Friday, June 15, 2012

Greece Election, Liquidity and Solvency

Greece voters go to the polls this Sunday. The election results will be close but my bet is that nothing final will be decided. Their problems are too embedded to be solved in a single election.

Most of the world is concerned about what the vote will portend about the future of the euro currency. My bet is the euro will be around for years to come. But whether Greece will be part of that common currency in a few years is highly questionable, no matter how the Greeks vote this weekend.

There is, of course, a lot of buzz about what may or will happen as a result of Sunday's vote. If you want to read about what a perhaps worst case could look like, see What's at Stake in the Greek Vote,  subtitled 'If a Greek exit from the euro zone looks close to certain after Sunday's election, we will see a full-fledged bank run.'  While I don't expect this to be the outcome, of course it could be.

My own guess, and it absolutely is a guess, is that the vote will be a close one but one which encourages pundits and even market participants, at least for a short time. {If I'm right, the New Democracy party will win a close election over Syriza, the radical left party. However, nothing will be solved, no matter which way the vote turns out.}

And the summer will be a long and difficult one for Greeks and the rest of the Europeans, too. Perhaps the entire world, us included. Add our upcoming U.S. fall elections to all that, and it looks like a most exciting rest of the year 2012 and beyond.

But We the People will come out stronger in the end. Of that I'm convinced. Now let's hope I'm right.

To repeat, after Sunday's vote, the Greeks will fight among themselves and with Germany and others all summer, fall and perhaps longer, too. Then there are the problems of Spain, Portugal, Italy, Ireland and other European countries. Lots of stuff going on these days.


The world's central bankers are on high alert and will likely act in coordinated fashion to prevent a "run on the bank" if the outcome of the Greek vote is seen as hastening Greece's exit from the euro common currency. Accordingly, there will be lots of liquid cash in the banks, so to speak.

Thus, liquidity will be preserved and a "run on the banks" panic will be avoided. At least that's the hope and the plan.

But if lots of Greek citizens decide to withdraw their deposits and ship them overseas, the bank run will happen but it will occur at a slower pace. You see, central bankers can create money but they can't make that money stay home and they can't make it be worth anything.


And that's where solvency comes into play. In simple terms, solvency means that there are enough assets to pay off liabilities. So if we own a house with no mortgage loan, as an example, and the house is worth $100, but we have no cash, we're illiquid but by no means insolvent. If push comes to shove, we can sell the house, receive cash and become very liquid.

But what if we owe $150 on the house that's worth $100? Now we're insolvent, since our house is worth $100 but we owe $150. In fact, we're both illiquid and insolvent.

Bankers can't do anything about the solvency issue. A house that we purchased for $150 and can't sell for anywhere near that amount now is the fundamental problem. It's not that a potential buyer can't come up with $100 in liquid cash to buy the house.

Instead, the problem is that the owner and his bank would lose $50, and that's $50 that they can't afford to lose.

Since other depositors with $150 on deposit in our hypothetical bank know that, they may act quickly to remove their $150 and deposit that money in a German bank. So even if the central bank prints a fresh new batch of money amounting to $150 in new bills, that doesn't alter the fact that the house is now only worth $100.

Greece's Problem

The problem with Greece is similar to the problems many other European countries have. They have valued their assets higher than they're now worth.  And their liabilities are greater than the value of their assets. Finally, their economies are receding and economic growth is nonexistent. As a result, something has to give.

Greece Votes Again is subtitled 'Polls suggest that millions of voters still want a free lunch." Here's what it says in part about Sunday's election:

"Nobody said the second time would be the charm. Greece's political parties failed to form a government after last month's parliamentary elections, and neither Greek citizens nor their creditors have any appetite for another inconclusive result after Sunday's runoff vote. But no number of polls will spell political stability for Greece unless Athens can show the credible commitment to reform that the Greek establishment has dodged for decades. . . .

Ahead of the election, the center-right New Democracy party looks to be leading the Coalition of the Radical Left—Syriza in the Greek abbreviation. But once again no party is likely to claim an absolute majority. Syriza was the sleeper story of last month's elections, winning second place with 16.8% of the vote; the party took less than 5% three years ago.

Syriza's ascent has given officials in Brussels and Berlin more than a few sleepless nights. Alexis Tsipras, the party's fiery 37-year-old leader, vows that he'll tear up the EU-IMF bailout agreement but keep Greece within the euro zone. If he becomes Prime Minister, he has said he'd nationalize Greek banks, halt privatizations, reverse pension and wage cuts, and scrap the current pledge to fire 150,000 government workers.

But equally worrisome is the centrist parties' collapse into irrelevance. New Democracy chief Antonis Samaras has made the right noises about tax freezes and structural reforms, but if his party wins first place on Sunday it would likely have to form a coalition with Pasok, the socialist party that won third place in May. A joint government with Pasok and one of the smaller parties would be encumbered by coalition politics and peopled by many of the same officials who swelled Greece's public debt and turned "Greek accounting" into an international punchline.

Any government that is formed after Sunday will have to move carefully or face swift collapse.... could lead to bank runs and a snap decision to print drachmas. Not even the charismatic Mr. Tsipras would be able to explain his way out of that one.

Yet a New Democracy-led government may be a safer bet only inasmuch as self-immolation is safer than a shot to the head. Mr. Samaras has promised to negotiate with Brussels to extend Athens's deficit targets, but any fealty to the current rescue plan would be held up by Syriza as evidence of complicity in Germany's "plot" to subjugate Greeks. Further anti-austerity riots could topple a Samaras Administration in months, allowing an empowered Mr. Tsipras to take a majority in a third election.

We hope the Greeks sort it all out, and that the Acropolis doesn't get destroyed in the process. But at one level the politics is a sideshow to the central lesson of Greece's crisis. For decades, and especially once they joined the euro zone, Greeks borrowed to consume beyond their means, and in 2009 the bill came due.

On Sunday Greeks try again to decide on the means of repayment: Mr. Samaras is offering to swallow the austerity medicine but seems fated to under-deliver on the restructuring that needs to accompany it. Mr. Tsipras is promising a free lunch. A Syriza victory Sunday would suggest that millions of Greeks still believe in no-cost dining.

That this is where Greece has come should give EU policy makers pause. Spanish banks are being bailed out and a deeper transfer union looms, but Greece shows that there are limits to what rescue money can achieve when it is poured into a broken political system.

The larger question raised by the current state of Greek politics is whether more transfers and more fiscal union can make Greece and the rest of Europe more like Germany. Or will they make European politics more like Greece's?"

Summing Up

While Sunday's Greek vote is important, it is indeed a sideshow to the much larger European entitlement welfare state issues and the lack of economic growth. Thus, whatever happens, the vote won't be decisive in any way.  In that regard, it will probably be similar to the U.S. vote this November. This problem is not a short term issue. It will take many years to unravel.

As the above article puts it, "But at one level the politics is a sideshow to the central lesson of Greece's crisis. For decades, and especially once they joined the euro zone, Greeks borrowed to consumer beyond their means, and in 2009 the bill came due." Sound familiar, my fellow Americans?

The real longer term issue and problem may be that the Greeks today still are ignoring reality. Too many of them may indeed be looking forward to even more free lunches.

But all the free lunches are over, even if all the Greeks don't yet realize that simple fact.

So in the U.S., let's heed the lessons from Greece (and others) and clean up our act while we still can.

Thanks. Bob.

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