Yves here. Welcome back Nathan Tankus, who has posted from time to time on Naked Capitalism.
Here Nathan describes some critical infrastructure, the payments system, and in particular, the so-called Target2 system. Quite a few financial commentators have taken the point of view that exposures of other nations to Greece through the Target2 system represented a big incentive for them to come to a deal with Greece. The argument went that a either a Greek default or a Grexit would lead to losses being recognized on exposures different nations have to Greece and these would require taxpayers to make up some of the losses.
While politicians might indeed decide to try to make noise about Target2 losses as a way to further demonize Greece, Nathan describes how the importance of this issue is considerably exaggerated. Target2 balances are accounting entries among entities in the ECB system that happen to have physical operations in various countries, as opposed to being assets or liabilities of countries.
A default by Greece in and of itself would not have any impact on the Target2 system. Even a Grexit, which would lead to actual losses (via at a minimum conversion of Greek law contracts and assets and liabilities at Greek banks to drachma, leading to losses on ELA loans by virtue of now being undercollateralized) are not de jure liabilities of the nations of the Eurozone.
If the losses at the ECB are large enough, it would have reduced equity or negative equity. Negative equity doesn’t impact in any way the ECB from conducting monetary policy or National Central Banks implementing it. Disrupting that would have huge negative effects across the entire Eurozone for no economic or political reason. a taxpayer levy on member states of the Eurozone would be a political choice with purely negative economic consequences. Nonetheless, some members of the ECB board, notably the Bundesbank’s Jens Weiemann, are sufficiently inflation averse (and anti Greek) that they are expected to pump for a taxpayer levy across Europe to recapitalize the ECB.
By Nathan Tankus, a writer from New York City. Follow him on twitter at @NathanTankus
Greece has been in a prolonged crisis for what is rapidly becoming a decade. The election of Syriza seems to mark something of an endgame for this crisis in that either the crisis will be resolved or it will (in some sense anyway) destroy Greece.
As we reach this endgame, it is important to understand how the system currently works and doesn’t work while outlining the policy options remaining to Greece. As Yves has outlined before, imposing capital controls much earlier would have put Greece in a stronger position both in negotiating a controlled default and/or exiting the Eurozone. Nonetheless, Greece still has some policy options. However, to understand the policy options it has and the serious issues it faces no matter how the endgame plays out, we must first understand the payment system which rules it.
Target2 is the system through which payments are settled electronically between countries. It is similar to the US system, Fedwire. The difference is that Fedwire is a national system that directly settles payments between banks whereas Target2 settles payments between each country’s “central bank”. This however, is a mirage. These “central banks” are simply extensions of the European Central Bank and carry out its directives. To quote two officials from the Bank of Portugal writing in an official ECB publication, “Institutional independence means that neither the NCBs nor any member of the respective decision-making bodies may seek or take instructions from any entity outside the ESCB”
Thus the Greek government has about as about as much control over its so called central bank as I do. That last statement is a bit of an exaggeration – but not by much. According to article 109 of the Maastricht treaty, “each Member State shall ensure, at the latest at the date of the establishment of the ESCB, that its national legislation including the statutes of its national central bank is compatible with this Treaty and the Statute of the ESCB”. Thus the elected government can affect any activity of their “central bank”- that hasn’t been outlawed or determined by the “Treaty and the Statute of the ESCB”.
If that’s the case ,what are the large “imbalances” in the Target2 system the media goes on about? They are simply an accounting record of the net amount of settlement balances the ECB has transferred from the accounts of one country’s banks to another. This accounting record becomes more negative when more settlement balances are sent away from that country’s banks than are recieved. This happens when
residents transfer deposits elsewhere in the Eurozone and when more payments are sent out of the country’s banks than towards it. In other words, when there is a bank run and/or a current account deficit. If the Federal Reserve records are good enough and enough research effort were made, I’m sure a similar record could be produced for every state in the country (something I suspect could happen if the threat of a state leaving became serious) going back decades. I would like to emphasize that this is merely an accounting record.
