What's Next for Greece?

It is a bit too familiar, isn't it?  Greece received a new loan so it can service its debt to the official creditors.  In exchange for the funds, of which practically none stay in Greece, the government has promised to carry out the reforms that the past few governments had agreed to but failed to implement.  Greece may no longer be in arrears to the IMF, but it is making ends meet by delaying payments to local service providers. 

Last week, the Greek parliament approved the list of what the creditors call "prior actions," committing the Greek government to those past reforms.  Tomorrow parliament will vote on two other measures; the Bank Recovery and Resolution Directive (BRRD) and a bill that modernizes the judicial system.    These measures are less controversial than last week's, but a few more Syriza MPs are likely to defect.  

The BRRD is an important measure that will eventually be enacted throughout Europe.  It allows senior bondholders and depositors to bear the cost of a failed financial institution before taxpayers money will be used.  Many countries have not passed the directive.  In May, the EC gave Italy, France, and nine others EU countries two months to approve BRRD. 

In Greece's case, invoking these measures may be counterproductive.  With the banks re-opening  for the first time in three weeks, and capital controls still in place, confidence in the financial system is poor.  Many are fearful that one way or the others, depositors are at risk of either a tax or confiscation of deposits over the 100k euro insurance threshold.  This fear encourages deposit flight, and in turn, prevents the lifting of capital controls.    

Greek deposits have fallen by 34 bln euros since last October.  Many of those with the means to set up offshore accounts have probably done so.  There is much precedent (not only in Cyprus but in the US too) of not protecting deposits beyond the insurance level.  

However, in Greece's case, this would likely hurt small and medium size Greek businesses that have their working capital in the banks.  The contracting economy, the bank holiday, the capital controls and the government's tardiness in paying its service providers are already hurting Greek businesses.  Although current hard data is not available, one must assume that business loans are souring.  Taking from the same business their working capital via deposits in excess of 100k would only aggravate the situation.  

Note that there are important differences between US deposit insurance and Greece's.  First the US FDIC insurance applies to each account, not to each depositor.  In the US, a depositor can have more than one account.  Each account is insured.  In Greece, the depositor is insured and with a lower ceiling than in the US.    Second, during the crisis, the US offered unlimited insurance for non-interest bearing transaction accounts, which are used for working capital.    

These would be two innovations that could be useful in Greece.  The purpose of which is not so much to help those who have as it is to increase the likelihood of success.   Bailing in depositors, including those with an excess of 100k euros could do more economic and financial harm than good.

What about shareholders?  Surely they should be liquidated as part of the recapitalization efforts, for which some 25 bln euros of a new aid package will be earmarked.    However, while the principle is right, the application in Greece is suspect.  The top four banks in Greece account for 90% the industry.  Two of the banks (Piraeus and Alpha) are 2/3 owned by the government and a third (National Bank of Greece) is owned 57% by the government.  The only one of the top four banks that the government does not have a majority ownership stake is Eurobank (35%).   

Given these circumstances, liquidating shareholders would reverberate back onto taxpayers.  It would not be particularly helpful in disciplining the owners.   It would likely complicate efforts to recapitalize the banks.  It may be more fruitful to consider consolidation as part of the recapitalization process. 

Some measures that the creditors have demanded from Greece are narrow and petty, like opening up shops on Sunday.  However, some demands seem to be more generally beneficial for Greece.  For example, as part of the "prior actions" reforms approved last week, Greece agreed to make its national statistics office independent.  This cannot simply be dismissed as a function of Greece becoming a vassal state.  Similarly, the reforms that will be voted on tomorrow include modernizing and making more efficient the Greek judicial system.  This will cut the time and costs of civil action.   Renzi has pushed for similar reforms in Italy. 

Last week's parliament vote saw 38 Syriza MPs vote against the government.   Those cabinet officials that failed to support the government were replaced.  Local press reports suggest another handful of Syriza MPS are likely to dissent tomorrow.   The bills will still pass, and by a wide margin.  The problem is that it weakens the government.  

Recall Syriza had 149 seats in the 300-member chamber.  Its junior coalition member has 13 seats, giving the government 162 MPs. Given the dissents last week, if more than four defect tomorrow, the government's support would fall below 120, which is seen as making it problematic to govern.  This is what is fueling speculation of an election later this year.  

It is possible, and even likely, that Syriza returns to government in a new election.  A newspaper poll put Syriza's support at 42.5%, nearly twice the support of New Democracy, which is in second place at 21.5%.    However, the problem with an election is that it may delay the formal review of Greece's actual implementation of the measures it has promised.  That in turn would delay the debt relief that now even Merkel has accepted as necessary and inevitable. 

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