejecting” Greece from the euro, and Greece’s government has repeatedly said it doesn’t want to voluntarily withdraw. That suggests an exit would come if the state of the banks is so bad that there is no other alternative.
How much worse do things have to get?
Not much worse, frankly. The banks are illiquid: they aren’t able to convert their assets (mostly loans) into the cash that their creditors (mostly depositors) are demanding. The only entity that had been providing this liquidity, by lending the banks emergency cash, had been the Greek central bank. But the European Central Bank has frozen that emergency lending.
The result is that the banks have shut down: They are dribbling their last remaining cash out to depositors, who are limited to €60 ($66) per day. They have stopped making electronic transfers of euros overseas.
In effect, Greece already has one foot outside the eurozone: Businesses and consumers in the country now prefer cash. A euro in a Greek bank account is not the same as a euro in cash or a euro in a German bank account. In effect, Greeks believe that the “currency” in their accounts is not really euros.
What would push it all the way out?
The ECB. The central bank could end the emergency lifeline; already it has signaled that it is uncomfortable with the risk of lending to Greek banks. A large chunk of the assets that Greek banks are pledging as collateral for these emergency loans comprises government or government-guaranteed securities.
If the lifeline ends, the Greek banks would have to repay their emergency lending. They can’t do that, and they would collapse.
What happens then?
The banking system will need to be restarted, if only to ensure trade in essential goods and services. There would need to be a giant, systemic bank resolution. The seizure of collateral by the central bank would deplete the banks’ assets, and the remaining assets would probably have lost a lot of value. Remember, the banks’ assets are largely loans to Greeks.
In the process of the resolution, the banks (whichever ones are elected to survive) would need to be recapitalized. A bank’s capital is its assets minus its liabilities, and there are essentially two ways to increase capital: add assets or subtract liabilities.
Could it do this in euros?
Yes, but it would require at the very least the help of the ECB. That’s the only entity that can provide liquidity support in euros needed to deal with frightened depositors is the ECB—it would have to restart the lifeline and lend euros to the newly constituted banks against their existing assets so that they could meet withdrawals.
Now, the banks would have to add assets in euros or subtract liabilities in euros. The only party in a position to add assets is the government. It has no euros, so it would need aid from its eurozone creditors to do so. That means a deal. Alternatively, the banks could subtract liabilities. Their liabilities are mostly to depositors. That means a “haircut”—telling depositors they now have a smaller bank account.
All of this is exceptionally painful. The other option is Grexit.
What would that look like?
If the government adopted a new currency—we’ll call it the drachma—it could use that to recapitalize banks. It could print a bunch of drachmas and use them to buy shares in the new banks. The banks would have fresh assets: drachma cash.
The Bank of Greece could provide drachma liquidity: it could lend as much drachma as it wanted to the new banks.
What’s the catch?
The financial system would be converted to drachma. Therefore, depositors who had €10,000 in their accounts, say, would have 10,000 drachma. It’s not a “haircut” in terms of numbers, but one drachma would assuredly be worth less than one euro.
How would a Grexit affect the rest of the eurozone?
It’s extremely hard to tell. Greece owes a lot of euros directly to its eurozone creditors: €131 billion to the eurozone bailout fund and €53 billion to the other eurozone governments themselves.
Greece would almost certainly default on those obligations and would need to restructure them. It also owes €34 billion to private investors through bonds issued as part of its big 2012 default. It would probably seek to restructure those, too. That could get messy. These debt obligations exist under foreign law and are subject to the jurisdiction of foreign courts, not Greek ones. Greece can’t simply pass a law changing the debts’ terms, as it did for the 2012 default.
And how about the European Central Bank?
The ECB as we think about it is really the “Eurosystem”—the ECB itself plus the 19 national central banks of the eurozone countries that are its members.
A collapse of the Greek banks would mean a loss of the €39 billion the Eurosystem has lent to them. But that lending is collateralized by very safe bonds, so the Eurosystem would be OK. The €89 billion in emergency funding operates under different rules; the risk of default on it is borne by the Bank of Greece.
A very open question is what happens to the so-called Target-2 liabilities owed by the Bank of Greece.
Briefly, commercial banks in each country interact with their own national central bank. When money moves between commercial banks in two countries, their national central banks handle the transfer. All the flows are added up each day.
The sum of all the flows between the 19 national central banks is by definition zero, but some national central banks have positive balances in the system and some have negative balances. In normal times, these balances aren’t very far out of whack: commercial banks lend each other money across borders, and so most flows are offset.
These are not normal times. The Bank of Greece has a negative balance, of €100 billion as of May. That is its Target-2 liability. It’s possible that the Bank of Greece could repudiate that, and then the Eurosystem would be stuck with a loss on the central-bank balance sheet. But as the economist Karl Whelan argues, it’s plausible that the Greek central bank might try to remain part of the Target-2 system even if it is no longer in the eurozone—the interest it pays on its Target-2 liability is tiny, currently 0.05%.
It all depends on how amicable the divorce is.