To restate, making payments from one bank to another a bank needs settlement balances. Just like in any other payments system, the central bank must make sure (either through loans or purchases) there are enough settlement balances to clear payments without writing down deposits (ie a “bail in”). During a financial panic, like the 2008 crisis in the United States, the ability of banks to borrow settlement balances from each other can become greatly inhibited. This kind of contagion seems now to be limited to periphery countries and is centered in Greece.
As a result, funds have been extended to Greek banks through an ECB facility called “Emergency Liquidity Assistance.” ELA is supposed to be short-term support for “solvent banks” with the loans “collateralized”. So far, the ECB has continued to provide settlement balances because not doing so would force a Grexit. Even though the ECB has made clear in various ways (meager increases in ELA limits, threats to tighten collateral rules) that is it uncomfortable with its position and is capable of restricting ELA support, experts see any aggressive action as a function of politics (i.e., the ECB at a minimum needs cover) political timetable, not of technical assessments bank equity and collateral.
Official documents claim that the National Central Bank is providing ELA to their local banks and “owe” (or are owed) Target balances to the ECB. This however, is nonsense. The national central banks implement monetary policy based on what the Executive Board of the ECB has told them to do. In other words, they are simply agents of the European Central Bank. If I attach a cell phone to the hand of a puppet, and then (as the puppeteer) direct the puppet to lend you the cell phone, you owe me, not the puppet, a cell phone. Further, if you default on your loan of the cell phone I would highly recommend a passersby to ignore me when I accost her claiming that since the puppet borrowed from me near her, the puppets debts were her responsibility.
It must be emphasized that without the accounting trick that is National Central Banks, Target2 balances couldn’t be assigned to any institution or country. There would simply be settlement balances held at the ECB by banks (i.e., liabilities to the ECB and assets to the banks) and loans made by the ECB to banks (i.e.,assets to the ECB and liabilities to the banks). These impose no burdens on any specific geographic area in the Eurozone just like loans to banks in the United States impose no burdens on any specific geographic area A default on ELA loans will reduce the equity of the European System of Central Banks. Maastricht lays out an arcane system by which these losses are accounted for, but ultimately they don’t matter. There is no current legal requirement for the ECB or the participating NCB to have positive equity or for Government budgets to fill those holes. This however, could be changed legally in order to punish Greece. To be clear, any attempt to use the measurement of net transfers of settlement balances from one country to another or negative equity at the Bank of Greece to force additional debt on Greece will be an act of political retribution and economic drivel.
For this reason, it is imperative that if the Eurozone were to force a Grexit by refusing to provide Greek banks the settlement balances it needs to make payments, the Greek government should not take any responsibility for the Bank of Greece. The ECB currently records a small interest charge charged to the Bank of Greece because of its Target2 balances but this could easily become larger. It is possible that the central bank could (through policy or legal change) give Target2 balances for countries outside of the Eurozone a maturity date, greatly increasing their burden.
In addition, Greece being forced into a de facto Eurozone is in a legal gray area. The Bank of Greece is not. A monetary policy based around drachmas, or even one that simply doesn’t conform with ECB directives directly violates the Maastricht treaty and would likely be referred to the European Court of Justice. Creating a new (and in many senses real) central bank would avoid this headache.
Next time, I’ll discuss the issue of capital controls and how (or if) it would be possible to maintain trade flows following defaults and/or an exit from the Eurozone
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The TARGET2 imbalances are not the result of monetary policy implementation, at least not primarily. They are the result of current account imbalances.
What does this mean for the ‘moral responsibility’ of the debts implicit in these imbalances? All of nothing. It’s all just politics. Trying to make a case that TARGET2 imbalances should not be paid back is easy, I can do it, but it’s all just politics and rhetoric. It is certainly a step far beyond ‘operational issues’.
From a political point-of-view its much better to think of the TARGET2 imbalances as a bargaining chip on the side of the Greeks rather than trying to come up with rhetoric to justify them.
