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Lessons from the Greek Crisis

The deal, obviously it looks bad. No sense in spinning: It’s unconditional surrender. It is bad.

There’s no shortage of writing about how we got here. I do think that we — in the US and elsewhere — should resist the urge to criticize the Syriza government, even for what may seem, to us, like obvious mistakes. The difficulty of taking a position in opposition to “Europe” should not be underestimated. It’s one of the ironies of history that the prestige of social democracy, earned through genuine victories by and for working people, is now one of the most powerful weapons in the hands of those who would destroy it. For a sense of the constraints the Syriza government has operated under, I particularly recommend this interview with an unnamed senior advisor to Syriza, and this interview with Varoufakis.

Personally I don’t think I can be a useful contributor to the debate about Syriza’s strategy. I think those of us in the US should show solidarity with Greece but refrain from second-guessing the choices made by the government there. But we can try to better understand the situation, in support of those working to change it. So, 13 theses on the Greek crisis and the crisis next time.

These points are meant as starting points for further discussion.  I will try to write about each of them in more detail, as I have time.

Continue reading Lessons from the Greek Crisis

Greece Thoughts and Links

Like everyone sympathetic to Greece in the current crisis, I was pleased by the size of the “No” vote in last weekend’s referendum. Even taking into account support from the far right, the 62% for No represents a significant increase in support from the 36% of the vote SYRIZA got in January.

But, I’m not sure how the vote changes the situation in any substantive way. Certainly it hasn’t led to any softening of the creditors’ position. The situation remains what it was before: Greece must comply with the full list of policy changes demanded by the creditors, and any further changes demanded in the future, or else the central bank will keep the Greek banking system shut down. The debt itself is just a pretext on both sides — repayment is not really what the creditors want, and default isn’t really what they are threatening.

I continue to think that the Bank of Greece is the key strategic terrain in this contest. If the elected government can regain control of the central bank — in defiance of eurosystem norms if need be — then it removes the source of the creditors’ power over the Greek economy. There is no need for a new currency in this scenario. If the Bank of Greece simply goes back to performing the usual functions of a central bank, instead of engaging in what is, in effect, a politically-motivated strike, then Greek banks can reopen and the Greek government can finance needed spending without the consent of the official creditors.

More broadly, I think we cannot understand the economics of the situation unless we clearly understand that “money,” in modern economies, refers to a network of promises between banks and not a set of tokens. In this sense, I don’t think it makes sense to think of being in or out of a currency as a simple binary. As Perry Mehrling emphasizes, there have always been overlapping networks of money-contracts, with various economic units participating in multiple networks to different degrees.

Here are a few relevant links, some spelling out my thoughts more, some useful background material.

 

1. Here is an interview with me on the podcast RadioDispatch. If you don’t mind listening rather than reading, this is my fullest attempt to explain the logic of the crisis.

RadioDispatch interview June 2015

 

2. I had a productive discussion with Dan Davies on this Crooked Timber thread. Since my last comment there got stuck in moderation for some reason, I’m reposting it here:

From my point of view, the key question is whether the ECB is constrained by, or at least acting in accordance with, the normal principles of central banking, or if it is deliberately withholding support from the Greek banking system in order to advance a political agenda.

Obviously, I think it’s the second. (And I think this is really the only leverage the creditors have — there is no reason that a default in itself should be particularly costly to Greece.) On whether it is plausible that the ECB would (ab)use its authority this way, I think that is unequivocally demonstrated by the letters sent to the governments of Italy, Spain and Ireland during those countries’ sovereign debt crises in 2011. In return for support of those countries’ sovereign debt markets, the ECB demanded a long list of unrelated reforms, mainly focused on labor-market liberalization. There is no credible case that many of these reforms (for instance banning cost-of-living clauses in private employment contracts) were connected with the immediate crisis or even with public budgets at all. I think it can be taken as proven that the EC has, in the past, deliberately refused to perform its function of stabilizing the financial system, in order to put pressure on elected governments.

