Greece's endgame is finally coming into view

Lightning in GreeceREUTERS/Marko DjuricaLightning strikes over buildings at central Syntagma square during heavy rainfall in Athens January 26, 2015.

The European Central Bank (ECB) decided Wednesday to stop Greek banks from being able to use the country’s government debt as collateral for loans, in a move that many see as a shot across the bow for Europe’s politicians. What it has undoubtedly done is brought forward the date at which a final decision over Greece’s future in the eurozone must be taken.

Here’s what we know has been happening. In December, Greek banks saw a €4 billion drop in deposits as their clients pulled money from their bank accounts. Estimates suggest that the figure for January could be as high as €11 billion.

The outflows have sharply increased the banks’ reliance on loans provided by the ECB with over €70 billion being received in January, according to Moody’s ratings agency.

Greek banks ECBMoody’sGreek bank funding mix.

These loans are guaranteed against government bonds or government-guaranteed assets that the banks hold. And they have become a key source of funding (see thick black line on the chart above). As the loans come directly from the ECB rather than Greece’s central bank meaning that the risk of them not being paid back is shared with the rest of the countries in the Eurosystem.

However, with Greece’s government debt and the debt of its banks currently rated “junk,” it technically falls below the ECB’s minimum standards to access this facility. In order to allow Greek banks to continue to use this lifeline while the country undertook deep budget cuts demanded by its European partners, the central bank issued a waiver effectively suspending its minimum requirements for collateral.

The condition was that Greece was obliged to “comply with the conditionality of the financial support and/or macroeconomic programme” agreed with the European Union and International Monetary Fund.

And it is this condition that the ECB is claiming has been breached so it has withdrawn the waiver. Except that it doesn’t have to prove that the conditionality has been breached. Instead, it is at the central bank’s Governing Council’s discretion exactly what constitutes a failure to comply and, in this case, it has decided “that it is currently not possible to assume a successful conclusion of the programme review.”

To demonstrate just how arbitrary this decision was, the ECB had already announced that it would remove the waiver for government-guaranteed bonds from the end of February. It just decided to cut that deadline short by a couple of weeks.

Despite the hyperbolic reaction in some quarters, this is not the end for Greece. The banks still have access to emergency liquidity assistance (ELA), which they access through the national central bank and can replace the loan funding they were previously relying on. (Although the ECB retains the ability to cut off that funding too at its discretion following reviews it carries out on a biweekly basis.)

In fact, three of Greece’s major banks have already tapped the facility this week for €2 billion in emergency funding.

But, as can be seen by the collapse in the banks’ share prices this morning, the ECB’s move doesn’t help. If, as seems likely, it increases the pace of deposit flight from Greek banks as nervous investors interpret the ECB as trying to buffer the rest of the eurozone from the possible damage of a disorderly exit by a country from the single currency, then the health of those banks could be compromised even further.

That is, the ECB has decided to mess around with the medication of a sick patient and risk pushing them into a vegetative state in order to force bickering relatives to agree on how best to manage the family estate. If the point of the emergency programme set up by the EU/IMF/ECB was to help Greece regain market access and be able to fund itself in future, this discretionary decision seems at best unhelpful and at worst positively damaging to that aim.

The new Greek government led by the left-wing Syriza party was trying to negotiate for some breathing room until the middle of the year, as it attempted to get to grips with the country’s finances and negotiate a new deal with its European partners. That timeline is now no longer realistic.

Instead, the country is now likely to run out of money to cover its bills some time in March.

So what does that mean for Greece now?

No doubt the ECB’s move will concentrate minds, but there is no guarantee that this will have a positive result. If the Greek government feels it is being squeezed by all sides to make it go back on its election pledges, it may decide to push back.

Finance Minister Yanis Varoufakis has already ruled out accepting the next tranche of the EU/IMF bailout funds under the current terms, and he could yet make good on that threat. In that case, Syriza would either have to be willing to let the country default on its obligations (and possibly trigger a messy exit from the euro), or be confident that its eurozone partners will extend short-term loans while negotiations are ongoing. The ECB’s decision could cast doubt on the likelihood of the latter.

Varoufakis might have expected his eurozone partners to balk at the deal on the table. He may even have expected that the ECB would put pressure on Greece behind the scenes to reach a deal quickly, using the emergency loan facility as leverage. What the Governing Council did, however, was preempt the negotiations and reduce the buffer within the Eurosystem against possible delays by forcing forward the deadline for a deal. It is difficult to square that with its mandate of maintaining price stability in the eurozone.

Ultimately, Varoufakis doesn’t really have any choices if no deal is struck: Greece must either accept the terms of the bailout or risk going bust.

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