I’m not making the case that they should not be paid back, I’m making the case that they are a liability on the balance sheet of an entity (the National Central Bank ie Bank of Greece) that under the institutional structure of the Eurozone Greece has no responsibility for.
I don’t think they are a bargaining chip, I think they are an albatross that Greece shouldn’t take on willingly and may or may not be forced on them.
That’s exactly the bargaining chip, isn’t it? The Bank of Greece possesses the operational capacity to handle a fiat currency for a country the size of Greece. So threatening to deprive Greece of the monetary expertise of the ESCB is not a credible punishment.
In such a hypothetical scenario where Greece is expelled from EMU for renouncing fraudulent debt, it simply takes the operational capacity of the Bank of Greece and leaves the euro debt behind for the euro system to figure out.
this is an interesting point, and one I’ll get to but it bleeds into the post I’m writing now. stay tuned
The debt is almost certainly not Greek law debt and cannot be repudiated. The “fraudulent debt” term gets bandied about a lot but has no legal foundation.
Also Greece is not going to be expelled. It can’t be de jure. It can only ask to leave and that request become effective in a maximum of 24 months.
Greece can be forced to make a de facto Grexit by removing ELA support or refusing to raise the ceiling when the banks need more funding. The Greek government would be forced to impose capital controls, nationalize its bank, and print drachma (funny money parallel currencies won’t do for an operation of this magnitude). This might seem like a distinction without a difference, but the ECB has been sending very clear messages that it is uncomfortable with how far it has stretched the ELA facility to support the Greek banks. Critics can correctly point out that the ECB has helped make the run worse by stoking concerns about ELA support.
As for the operational capacity, you are assuming that the Greek government can take that over. Nathan will get to that in his next piece.
IOW, is Greece still a sovereign country, or not? And doesn’t the same question apply to every Eurozone country?
As I have told readers regularly in these posts on Greece, the governing treaties of the EU and Eurozone explicitly state that these are new, unique governance arrangements (I’m not using their jargon, but this is the drift of the gist) and that the member states recognize that they are accepting limits on national sovereignity. They agree that the only courts that they can look to are EU courts (as in they also surrender the right to go to other international courts). In keeping, when the Germany constitutional court made a ruling on an ECB dispute, its jurists referred their decision to the EU court, effectively acknowledging that they did not have the final say.
Shorter answer, no.
Not in the case of government debts to the EFSF. These are governed by English (not EU) Law.
I have no problem saying that euro member nations are no longer nations.
But I would then observe that under such a standard there is no moral ground to complain about the treatment of Greece. Greece is much smaller than Texas (and like Texas, joined the union quite eagerly). Who outside of Texas gives a rat’s patootie when Texans complain about federal actions? US states run balanced budgets and accrue liabilities in a currency they do not control.
In the words of a famous fraudster, suck it up and deal.
not having sovereignty and not being a nation are two different things. The difference with Texas is Texas is in a system where insuring deposits is federal, social insurance (such that it is) is federal and automatic stabilizers prevent the worst from happening to any particular state.
and even with all this, i don’t think states in the U.S. should just “suck it up and deal”
Yeah, I’ve heard that line of thought, but I wonder if people have really thought it through. Texas started asking around about getting admitted into the Union in the 1830s. FDIC insurance and the Social Security Act weren’t passed until the 1930s. Even if we only start from the Federal Reserve Act in the 1910s, that’s more time without such fiscal infrastructure than it has been since Greece joined the euro system.
As far as states not operating with balanced budgets, that’s not an area I’m familiar with. Perhaps you’re teasing a future post we can anticipate on that topic?
No, Oregoncharles, you are right.
Yves is not. Greece is still sovereign, still a nation, still has international legal personality, still a subject of international law, still a member of the UN. Yves, the governing treaties make no such claims. There is no such renunciation of international law and courts. The treaties explicitly contradict such claims in many places.
I have posted many citations – including to the European Court of Justice! – showing that the EU and its members consider themselves bound by international law. And because everyone agrees the UN Charter is supreme over EU law or any other treaty – it wouldn’t even matter if these treaties did say such amazing things!
