Grexit Drama: ECB Suspends Greece Bonds as Bank Collateral

The Grexit drama appears to be crescendoing.

In a move to forcefully address the stalemate between the new government of Greece and the EU, the ECB has partly withdrawn funding of the Greece financial system by suspending Greek bonds as bank collateral

The ECB’s official statement here.

Marketwatch.com explains the ECB action: (bold mine) 

What did the ECB just do? 

The ECB’s Governing Council suspended a waiver that had allowed Greek banks to use the country’s junk-rated government bonds as collateral for central bank loans. 

Why did the ECB do it? 

Greek bonds are junk rated, thus the waiver was needed to allow the banks to post collateral that could be used for cheap funding from the ECB. One of the prerequisites for the waiver was that Greece remain in compliance with a bailout program.

In its decision, the ECB said it pulled the plug on the waiver because it can’t be sure that Greece’s attempts to secure a new program will be successful.

Beyond the official reasons, the move is seen as a definitive warning that, like Germany, the ECB is in no mood to give in to Athens’s request for a debt swap. News reports also indicated the ECB isn’t open to requests to allow Greece to raise short-term cash by issuing additional Treasury bills in an effort to keep the government funded as it attempts to reach a new deal with its creditors. 

Where does that leave Greek banks? 

It’s not a welcome development. Greek banks have suffered significant deposit withdrawals before and after the January election that brought the antiausterity government, led by Syriza’s Alexis Tsipras, to power.

“This news will likely scare depositors and result in further bank runs,” said Peter Boockvar, chief market analyst at the Lindsey Group in Fairfax, Va.

“This all said, if Greece can come to an agreement with the troika[ i.e., the International Monetary Fund, the European Commission and the ECB], I’m sure the ECB will reinstate the waiver,” Boockvar added.

While the kneejerk reaction in markets has been negative, analysts note that junk-rated Greek sovereign debt made up a relatively small portion of the collateral used by Greek banks in funding operations as of the end of last year. Karl Whelan, economics professor at University College Dublin, recently estimated that Greek banks were using a maximum of €8 billion in Greek government debt as collateral for loans from the Eurosystem as of December versus total loans of €56 billion.

Meanwhile, the ECB said Greek banks will be able to tap funds through a program known as emergency liquidity assistance, or ELA. Under the program, the loans are more expensive and remain on the books of Greece’s central bank rather than the ECB.

The BBC diagram above shows of the share distribution of Greek creditors via holdings of Greek Bonds

The BBC says that : Greece has about €20bn (£15bn; $22.5bn) to repay this year, according to the Greek finance ministry. Economists estimate that Greece needs to raise about €4.3bn in the first quarter.

By withdrawing ECB guarantee, it’s not just about withdrawing liquidity but likewise to implicitly exacerbate the downgrade of what has been already rated as “junk”.

In addition, the remaining lifeline for Greek banks would be the ELA. The ECB’s bailout program is due to expire in February 28, which if not renewed would mean Greece will be on its own. 

So the showdown between the ECB and Greece has become a “game of chicken”. And the “game of chicken” will have consequences. One of them is likely the intensification of “significant deposit withdrawals” which is a euphemism for “bank run”…a systemic Greece bank run. Yet if a run materializes, where will the money go...Germany, Swiss, US or Asia or under the household pillow mattress?

It’s true that since official institutions have become the biggest creditors to Greece, there has been less exposure by the private sector which is probably why the reactions of the financial markets to the ECB hardline stance has hardly been violent…yet. But this lack of drama doesn’t imply that current reactions will project to the future. Or said differently, since sentiments have always been fickle, should a radical shift occur, then the momentum of the ballgame may reflect on such a shift.

And official exposure on high risk junk Greek debt doesn’t extrapolate to free lunch too.

If the Greek government defaults, whether the governments of the Eurozone, IMF or the ECB, someone would have to pay for those losses and that someone, the forgotten man, would be the taxpayers.

As the Zero Hedge points out: (bold original)

yet Bloomberg does bring up a relevant point: "The nominal amounts at stake do illustrate the motives for German resistance to restructuring. Yet a more relevant measure would adjust for a country's ability to absorb those losses. The picture radically changes when that exposure is expressed as a share of 2013 nominal GDP. On this ranking, Germany falls to No. 9 with an exposure amounting to 2.2 percent of its economy's size. France falls to No. 8 (2.2 percent) and Italy to No. 7 (2.5 percent). Portugal (3.2 percent), Cyprus (2.8 percent) and Slovenia (2.6 percent) top the ranking, meaning these countries have the most to lose if Greece decides to write down its public debt."

Should the EU-Greece game of chicken lead to a Grexit, there will be pain for these debt holders. The degree pain will not  be the same, but again there will be pain. The subsequent question is what will be the indirect (non-linear) ramifications?

Of course, in a world where governments have been hocked to the eyeballs with debt, and where central banks have provided the band-aid or patchwork for all the accruing imbalances via the extinguishment of risk conditions through financial asset pump, a Grexit may change the complexion of risk. Risk, like the mythical Phoenix, may resurrect or may be reborn.

Remember all it takes is for a Bear Stearns to lead to a Lehman moment. Could Grexit be the modern day version of Bear Stearns or the Great Depression's Creditanstalt?

Will record high stocks be immune to this? 

Very interesting.