The view from Berlin

…and how EU citizens will pay dearly for it.

Trichet, Lagarde know that eurobank capital adequacy not enough to survive Greek default

The next ‘Troika’ review of Greek progress is due to take place this coming Sunday – the 10th anniversary of 9/11. This will show that the Athens austerity programme is hopelessly behind schedule. Under the terms of Angela Merkel’s agreed pact with her CDU/FDP colleagues struck last Monday, the German Chancellor must pull the plug on Greek monies the next day….triggering a hard Greek default. But she won’t….and it’s not hard to work out why.

In a spirit of truth if not reconciliation, the morning currency note from RBS yesterday said they expect Greece to default in December this year. Other analysts agreed, in some cases referring to default by that date as inevitable. Simple maths support this contention – and most credit sector opinion leaders did them weeks ago, if not longer.

Further down the RBS note, however, having listed the obvious reasons why its opinion is undeniable, the bank slotted in this gem:

‘Indeed, all of these factors apply to the current Sep-11 review’

This was merely supporting what the Forex International site had said the day before: that technically, Greece must default and leave the eurozone ‘within days’.

We already know from several sources secret and published (see yesterday’s second Slog piece) that the Troika review team (EU, IMF & ECB) regard the progess on Greek austerity as risible: as the CDU’s Pomeranian election disaster was unfurling, Troika members told senior CDU and banking figures Athens had failed to make progress on fully two-thirds of the items on the agreed to-do list. Indeed, an independent Greek parliamentary committee of experts last week reported that Greece’s national debt is “out of control”. And even Greek Finance Minister Evangelos ‘It’s all lies I tell you’ Venizelos admitted last week that Greece would miss its target of bringing the budget deficit below 7.6%.

So whichever way you look at it, it’s a done deal: based on Merkel’s domestic pledge, Troika rules – and IMF articles of association – the game ends Sunday. Greece will default.

Except that it won’t. And it won’t, because the EU banking system isn’t ready.

All of which means that German Chancellor Angela Merkel must either break the pledge she gave only 48 hours ago…..or break the eurozone banking system.

A major Frankfurt bank executive has this to say:

“Athens is behind on everything really. A colleague who was there last week tells me he doesn’t believe the Papandreou Government really cares. There is no doubt at all that Greece is doomed….in fact, it will be in default on a number of bases after the [Troika debrief]. But I do not see how Chancellor Merkel can allow this….whatever she has said to Coalition colleagues.”

The source confirmed that the banking ramifications would be horrendous. A Swiss-based Athens credit negotiator told The Slog:

“Obviously, I don’t know about the state of every bank owed a heap of money by the Greeks. But everyone is wary – you only have to look at the mountain of cash being parked in the ECB [Central EU Bank] every night. It’s Lehman again….there is no trust.”

In a typical piece of misleading rhetoric, Frau Merkel told the Bundestag this morning, “The euro is the guarantor of a unified Europe. If the euro collapses, Europe collapses.” None of that is true: we have had a unified Europe without war for much longer than the euro has existed, and it’ll be the EU that collapses, not ‘Europe’. Europe is the real deal……the EU is an egotistical fantasy gone very badly (and predictably) wrong.

Few doubt that Angela Dorothea Merkel believes in the ‘European Project’: apart from anything else, it gives the Germans an artificially cheap currency with which to boost exports. But a true believer in that ideal with no other axe to grind would have kicked the Greeks out months ago…if only in self-defence. A true believer in a totally united Europe would not be asking her legal experts about the ramifications of a smaller eurozone based on a new EU Treaty.

No: Chancellor Merkel will turn a blind eye to Greek default this weekend – even though privately she would prefer to lose Greece and Italy from the zone – because the lenders exposed to Greece in general (and Jean-Claude Trichet in particular at the ECB) have told her that to declare the Athens regime in default now would destroy large parts of the banking system….inside and outside the eurozone. This is partly because market sentiment re Italy is almost as negative as that towards Greece – but mainly because a ‘zero borrowing credibility’ would apply throughout the ClubMeds

In the event of a Greek default, the following would happen immediately:

Every bank in Greece would declare itself insolvent.

The Athens government would nationalise every bank in Greece,  and forbid withdrawals from Greek banks.

A new currency would emerge, devalued cf the euro by some 30-70% .

Most estimates around today suggest that the result for sovereign lenders to Greece would be a loss of around 60+% or more of all Greek euro-denominated debts. At this point, a number of French and German banks would make such losses, they could no longer meet regulatory capital adequacy requirements. The real capital adequacy situation that pertains in Europe is precisely the reason why Christine Lagarde had such an epi at Jackson Hole the weekend before last.

Lagarde, of course, has known about the inadequacy for months. But it wasn’t until she got the full IMF strength on Greek ‘progress’ under the bailout terms that she grasped the urgency of the situation: hence one of the great volte-faces in financial political history. (Lest we forget, EU-wide stress tests Lagarde oversaw in July did not build in the impact of a Greek default. Imagine that.)

“Turmoil in the sovereign debt markets and uncertainties about banks’ capital adequacy and future resolution regimes for failing banks have eroded market confidence, increased wholesale funding costs, and blocked market access for some banks,” said S&P’s Andrew Hinckley yesterday. As long ago as last May, the Wall Street Journal blog noted:

‘…Politicians can’t bear the near-term economic pain associated with a proper clean up of the banking sector. So they allow banks to hide some bad assets and to inflate the value of others. They allow bankers to divert profits that should be going towards rebuilding their balance sheets into employee bonuses instead. They conspire with bankers to give the illusion that something is being done when in reality very little is being done. And they relax rules….[so]….News that European regulators could allow their banks to avoid strict capital-adequacy rules shouldn’t come as too much of a surprise.’

An extremely prescient piece: because this is exactly what has happened.

Even if there might be just enough capital adequacy to go round in the eurozone, the private ECB view as expressed is that “any other debtor State’s ability to borrow money would disappear overnight”. Italy in particular would probably default whether Brussels liked it or not.

This is why Merkel will put her blind eye to the microscope on Sunday. But that doesn’t alter the fact that the eurozone banks have just three months to sort out a problem which, as usual, they display no interest whatever in solving. And the bottom line of that is as follows:

* EU taxpayers are going to chuck money pointlessly down a Grecian toilet in order to save the banks now.

* They will then be asked to cough up when the banks fail through poor capital adequacy ratios.