I finally had the time to post a lengthy reply on such matters, with yet more citations, in Greece: An Endgame Finally in Sight.The burden is on the maker of extraordinary claims to cite a treaty and specific article and text. But these “renunciation” claims have never been backed up with a single citation to any treaty or authority.
Wow. Opened a can of worms there, didn’t I? AKA the Eurozone.
Taken together, these answers add up to complete confusion – which, as Tankus agreed somewhere above, seems to have been the point.
No wonder they’re holding those long, fake negotiations: no one knows quite how this works, and no one wants to admit what a mess it is.
The EU and Eurozone are clearly longterm integrative projects. Thatis embodied in establishing of EU/Eurozone level institutions and haivng member states transfer of significant decision-making powers to them. I don’t see how you can continue to deny these facts on the ground. Greece does not have its own central bank and does not control its own monetary policy. That ALONE is a significant ceding of sovereignity, as is lessening regulatory authority over its banks (it is EU level institutions that have conducted the stress tests for instance).
In Costa v ENEL, the ECJ ruled that:
Of course Greece has a real problem successfully repudiating non Greek law debt. But it can try. The usual, main case law citation / evidence of international custom / law for fraudulent / odious debt is Taft’s Tinoco Arbitration. There is some legal foundation for the concept.
It’s quite easy to repudiate debt denominated in foreign currencies and issued under foreign laws; it’s done *all the time*. It’s really a question of whether the repudiation can be made to stick.
What are the creditors gonna do?
— Seize the assets of Greece in foreign countries? What assets? This was the threat used against Argentina recently.
— Invade using “gunboat diplomacy”, such as traditionally was done to Mexico? This is considered a war crime and would be very unpopular at the UN, plus which I don’t think any of the Euro countries would go for it.
— Issue sanctions? Well, Greece has other potential trading partners, lots of them.
— Attempt a blockage/embargo? Again, I don’t think the Euro companies would actually do this.
The USSR made stick its repudiation of *all* prior debts and nobody *dared* try to collect them. That’s an extreme example.
Right. Unfortunately the legal discussion here is marred by general lack of understanding of such basic points and so of how extraordinary some claims are. So much of the criticism here of Syriza and Greece, who of course do understand the basics, is ill-founded to say the least. Sanctions/blockades/embargos are possibilities almost as ludicrous as an invasion.
The USSR made stick its repudiation of *all* prior debts and nobody *dared* try to collect them. That’s an extreme example.
Had the invasion of Russia after WWI, which the Allies did dare, succeeded, I doubt the repudiation would have been as successful.
Yeltsin settled the old czarist bonds at about 1% 20 years ago, by the way.
Without doing justice to the rest of Tankus’ article, from what I’ve been reading it is precisely this sort of neoliberal emphasis on what Lapavitsas would call “stocks,” balance sheets, instead of “flows,” maintaining economic activity, that could greatly worsen the economic impact of a Grexit. With Europe struggling to escape deflation, sucking funds away from consumption in order to recapitalize is simply foolish.
I’m not endorsing the Weidmann view, as you seem to insinuate. I am merely laying out the power dynamics in this struggle. Weidmann is a very powerful player and many other members of the ECB board, like Noyer in France, are as rabid. The politicians have good reason to try to stare them down, but if things got to that point (unlikely but much of what happened in the fall of 2008 seemed almost impossible until it happened), it would probably be a big political battle.
” These impose no burdens on any specific geographic area in the Eurozone just like loans to banks in the United States impose no burdens on any specific geographic area”
Actually, they do. U.S. district Reserve banks need to settle inter-district settlement balances each April. This imposes the burden on each district Reserve that it have appropriate settlement media; US Treasuries.
As I argue above, a “burden” on a regional Fed bank or a NCB is not a burden on that region’s government and should not be confused with it. perhaps that should have been more clear.
FYI I really enjoyed your article on this issue!
Is the system intentionally obscure and counter-intuitive? I’m not blaming Tankus; I think he’s struggling to explain something genuinely difficult, at least if you’re not familiar with it.
