Greek stocks and bonds plunged on Thursday after the European Central Bank said that it would stop accepting Greek bonds as collateral for central bank loans. Greek Finance Minister Yanis Varoufakis had pleaded with ECB chairman Mario Draghi to allow Greek banks to buy $11.4 billion more in Treasury bills so that Greece is financed for a few more months. Draghi refused and deferred it to the Council of Finance Ministers of the Eurozone. If the ECB objection stands, the Greek government may ask depositors to directly buy 3- and 6-month Treasury bills, a plan very unlikely to succeed. Therefore, Greece could run out of money as soon as March.
Greek banks are very squeezed. Out of $160 billion in total deposits, Greece withdrew $11 billion to $23 billion in January because of the uncertainty implied by the elections and Syriza victory. Now Greek banks “live” with $114 billion in liquidity provided by the ECB. That’s not much, and to make matters worse, that liquidity is conditional on “being in the rescue plan,” which the Greek government rejects. The rescue plan ends on February 28, so Greek banks could collapse on March 1st and Greece could find itself in a New Drachma.
Given these pressures, Syriza is in a vulnerable spot. Greeks elected the anti-austerity party last month on promises to erase a chunk of the country’s public debt, reverse privatizations and other structural reforms aimed at making the economy more competitive, expand the public sector, and significantly raise wages and pensions. These measures were widely supported as Greeks have lost 25-30% of their income in the last five years, and most of them found it hard to imagine that things could get worse.
The problem is that (except for the debt position) these measures require very significant increases in government spending, and Greece is strapped for cash. Over the last five years, the rescue plan of the European Union, the International Monetary Fund, and the European Central Bank has let Greece borrow about $286 billion at a very low interest rate of less than 2% in exchange for Greece implementing structural reforms. However, reforms are in opposition to Syriza’s ideology. So Syriza wants to end the rescue plan and even refuses to receive the last installment of about $8.2 billion that Greece desperately needs.
The usual avenues to find money are unavailable. Greece cannot borrow from money markets since the yield on its 10-year bonds hovers around 10%. It also cannot borrow from EU or the IMF unless the country proceeds with reforms.
Having no other alternatives, the country wants to issue 3- and 6-month Treasury bills to be bought by Greek banks. The problem is that these banks already hold $17 billion of such bills, and the ECB does not allow Greek banks to hold more than that amount at any time.
Given that there are few, if any options left, it is time for a new “kolotoumba.” We’ll likely see Syriza soften its leftist position in the coming months, as the first sign happened this week when Varoufakis abandoned the pre-election promise to erase a chunk of Greece’s public debt. Instead, he promised that the country would pay down its entire debt under new terms. It’s also likely that Greece will drag things out for a few more months, possibly reverting back to its previous rescue package so that Greek banks have enough money to stay afloat. This is likely to be presented as a “technical extension” and not pose a big political risk for the government.
The third kolotoumba, and this is a major one, will likely be the creation of a “bridge rescue plan” by the EU that would finance Greece for a few months in return for reforms, such as no expansion of the public sector, no reversal of old reforms and privatizations, and even some attempt to revamp tax collection.
This U-turn will impose significant political costs to Syriza since it stands against its pre-election platform. This series of U-turns will be best for Greece, but it is far from certain they will happen.
This week, 3-year Greek government bonds that were issued in Spring 2014 at 3.5% interest are trading at yield levels that imply a 25% to 35% probability of Greek bankruptcy with the Euro or even “Grexit.” The latter would be a catastrophe for Greece since a New Drachma would be highly devalued resulting in high inflation, severely restricting the buying power of Greeks, and would come in the aftermath of a run on Greek banks.
Nicholas Economides is an economics professor at New York University Stern School of Business.