The Greek referendum has left the Governing Council of the European Central Bank (ECB) with a political choice that it should not have to make. The ECB will need cover from Europe’s political leaders no matter how this plays out. As with most important choices, this one will make some people very unhappy. We should expect to see opposition emerge both in the media and in the courts. Worse, the choice that the ECB has to make will unfold in stages. It involves a series of decisions and not a simple one-off commitment. That means Europe’s political leaders will have to insulate its central bankers from opposition for the foreseeable future and probably until long after the immediate crisis has passed. Finally, this is a choice that will define Europe’s future; not only will it tell us precisely what it means to be a member of the euro as a single currency, but it will also set a precedent for how much solidarity national governments should expect to receive and to offer.
The Greek referendum is postmodern and I don’t mean that in a good way. The question is an ‘empty signifier’. No one can understand its literal meaning and that literal meaning is no longer relevant in any case. So you can think of referendum as a big symbol that you can fill with whatever you want; hopes, aspirations, worries, and disappointments all fit in nicely. Moreover, there is no reason any one person has to interpret the question in the same way as anyone else. On the contrary, politicians will try anything to find a hook that will pull you to their side of the issue. No wonder Greek society is evenly (if deeply) divided. Is the glass half full or half empty? Is it really a ‘glass’? What is ‘it’? Even the response assignments are counter-intuitive. According to the government, you vote ‘no’ to have a brighter future; according to the opposition, you vote ‘yes’ if you fear the unknown. What’s more the process itself is controversial. Greece’s detractors decry this whole exercise as a cynical manipulation; for Greece’s supporters, it is a celebration of democracy.
None of what we are facing now is new or (wholly) unexpected. Of course everyone hoped this set of problems would pass and believed that politicians would do their utmost to make matters better. But no-one ever completely discounted the possibility that Europe would fall back into crisis.
Eighteen of the nineteen Eurogroup finance ministers met Saturday night to discuss what to do about Greece. What they agreed – according to both their official statement and to the press statement released by Eurogroup president Jeroen Dijsselbloem a couple of hours later – is ‘to complement any actions the ECB will take in full independence and in line with its mandate.’ They also agreed, on behalf of ‘the institutions’, ‘to provide technical assistance to safeguard the stability of the Greek financial system.’
There is a debate right now between those who argue that the single currency can more easily survive a Greek exit from the euro than it could have in the past and those who argue that it will be a shock to the markets similar to the collapse of Lehman Brothers in September 2008. That debate will only end if the crisis abates or there is a natural experiment. The differences between the two camps are irreconcilable.
There is less discussion of what would be the longer-term impact of Greece exiting the euro. Optimists argue that the euro will emerge as a more disciplined union because member states will know that they will not be bailed out. Pessimists warn that Europe will stagger from crisis to crisis as market participants turn on weaker member states as soon as the first sign of trouble. This seems to be a stark dichotomy and yet it is not.
Europe’s heads of state and government held an emergency summit on Greece at roughly the same time that European Commission President Jean-Claude Juncker unveiled a report he drew up with support from the Presidents of the European Parliament, European Council, European Central Bank, and Eurogroup for ‘Completing Europe’s Economic and Monetary Union.’ This juxtaposition is only partly coincidental. The ‘five presidents’ have been working on their report because the ongoing crisis in Greece makes it clear to all that there are still important gaps in the architecture of the single currency. Greece is not, however, the only reason many regard further reform of European institutions for macroeconomic governance as inevitable.
Last week my SAIS colleague Filippo Taddei gave an interview to a Bloomberg journalist about the Greek crisis where he argued that there is no necessary link between a Greek government default and the exit of Greece from the euro area. The reason, Taddei explained, is that a government default is only relevant to Greece’s euro membership insofar as such a default would wipe out many of the assets — and essentially all of the collateral — of the Greek banking system. If that were to happen, then the Greek central bank would have no choice but to give loans to the country’s commercial banks against little or no collateral in order to maintain the liquidity of the Greek financial system. Moreover, everyone is aware of this fact. You only have to look at what happened during the second Greek bailout in March 2012 to see the connection. Hence it is only reasonable to assume that the European Central Bank (ECB) would either accept the extraordinary measures of the Bank of Greece to keep the Greek banking system afloat or come up with some arrangement of its own to restock the collateral of the Greek banking system and restore its liquidity during the process of resolving the Greek government’s default. Indeed, Taddei suggested, people active in European economic policy circles are already planning along those lines.
One of my students asked me why we should worry about a Greek default or exit from the euro when the markets can already factor those risks into the price of any assets likely to be affected in the markets. This is the same question that Gillian Tett highlights in her column in the FT last Friday. Tett’s answer is that there are always institutional quirks in the markets that are hard to factor into different prices. That answer should send investors – and their lawyers – to look through the fine print of marketable assets to find arbitrage opportunities that have not yet been exploited.
They shouldn’t bother. They may well find something worth exploiting but that won’t make it easier to price in the risks around Greece. The reason market participants fail to price such risks efficiently has less to do with the completeness of their models than with the fact that many if not most of them are going to switch from one set of models to another in the event of a Greek default. It is this model switching – and not the discovery of new information – that will roil the markets. Moreover, no-one can predict just how big of an impact this model switching will have on prices. I suspect it will be large.