Isn’t this exactly one of the original criticisms of the Euro, that it creates an unprecedented and potentially unworkable hybrid system? It seems very strange for national central banks to be just cat’s paws of an extra-territorial entity. And does this mean that the national deficits the whole fight is over are really illusory?
Good thing there’s another part.
“Is the system intentionally obscure and counter-intuitive?” absolutely. your comments on this point hit right on the mark. The point of the shell game is literally so that there is an entity that shares a name with the country that the country could be presumed to be responsible for. God help Richmond if the same kind of people appear in the states.
The national deficits aren’t illusory, just the Greek’s governments supposed responsibility for the Bank of Greece. They need to make payments and can’t because there is no entity stabilizing the interest rate on their debts. all you get is piecemeal “breaks” and restructuring of existing debt. I’ll talk more about this in another part
so I wasn’t merely puzzled. What a relief!
I am a software engineer and happened to work on a large project that tracks the settlements among the branches of a very large bank. A very large number of transactions take place each day. Thus it is not cost effective (and also a performance drag) to keep all the records going back to decades. There are legal limits on how much of records has to be kept online for auditing purposes (which was 6 months as I remember). So, most banks (and other entities that deal with large volumes of data) simply keep the minimum they have to. Of course, there is backups but, it is extremely difficult to restore backups without disturbing the production systems if the system was not designed with that in mind. On top of that it is almost impossible to make selective restores e.g. transactions involving Greece only.
Furthermore, these transactions does not only involve bank accounts, the money got spent, it got invested in stock market , or property for example.So, you must also be able to follow all and every investment track. In short, it is practically impossible to trace money and decide on the origin. Thus once the Greek euros leaves Greece, it is no longer a Greek euro, simple as that.
Once we acknowledge this, it becomes obvious to me that letting a bank run is advantageous for Greece. Just let the bunk run to continue in a controlled manner and simply shut down the Greek National Bank, introduce a new currency, convert all contracts and debt to your new currency. Now your citizens have a lot of purchasing power they can safely transfer back into Greece once the dust is settled. It is irrelevant for Greece whether the National Bank have a negative balance or not. They can simply declare that they convert all government obligations to Drahma. Short of sending tanks, I don’t see how the EU can prevent that. What am I missing in the above scenario?
The timeline for setting up a new national bank? “Simply declare” could have a lot of operational issues.
Surviving on austerity has a lot of operational issues (I know plenty of people evicted or who lost jobs two years ago in Spain, I am unemployed for one year, so I know what I talk about).
Syriza is putting the operational issues at the institutional level instead of dumping them on the citizens. They are ensuring that there is no “corralito” like in Argentina, which caused very severe lost of government support from the only ones that still supported/formed the State: small scale savers, pensioners, public workers, professionals, etc.
The insistence of the institutions on the need of capital controls should have already told Syriza, if they still didn’t know it, that it is not good for them… Also, I guess, when they promised not to take unilateral measures in February this was included. Varoufakis has complained recently that he was not allowed to take any measure…
“Syriza is putting the operational issues at the institutional level instead of dumping them on the citizens” I would love evidence for this statement. It would be a major relief to know that they have large enough institutional capacity to manage a grexit and making sure imports and exports of euro financing in some fashion and all the other fractally expanding issues.
I’m writing about organizational capacity in my next post.
I was meaning that, instead of imposing capital controls and dump the costs of the crisis into the civil society in the form of forced bail-ins, as in Argentina and Cyprus, they are letting them put their euros safely somewhere. It is up to the European Institutions like ECB and others to take care of keeping the bank run at bay. One could say that the Greek government has no longer means to manage monetary policy, so it is the ECB who needs to take care of it.
There was a bit (or a lot) of irony in my comment. I’m not saying it will be easy or costless. Sorry if it didn’t transpire. I’m waiting for these post, it is uncharted territory, I guess, for most if not all of us.
