On The Possibility Of A Greek Exit And The SNB's Surprise Move

The Greek election is on January 25. Syriza, the leftist party that seeks to negotiate more aggressively with the Troika and roll-back some of the austerity imposed appears to be maintaining its lead of 2-3 percentage points. Even though it may win a plurality, heading up the next government is a different story. That requires a majority of parliament.

It may not be able to achieve this even with the 50 bonus seats given to the party that receives the most votes. This warns of the risk of extended political uncertainty after the election.

The SNB's decision to abandon the cap has been linked by many observers to the ECB's possible decision this coming week to buy sovereign bonds. We think some upward pressure on the franc may have been coming from risks around the Greek election (and capital outflows from Russia). We have all seen the stories how banks, electronic platforms and the like are making contingency plans in case Greece leaves the EMU and reintroduces its own national currency.

Greeks themselves appear to be also making contingency plans. Deposits in Greece fell by three bln euros in December. Some estimate that another four bln euros have already fled this month.

Two Greek banks have applied to the national central bank for emergency funds. The fact that they went to the national central bank instead of the ECB is important. Those emergency funds (ELA) are more expensive than funds from the ECB directly. Under the ELA program, the national central bank absorbs the risk and takes lower quality collateral. The Greek banks either do not have or feared that they would not have the quality of collateral for borrowing from the ECB.

Since Greece lost its investment grade status, the ECB has still accepted Greek government bonds as collateral. Greek bonds appear to stand behind around 2/3 of the 41 bln euros that Greek banks have borrowed from the ECB.

In light of the European Court of Justice preliminary decision early last week, and some comments from EC officials, the ECB's role as part of the Troika of official creditors in the EMU needs to be re-thought. Even without being part of the Troika, the ECB is powerful. It has warned that if Greece fails to arrive at an agreement with the Troika, and the current agreement expires at the end of next moth, it would no longer be able to accept Greek government bonds as collateral. Moreover, ECB approval for the extension of ELA is necessary.

The ECB will review the Greek Central Bank's request for permission to extend ELA funding this coming week. It will likely approve. However, after the end of February, and if there is no agreement with the Troika, it could refuse to grant such permission. This would be a financial stranglehold on Greece. As there is no mechanism in the controlling treaties to expel a country from monetary union, this could be the causa belli that leads to Greece's exit.

I did not think Greece was going to leave the EMU in the 2010-12 period, and I still do not think it will leave now. I suspect that the SNB is surprised by the magnitude of the reaction to its abandonment of the franc cap, in a similar but different way than officials were surprised by the impact of the fall of Lehman. No one can feel comfortable thinking that a non-disruptive Greek exit is possible.