Default Does Not Equal a Grexit: Get Ready for Additional Acts in the Greek Debt Drama

It appears to me, and what I have said on this page in the past, is that there is no alternative to a Greek default on its debt obligation to the troika -- International Monetary Fund, European Central Bank and the European Commission; either that or a complete about-face by the troika, capitulating on its demands to cut pensions and loosen labor laws. Germany's strict allegiance to austerity, as well as antipathy towards Greece shared by eurozone states Finland, Spain, et al makes a troika capitulation a long shot.

Several stories this morning (James Kanter and Niki Kitsantonis, "Tsipras Attacks Greece’s Creditors as Pressure Grows on Debts"; Peter Eavis, "Greek Exit Would Shake, but Most Likely Not Shatter, Eurozone") sound the alarm on the coming Greek default. The one story that caught my eye though was an AP piece ("Will Greece Leave the Euro? A Look at Its Options") that problematizes the notion of any clear resolution of the Greek debt drama once the country defaults at the end of this month:

Here are some questions and answers on Greece's future. They could come in handy during Thursday's meeting of eurozone finance ministers in Luxembourg.

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HOW DOES A COUNTRY LEAVE THE EURO? 

Technically, it can't. These are uncharted waters. European Union treaties legally allow members to leave the 28-nation EU, but no mechanism was foreseen to let countries leave the euro. Theoretically, if all 19 nations agree that it's time for Greece to go then a "Grexit" could be negotiated. Some argue the country might have to leave the EU altogether to leave the single currency. 

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WHEN IS THE POINT OF NO RETURN? 

That would be when the European Central Bank decides to cut off emergency credit to Greece's banks, according to Zsolt Darvas, senior fellow at the Breugel think-tank in Brussels. 

That could happen if there is a run on Greek banks — in which case the ECB might not want to risk its money supporting them. Concerns over a run on banks could grow if it becomes clear that Greece will default on its next debt repayment, due June 30.
The ECB could also cut Greek banks loose if the country defaults on debt repayments due to the ECB in July and August. 

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WHAT WOULD HAPPEN THEN? 

Banks would probably have to close for a while and when they reopen, the government would likely put limits on how much money depositors can take out. "People would try to take their money out of the banks. The banks would not be able to pay," Darvas says. "People would try to store their euros at home, not pay taxes, and the whole financial system would come to a halt." 

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HOW CAN GREECE AVOID SUCH A DISASTER? 

Apart from pay its debts on time, some experts believe Greece could limit the damage by engineering its departure in secret. A small group of officials could make the exit preparations and then act on them almost immediately. They would inform their eurozone partners just hours before Greece walks out the door, according Roger Bootle, who heads the research analysis group Capital Economics. The public would be the last to know.

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WHAT MONEY WOULD GREECE USE? 

Greece could go back to using the drachma or introduce a new currency. Either way, volume is essential, and that implies serious challenges. Iraq faced similar issues when it introduced a new dinar in just three months following the U.S.-led invasion. "You would need a huge volume, very quickly. There's also the transportation that is a very big challenge. A lot of police, troops would be required to attend to the cash needs of a country the size of Greek. Logistically it would be a huge challenge," Darvas says. 

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WHAT WOULD HAPPEN TO ITS DEBT? 

Greece's bills won't go away, and the jury is out on whether they could be converted to a new currency, although Greece would probably try to redenominate and renegotiate the debt. The one advantage in this for Athens is that all kinds of loans would probably be written down by its creditors. But Darvas says that "all of these technical issues can be resolved. The economic costs of a euro exit — GDP fall and the rise in unemployment — will be far higher."

If you are burnt out on following the debt-negotiating drama don't expect any relief come end of the month. I don't think Greece has any intention of exiting the eurozone; if it had, if preparations were being made to issue drachmas, there would be leaks by now. Once Greece defaults, that is when another round of negotiations will get going. The ECB could force Greek banks to collapse by freezing Emergency Liquidity Assistance (ELA). But by making such a move, the troika would lose the political battle; Syriza would be vindicated.

Greek Debt Negotiations to Muddle Along, But Things Actually Looking Up for Syriza

It is Monday morning which must mean that there is a meeting in Brussels between eurozone finance ministers and Yanis Varoufakis' Greek negotiating team. Tomorrow is the deadline for repayment of 750 million euros to the IMF. Last week Varoufakis said Greece would make the repayment. The ever-skeptical Yves Smith of Naked Capitalism is not so sure. As she argues in her post today, "Greece Finally Threatens Default as Deal with Creditors Remains Remote,"

The ruling Greek coalition appears to have finally woken up to the fact that it it cornered. As we indicated, the longer the creditors keep Greece in the sweatbox, the more its popularity is destined to decline. 