In retrospect i get more of what you meant. As I said, I’m writing about organizational capacity right now and your language seemed similar but was obviously meant financially. sorry about jumping on you
I agree
fyi something I think I’ll touch on at some point: I’m not sure that the euros in other countries are safe. if the BoG gets dumped on the Eurosystem and banks default en mas on their ELA funding, I could see a bail in for Greek residents deposits abroad if the Troika is crazy enough. Doesn’t seem likely but in a crisis point with no clear legal or political lines it is impossible to see in advance what elites come up with for good or (most likely) ill.
I’m curious what is meant by this? Is it a deeper/tinfoil hat kind of observation about bankers ruling the world? Or a statement on the logistics of contemporary fiat money systems? If the latter, I think it is such an exaggeration as to be rather inaccurate.
The NCBs are by definition quite separate from the ECB; that’s the whole point of the ESCB – it is a system of central banks. Several ESCB NCBs don’t even use the euro in their home country(!).
The Bank of Greece is headquartered physically in Athens, and it has a professional banknote printing works. Unless the IMF and the ECB conjure up an army and invades Greece, the government of Greece is quite firmly in control of the Bank of Greece in extremis.
https://www.ecb.europa.eu/ecb/orga/escb/html/index.en.html
They are not “quite separate”. Read Maastricht. Those CBs in the ESCB that aren’t part of the Eurosystem are either joining soon or have a waiver (called in the treaty a “derogation”) which allows them independent monetary policy. the default stance absent a derogation is the ECB calling the shots.
Do not be fooled by where the building is physically. Greece could take it over but what I’m saying is that that’s a trap that involves taking on all of the liabilities (and rapidly failing assets) that will just weigh it down more. The Richmond fed is in Richmond, doesn’t mean RIchmond is responsible for settling Inter-District Settlement claims if the Richmond Fed “can’t”.
I look forward to the next part.
I just am more on the ‘possession is 9/10 the law’ continuum. My point is that all of this assumes Greece is trying to figure out how to pay off the euro debts, and so ELA and NCB liabilities and so forth is a major operational problem within that constraint.
If Greece doesn’t accept the liabilities, then they’re not a trap. A debtor in arrears is a problem for the lender, not the debtor.
This is a terrific post and a great choice of topic. I haven’t seen these issues covered elsewhere, and clearly they could become critical in the coming days.
(In a way, a lot of the ideas for the Greeks “simply setting up their own national bank” (I paraphrase) remind me of the famous story from The Guns of August where the Kaiser, after hundreds of troop trains had already started for the Western Front, conceiving the notion of throwing Germany’s main weight against Russia instead, and (paraphrasing again) telling von Moltke “Just turn the trains around and send them in the other direction!” (with helpful hand-waving). Word is that von Moltke never recovered his sang froid. The Kaiser’s idea may in fact have been good; but the logistics were non-trivial, and timing issues would have needed to have been taken into account….)
If Syriza has any sense (and I’m not saying they do), they have spent the last nine months setting up their own national bank in secret.
I would have. It’s the absolute best reason for all these delays.
This is a really interesting article, thank you. One thing that confuses me: when the ECB extends ELA is it creating positive balances de novo, allowing negative balances or simultaneously deducting from other accounts, either ‘reserve’ accounts or those from other countries?
Target is essentially the settlement balance system for national central banks where the equivalent of an overdraft is automatically given. so the national central bank creates settlement balances “de novo” through ELA and then sends a payment to another national central bank by debiting that bank’s settlement account and crediting the national central bank of the bank receiving the payment. Remember though that the settlement balances held with the NCB are only euros if payments clear at par ie if access to target continues. In retrospect one thing i should have mentioned is this: ELA shutting off could be consistent with staying in the euro if a bank holiday was declared and deposits were written down ie Cyprus. But that requires the BoG operationally shutting down the banks and going through the books to manage slashing. It is impossible for me to imagine Syrizia letting that happen. More on this in later posts.
OK thanks. It is interesting that there was felt to be a need to use a seperate settlement system for countries one the one hand and for commercial banks on the other.