Council on Foreign Relations: Greece Could Face Extended Bank Holidays

Sebastian Mallaby, the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations, has put out a pretty decent explainer on the current Greek situation:

Since the start of the Greek financial crisis more than five years ago, the country has repeatedly defied predictions of a fast exit from the eurozone. But the moment of truth is approaching.

In January, after enduring a decline in living standards of fully one third, the Greeks elected an anti-austerity government that promised to stand up to the creditors; and the creditors have hit back, determined not to let one country abandon reform lest other electorates demand the same indulgence. Bad-tempered negotiations between the Greeks and their partners have deadlocked, with the populist Greek prime minister, Alexis Tsipras, accusing foreigners of "pillaging" his country. Barring a dramatic change of tune, Tsipras is evidently choosing to embody a cause, not lay the ground for a solution.

The Greeks now face a series of tests, any of which could precipitate the endgame. On June 18, the Greeks were due to meet with European finance ministers in hope of breaking the deadlock. The odds of progress seemed extraordinarily slim, given the recent tone from the Greek government. Assuming nothing comes of Thursday's meeting, there may be another chance this weekend, when an emergency summit of eurozone heads of state may be convened to give a final chance for negotiation. After that, the Greeks will run into a series of debt-repayment deadlines. Without an agreement with the creditors that unlocks fresh international aid, they are unlikely to find the money.

The first repayment deadline comes at the end of June, when the Greeks are due to come up with a bit less than $2 billion for the International Monetary Fund. Nonpayment would raise questions about whether the European Central Bank will continue to support Greek private banks. Technically, the ECB is only supposed to provide liquidity to a bank that can provide good-quality collateral. But Greek banks' main collateral consists of Greek government bonds. If the Greeks have just defaulted to the IMF, it will be hard to pretend that its bonds are worth their face value.

If the ECB curtails loans to Greek banks, they will be at risk of failure. Rational depositors will run, turning that risk into a certainty. The government will therefore have to counter by prohibiting withdrawals: There will be extended bank holidays, and a ban on taking euros out of the country. Meanwhile the government, deprived of the option of selling bonds to its own bankers, will have no choice but to pay civil servants and pensioners with IOUs—effectively, a new domestic currency. At this point, monetary union will exist in name only. A euro locked inside a bank in Greece will no longer be equivalent to a euro in Germany or Holland.

It's possible, indeed likely, that the ECB would avert its eyes from the IMF non-payment to avoid tipping Greece into a death spiral. The central bank may pretend that the Greek collateral is good and so extend the banks' survival. But then Greece will immediately confront a set of further tests. The government faces repayments to bond holders on July 10 and July 17; and then, on July 20, it must repay the ECB itself, to the tune of 3.5 billion euros. Again, the Greeks won't find the money for this repayment unless they receive fresh foreign help. If they default to the ECB, it is hard to see how the central bank can continue to look the other way. Extend and pretend will be over.