While the latest polls still show Syriza as the most popular party, its support is now at 36%, a round trip from a huge surge after the government took office to back to where it stood when it was voted into office. Approval ratings of the government’s strategy have dropped precipitously from the very high levels reached shortly after the new government took office. As e pointed out early on, the best strategy for the creditors was simply to remain non-negotiable. Either Syriza would capitulate to their demands, or the government would lose support, paving the way for the return of a more complaint coalition. Syriza appears to realize that following the inertial path of trying to extend its negotiating runway does not work in its favor. Even if Greece were to pull a rabbit out of the hat and make the €750 million IMF payment, it has a total of €1.5 billion coming due to the IMF in June, which it almost certainly can’t satisfy if it fails to unlock the bailout funds.

Yves Smith seems to think that Syriza can either make the IMF payment tomorrow and risk having to issue scrip to pensioners and government workers at the end of the month, or it can stiff the IMF, a course of action that would not immediately precipitate default and Grexit. As Smith explains:

The situation is more fluid than it appears. The odds are high that blame game political calculations will win over sound policy. We’re already seeing jockeying starting to take place. Notice Schauble’s “justifiable conditions” caveat. He’s made clear repeatedly that he’d just as soon see Greece leave the Eurozone, but no one, particularly Merkel, wants to be seen to have pushed Greece out. Thus if Greece plays its cards so it can be depicted to have brought the default (and if it comes to that, an exit), that works to the advantage of the hardliners who see Greece as disposable and believe a default/possible exit can be made painful enough for the Greek people so as to make any other country that might contemplate leaving the Eurozone to see that alternative as too costly.

Despite the continued impasse, and virtual certainty of a default on Tuesday [!], the creditors have quite a lot of choices and options. For instance, despite the IMF’s tough talk about not giving Greece any grace period on a default, an IMF default is not as fine a trigger event at a private sector bond default. As the Financial Times explains:

But that hard line masks a little wiggle room created by the IMF’s own procedures. Under the official timeline plan, it is not until a month after a missed payment that the managing director formally notifies the board and not until three months afterwards that a formal statement to the outside world is expected to be made.

In other words, even if Greece defaults on the loan repayment to the IMF, things can continue to muddle along as they have. The June repayments are larger than this month's. But if missed payments can play out over months before a default is officially declared, there is no reason why this can't repeat itself next month.

In the Business section of today's "newspaper of record" is a slightly more sanguine treatment of the Brussels negotiations. Peter Eavis, Jack Ewing and Landon Thomas, "I.M.F. and Central Bank Loom Large Over Greece’s Debt Talks," see a chink in the troika's armor, and it is not the wiggle room on IMF repayments; it is the risk aversion of the European Central Bank:

It would of course also be a high-stakes gamble for Greece to do anything that could undermine relations with the central bank, which is shoring up Greece’s banking system. It has lent Greek banks more than €110 billion, cash the lenders need to operate but would have trouble raising on international money markets. 

The support to the banks is not the debt that the officials in the Greek government would consider for default. Instead, the idea would be to not repay Greek government bonds held by the central bank. Greece is scheduled to repay nearly €7 billion on those this summer. 

If the Greek banks could not repay their central bank loans, the losses would be passed on to other eurozone countries. An outcry would come from Germany and other countries already fed up with what they regard as Greece’s misbehavior. The central bank’s credibility — probably a central bank’s most important asset — could be damaged. 

Still, the central bank’s deep caution about financial stability would most likely limit how hard it pressed Greece. As the guardian of the single currency, the central bank may not want to do anything that could set off a chain of catastrophic events in Greece’s banking sector that could lead the country to quit the euro. 

“The E.C.B. does not want to be responsible for precipitating a crisis,” said Mujtaba Rahman, practice head for the European Union at Eurasia Group, a political consultancy. “They are very, very concerned about having blood on their hands.”

I know at the end of April when last I wrote about this I said climax was near. Then it looked impossibile that Varoufakis could scrape together the 750 million euros due the IMF on May 12. At the time there was the brouhaha over Varoufakis' obstreperousness; things seemed to be at an unbridgeable impasse and something was going to fracture. But then Tsipras organized a deft cosmetic reshuffling of the bargaining team, with Varoufakis nominally sent to the sidelines, and that seemed to cool things down. Also, I had no idea just how wide the nonpayment wiggle room to the IMF is. Things can continue to go on as they have for months.

Syriza will get some rhetorical help from the Scottish National Party blasting away at austerity. And there is evidence that the U.S. is extremely jealous of Russian pipeline overtures to Greece. So all in all I am more hopeful of some sort of resolution that favors Greece than I have been in months.

Listen to the Left

Peter Eavis' frontpage story this morning about the Dow hitting its all-time high yesterday is worth reading. It's peppered with skepticism. We had a tech bubble followed by a real estate bubble; this is a Fed bubble:

Previous highs occurred when investors believed the economy could keep growing without any extraordinary assistance. By contrast, this rally has occurred on the back of enormous monetary stimulus by the Fed and the world’s other central banks. 

Since the end of 2007, five major central banks have injected some $6 trillion into the global economy, according to figures from the Bank for International Settlements. This was done to prevent bank runs and revive economies. 

As the stimulus forced down interest rates, it eventually whetted investors’ appetite for riskier assets like stocks.

