PLAN B: Morgan Stanley's 5-Step Emergency Response For Limiting Greek Exit Contagion


Morgan Stanley European economics team recently increased the odds of a Greek exit from the euro to 35% within 18 months.

The team offered several scenarios outlining how things would unfold for Greece in the wake of an exit.

Ultimately, everyone is worried that an exit will be disorderly and result in rampant contagion across the eurozone and perhaps the world.

As such, Morgan Stanley offers  five steps to limit or prevent contagion in response to an exit.

The steps include two short term and three long term responses, with the short term responses being instrumental in implementing the long term responses.

1. More Aggressive ECB Policy Action

In order to limit contagion, Morgan Stanley believes the ECB must have more aggressive policy action. By this, the bank means that the ECB needs to focus on more long-term refinancing operations (LTROs) that have longer maturities and lighter collateral rules.

Morgan also sees a need for quantitative easing in the Eurozone, or large-scale purchases of private and public sector bonds.

This step is just a way to buy time until the rest of the steps can be completed.

Source: Morgan Stanley

2. Recapitalization of Peripheral Banks

A recapitalization of the peripheral banks through the ESFS (European Financial Stability Facility) and ESM (European Stability Mechanism) could help buy more time to complete other steps to preventing contagion.

Morgan also suggests that the ESM becomes a legitimate counterparty to the ECB.

Source: Morgan Stanley

3. Federal Deposit Guarantee Scheme

The entirety of the eurozone would have to come together and agree to guarantee bank deposits. Many countries in the eurozone have made strides to upgrade deposit guarantee schemes (DGS), but a federal DGS could provide much needed security to potential depositors. This is a lengthy process, which is why the first two steps are necessary for a federal DGS to be implemented.

Source: Morgan Stanley

4. Fiscal Union

In order to prevent contagion, Morgan feels that the governments in the eurozone must move towards joint funding and fiscal transfer mechanism. There is debate over whether or not the 'no-bailout clause' means that no country can be forced to bailout another country or whether it means that one must not bail out another sovereign. This must be resolved, and constitutional and treaty changes must occur, which takes a significant amount of time.

Source: Morgan Stanley

5. ECB Becomes Official Lender of Last Resort

A meaningful policy response to prevent contagion would have to consist of a more federal Europe and near-term measures to sustain the financial system. It is necessary for the ECB to make government bond risk-free, including during crisis times. This, also, is a very lengthy process and would require the previous four steps to be completed before implementing this final step.

Source: Morgan Stanley

In the long-run, a Greek exit might be small potatoes

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