The ECB’s 3 tough choices

Financial Mirror (Cyprus) - - FRONT PAGE -

At its weekly meet­ing on April 29, the ECB will be un­der tremen­dous pres­sure to keep Greece on its life sup­port sys­tem. But with­out progress else­where, this pow­er­ful mon­e­tary in­sti­tu­tion is at risk of join­ing other ac­tors in the Greek drama that are un­in­ten­tion­ally tran­si­tion­ing from be­ing a ma­jor part of the so­lu­tion to a big part of the prob­lem now and in the fu­ture. This risk is symp­to­matic of the much larger dys­func­tions un­der­min­ing a com­pre­hen­sive and sus­tain­able out­look for Greece within the euro zone.

The ECB de­ci­sion will in­volve some vari­ant of three ba­sic al­ter­na­tives:

1. Pre­tend and ex­tend.

The ECB, through the Emer­gency Liq­uid­ity As­sis­tance op­er­ated by its net­work of na­tional cen­tral banks, would con­tinue to ex­tend ex­cep­tional fund­ing to Greece. This would be done un­der the pre­tense that it is help­ing Greece deal with a liq­uid­ity prob­lem in­stead of ac­knowl­edg­ing the coun­try’s true predica­ment, deep eco­nomic and sol­vency de­fi­cien­cies. This ap­proach has the ad­van­tage of keep­ing op­tions open in the hope that Greece and its cred­i­tors will fi­nally break through to de­ci­sive pol­icy and fi­nan­cial so­lu­tions. The down­side is that it would in­crease the ECB’s fi­nan­cial ex­po­sure to a prob­lem case that, at least so far, has shown lit­tle chance of re­solv­ing it­self in an or­derly fash­ion. It would also raise con­cerns about bur­den-shar­ing as the ECB would act even as other cred­i­tors, not only from the pri­vate sec­tor but also public in­sti­tu­tions such as the In­ter­na­tional Mon­e­tary Fund, are sched­uled to get re­paid.

2. Pull the plug.

Un­der this sce­nario, the ECB would be forthright. It would limit any fur­ther fi­nanc­ing to Greece, rais­ing not only the le­git­i­mate bur­den-shar­ing is­sues but also rightly not­ing that liq­uid­ity sup­port would con­tinue to prove in­ef­fec­tive with­out ac­com­pa­ny­ing mea­sures to im­prove growth and fi­nan­cial sol­vency. It would make fur­ther as­sis­tance con­di­tional both on pol­icy progress and new money to Greece from other sources, along with debt re­duc­tion. If such con­di­tions failed to be met, the ECB de­ci­sion would likely lead to even greater cap­i­tal and de­posit flight from Greece. And this, un­der most re­al­is­tic sce­nar­ios, would prompt the Greek gov­ern­ment to im­pose cap­i­tal con­trols, de­fault on pay­ments and take even more dra­co­nian steps to gain con­trol of any idle cash bal­ances in the coun­try. All of th­ese de­vel­op­ments would in­crease the risk of Greece ex­it­ing the euro zone.

3. Pull the plug as part of a com­pre­hen­sive Plan B.

In this case, the ECB’s re­fusal to ex­tend ad­di­tional liq­uid­ity sup­port would be part of an at­tempt (al­beit a risky one) at an or­derly pivot for both the euro zone and Greece. The ECB would seek to min­imise the risk of Greek contagion and dis­or­derly spillovers to other economies (such as Cyprus, Italy, Por­tu­gal and Spain) by ex­pand­ing its fund­ing win­dows for both gov­ern­ments and fi­nan­cial in­sti­tu­tions. It would also step up its large-scale pro­gram of se­cu­rity pur­chases (known as quan­ti­ta­tive eas­ing). Mean­while, work would pro­ceed on some sort of in­terim Euro­pean ar­range­ment for Greece, in­clud­ing the pos­si­bil­ity of an as­so­ci­a­tion agree­ment with the Euro­pean Union or, even, re­main­ing in the EU but out­side the euro zone, like the U.K.

One of the big lessons of the last few years is that, re­gard­less of the facts on the ground, no one — whether on the Greek side or among its of­fi­cial na­tional, re­gional and in­ter­na­tional cred­i­tors — wishes to go down in his­tory as the cause of the first exit from the sin­gle cur­rency. For that rea­son, the ECB would most likely opt again for the first op­tion — ex­tend­ing the ELA and pre­tend­ing that a durable so­lu­tion is around the cor­ner — and it would hope that its in­volve­ment wouldn’t be over­whelmed by fund­ing de­mands caused by ac­cel­er­ated de­posit flight from Greek banks.

All this speaks to what is per­haps the great­est tragedy of all. For sev­eral years, very few peo­ple — whether in Greece, among its Euro­pean part­ners or in the ECB, EU and IMF — have stepped up to the chal­lenge of a life­time: that of ei­ther tak­ing de­ci­sive break­through pol­icy ac­tions or prop­erly press­ing the re­set but­ton. In­stead, the de­ci­sion has been to en­gage in a col­lec­tive mud­dle-through, hop­ing some per­fect — in­deed, im­mac­u­late — so­lu­tion would ap­pear down the road. Such a so­lu­tion is hard to come by. And the wait for one is far from cost-free.

Mil­lions of Greeks, in­clud­ing an alarm­ing por­tion of the coun­try’s youth, have be­come mired in dev­as­tat­ing un­em­ploy­ment and spread­ing poverty. And with hun­dreds of mil­lions of eu­ros of debt obligations hav­ing been trans­ferred from the pri­vate sec­tor to Euro­pean tax­pay­ers, the would-be solvers of this Greek tragedy have be­come a grow­ing part of the prob­lem. (Source: Bloomberg)

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