ECB's Greek Fudge: Nutty and Stale?

The ECB has made some decisions regarding Greece that clearly indicate it does not want to push Greece out of monetary union. It has gone so far as to essentially allow the Bank of Greece to fund the Greek government. 

Consider the sequence of events. There was a 31.5 bln euro aid tranche that was due in June that the Troika delayed disbursement of pending commitments from the new government. This included 25 bln euros to recapitalize Greek banks.

 

Without have the aid assured, the ECB seemed to have little choice and last month decided to no longer accept Greek bonds (or Greek government guaranteed bonds) as collateral for refi operations. Facing a 3.2 bln euro bond redemption (held incidentally by the ECB), Greece reportedly asked for a bridge loan to cover until the aid tranche is paid. The ECB refused. Greece sought to trigger a clause giving it a month grace period for its payment. The ECB refused.

This could force Greece to issue its own currency. However, the ECB threw Greece a life line of sorts. As we noted previously, the ECB approved lifting the cap amount of Greek T-bills the Bank of Greece can accept from Greek banks as collateral for lending under the ELA (Emergency Liquidity Assistance).

This, in turn, will allow the Greek government to service its near-term debt obligations by issuing T-bills, which its banks will be the dominant buyers. The Greek banks will likely use those bills as collateral for new borrowing under the ELA. The ECB regulates the amount of ELA that a member central bank can offer. In the middle of Q2, the ECB raised the Bank of Greece's ELA cap to 100 bln euros. This gives the central bank scope to lend another 30-35 bln euros. Some reports suggest that as early as tomorrow the Greek government can announce an increase in its T-bill offerings.

It is not clear how long the 100 bln euro ELA cap will have to last Greece. Previously it was anticipated that the Troika would reach a decision in time for the mid-Sept Eurogroup meeting. This is looking increasingly unlikely. The latest press reports indicate that nothing will be decided in September. Instead the Troika will "occupy" Greece through September and its review of Greece would be presented to the Eurogroup meeting scheduled for Oct 8. 

Follow the daisy chain: Greece issues T-bills to pay its official creditors, who have thus far refused to make the tranche payment that was due two months ago. Greek banks will buy those T-bills and then use the same to get new funding from the Greek central bank under the ELA that has been approved by the ECB. It is not immediately clear how long this fudge can last. If the ECB's ELA cap or the limit on the amount of T-bills that it allows the Greek central bank to accept as collateral from Greek banks is approached it seems reasonable to assume that it (the ECB) will simply lift the ceiling and caps again.

This seems to reflect a reluctance on the part of the ECB squeeze Greece to the point of forcing it out of the monetary union. We, like many, are concerned that if Greece is forced out, that it would increase rather than diminish the risk that others are forced out as well. Moreover, given the imbalances, unfathomable indirect impacts, and other unknowns, it may very well be the case that it is cheaper to keep Greece on life support than to pull the plug. Nor will a Greek exit make it any easier to address the larger problems in Spain and Italy.