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Plan Beta double minus

6 February 2012 By Hugo Dixon

The euro zone needs a contingency plan to handle a potential Greek blow-up. The latest game of brinkmanship being played in Athens will probably end in a fudge – that’s how such games normally resolve themselves. But if it doesn’t, Greece’s banks will go bust and the rest of the euro zone will need a plan to prevent a panic in its own banking industry.

The hardliners in Europe, led by Germany, have virtually lost patience because of the Greek government’s inability to deliver on its promises. The fact that the next tranche of bailout cash is supposed to be a super-sized 80-90 billion euros seems to have made the lenders even more determined to secure reforms to make the economy more competitive. This is serious money, after all. The Greek politicians, meanwhile, are reluctant to force the voters to drink any more unpleasant medicine – especially given that there could be a general election in April.

But is the rest of Europe really prepared to pull the plug? Doing so wouldn’t just mean that the Greek government would go bust, as it would be unable to pay a bond that comes due in March. It would also mean that the country’s banks, which are stuffed with their government’s debt, would go belly up.

If the Greeks were the only ones who would suffer from such a catastrophic bankruptcy, their partners could afford to hang tough.But such a scenario would probably provoke runs on banks in the rest of the euro zone – especially weak economies such as Portugal, Ireland, Spain and Italy. The European Central Bank would, again, have to ride to the rescue by flooding the system with liquidity.

Helping banks deal with an all-out panic wouldn’t be easy. After all, the ECB is only supposed to provide liquidity in return for adequate collateral. And, in some cases, banks have run out of such eligible assets. This is why the ECB has already authorised national central banks to provide so-called emergency liquidity assistance to their country’s banks in return for lower quality collateral.

But in a panic even this ELA support might run out. Then the ECB would need to get more creative. One option would be to let banks issue bonds guaranteed by their own governments and pledge those to their national central banks in return for cash. While that might bail out the banks, it would heap further contingent liabilities on their governments – potentially gumming up the sovereign bond markets, which would already have been savaged by a Greek default. So some sort of programme to shore up the weak governments, presumably by accessing the war-chests that the euro zone and International Monetary Fund are assembling, would also be needed.

Such a plan may never need to be used. But if it doesn’t exist and the brinkmanship in Athens doesn’t have a satisfactory conclusion, the euro zone will find itself in a deep chasm.


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