And this from today's naked capitalism blog:

It’s hard to fathom the celebratory mood in the US markets, save that the moneyed classes are benefiting from a wall of liquidity reminiscent of early 2007, when risk spreads across virtually all types of lending shrank to scarily low levels. Then the culprit was not well understood, although Gillian Tett discerned that CDOs were a huge source of leverage, and in April 2007, an analyst, Henry Maxey at Ruffler, LLC, did an impressive job of piecing together how levered structured credit strategies were driving market liquidity. 

Now it’s a lot easier to see what is afoot. The Fed has been trying to reflate asset values to goose the real economy. What it has done instead is goose the incomes of the top 1% while everyone else is on the whole worse off. But the central bank is suffering from a very bad case of “if the only tool you have is a hammer, every problem looks like a nail” syndrome. It’s unwilling or unable to admit that its program is working only for a very few. It has convinced itself that if it just keeps on the same failed path long enough, things will turn around. As we can see from Japan, “long enough” can exceed 20 years, and it is not clear that the latest Japanese pump priming will finally pull the economy out of the ditch.

What's called for is a massive public works program that would employ the unemployed and build things that future generations could use to live better lives. But this is not going to happen because Republicans as a minority party have figured out how to control the national government. I would guess the GOP will control the House and the Supreme Court for at least the next decade. And to be charitable to Obama, assuming he's not the Manchurian Candidate of the 1% as the Counterpunch Left perceives him, I think this is what lies behind his search for a grand budgetary bargain with Republicans here and now; he doesn't see them going away anytime soon. So better to try to cut a deal now on Social Security and Medicare that doesn't include an increase in eligibility age; cut a deal now while his election mandate hasn't completely evaporated (as it almost already has).

Generally, as a rule of thumb, the Left is right; that's why it's wise to pay attention to what is being said on blogs like naked capitalism and web sites like Counterpunch and in publications like Monthly Review; while not being 100% correct (who is?), the interpretive framework is more coherent. To give one prominent example of the Left being spectacularly correct while simultaneously the Right was disastrously wrong recall Saddam's weapons of mass destruction. The Left went with Hans Blix and said there's nothing there. And they were right. Don't ignore the Left.

The Case Against Standard & Poor's

Peter Eavis in a story that appears on page A3 of today's paper explains that the heart of DOJ's case against Standard & Poor's has to do with the computer models the company used to analyze both collateralized debt obligations and the underlying mortgages. The models were cooked, bogus, jiggered with to produce the high credit rating that the issuer wanted. As Eavis explains,

As home prices soared and buyers clamored for properties, banks began to churn out more loans and bundle them into mortgage securities. To analyze mortgages, S.& P. used a program called Levels version 5.6 at the time. S.& P. used that data to come up with its credit ratings for mortgage-backed bonds.

As early as 2004, S.& P. considered broadening the pool of loans in the model. The upgrade was intended to create a more realistic model called Levels 6.0, and S.& P. announced it was forthcoming. But the model was never released, the lawsuit claims.

Instead, S.& P. introduced a more modest upgrade in 2006, Levels 5.7, according to the suit. But the Justice Department contends that model did not provide an accurate picture of the loans. The suit said that an executive made a change to the model that would keep ratings artificially high. 

Ms. Mathis, the S.& P. spokeswoman, said the description of the adjustment to Levels 5.7 was inaccurate. “We are not aware of any changes made to the 5.7 model that were not analytically justified, nor that any changes were made by an individual as opposed to a committee,” she said.

As to the inference by the S&P spokeswoman that model adjustments were kosher as long as they were made by committee, Mary Williams Walsh and Ron Nixon address it in their frontpage story about Attorney General Eric Holder's announcement of the lawsuit to the media yesterday:

Remarks that S.& P. employees made in internal memos and electronic communications show that as early as spring 2004, certain executives wanted to change the firm’s rating methodology, but only after polling “an appropriate number of issuers and investment bankers” as to the “rating implications.” 

The idea of asking bankers what they thought about a change in the firm’s methods shocked some S.& P. analysts and executives, including one who fired back, “What does ‘rating implication’ have to do with the search for truth? Are you implying that we might actually reject or stifle ‘superior analytics’ for market considerations?” 

In May 2004, an analyst warned that S.&. P. had just lost to its competitor Moody’s Investors Service the chance to rate a very large deal by being too hard-nosed about the amount of collateral that would be required to get a good rating. More collateral would mean less profit for Mizuho, the bank putting that deal together. 

“We must address this now,” she said — otherwise the firm would lose more deals. 

The complaint describes a debate in 2004 and 2005 about whether S.& P. should change its model for rating C.D.O.’s and what effect the proposed changes might have on its business. The change was scheduled for July 2005, but before it could happen, an analyst sent an e-mail saying that according to the investment bank Bear Stearns, the older model “had been the ‘best’ ” at rating weaker pools of mortgages, compared with Moody’s and Fitch.

DOJ's case looks solid and easy to understand. In order to make garbage look like gold S&P ran the garbage through a computer model; it popped out as gold. If the computer model popped out something different, say, lead or bronze, a new computer model was devised. People can understand that. It's called fraud.