We can debate how exactly this precedent fits Greece. But I don’t think a central bank that allows its country’s banking system to collapse can ever be said to be doing its job. Every modern central bank — including the ECB with respect to every euro-area country except Greece — will go to heroic lengths, bending or ignoring rules as need be, to keep the payments system operating.

 

3. Over at The Week, I talk with Jeff Spross about the idea that changes in private financial flows between euro-area countries can be passively offset by balances between the national central banks in the TARGET2 system, avoiding the need to mangle the real economy to produce rapid adjustment of trade flows.

Like many critics of the euro system, I used to think that they had succeeded in creating something like a modern gold standard, and that the only way crises could be avoided was with a fiscal union, so that public flows could offset shifts in financial flows. But I no longer think this is correct, I think that the TARGET2 system can, and has, offset changes in private financial flows without the need for any fiscal payments.

(The Week also had a nice writeup of the Reagan-debt post.)

 

4. I reached this conclusion after reading several pieces by Philippine Cour-Thimann, who is the source for understanding TARGET2 and its role both in the normal operations of the euro system and in the crisis. I recommend this one to start with. (Incidentally it was my friend Enno Schröder who told me about Cour-Thimann.)

 

5. One topic I’ve wanted to get into more is the (in my view) limited capacity of relative-price adjustments to balance trade even when exchange rates are flexible. In the past, I’ve made this argument on the crude empirical grounds that Greece had large trade deficits continuously for decades before it joined the euro. I’ve also pointed out Enno’s work showing that the growth of European trade imbalances owes nothing to expenditure switching toward German products and away from Greek, Spanish, etc., but is entirely explained by the more rapid income growth in the latter countries. Now here is another interesting piece of evidence on this question from the ECB, a big new study finding that while there is a substantial fall in exports in response to large appreciations, there is no discernible growth in exports in response to depreciations. This fits with the idea, which I attribute to Robert Blecker, that in a world where prices are mainly set in destination markets rather than by producer costs, changes in exchange rates show up in exporter profit margins rather than directly in sales volumes. And while large losses will certainly cause some exporting firms to exit or fail, large (potential) profits are only one of a number of conditions required for exporters to grow, let alone for the creation of new exporting industries.

 

6. This is a great post by Steve Randy Waldman.

 

7. Here’s an interesting find from a friend: In the 1980s, Fidel Castro proposed “a cartel of debtor nations” that would require their creditors to negotiate with them as a group. See pages 278-285 of this anthology.

 

UPDATE: Re item 2, here’s Martin Wolf today (his links):

The European Central Bank could expand its emergency lending to the Greek banking system. If the ECB were a normal central bank that is exactly what it would do. Greece has a run on its banks. As the lender of last resort, the central bank ought to lend into such a run. If the ECB believes the banks are solvent, it must lend. If the ECB believes the banks are insolvent, it should arrange recapitalisation — by converting non-insured liabilities into equity, by selling banks to new owners or by securing funding from the European Stability Mechanism (ESM).

Unfortunately, the ECB is not a normal central bank…

What Greece Must Do

Greece doesn’t need a new currency, it needs control over its central bank.

The Greek crisis is not fundamentally about Greek government debt. Nor in its current acute current form, is it about the balance of payments between Greece and the rest of the world. Rather, it is about the Greek banking system, and the withdrawal of support for it by the central bank. The solution accordingly is for Greece to regain control of its central bank.

I can’t properly establish the premise here. Suffice to say:

(1) On the one hand, the direct economic consequences of default are probably nil. (Recall that Greece in some sense already defaulted, less than five years ago.) Even if default resulted in a complete loss of access to foreign credit, Greece today has neither a trade deficit nor a primary fiscal deficit to be financed. And with respect to the fiscal deficit, if the Greek central bank behaved like central banks in other developed countries, financing a deficit domestically would not be a problem. And with respect to the external balance, the evidence, both historical and contemporary, suggests that financial markets do not in fact punish defaulters. (And why should they? — the extinction of unserviceable debt almost by definition makes a government a better credit risk post-default, and capitalists are no more capable of putting principle ahead of profit in this case than in others). The costs of default, rather, are the punishment imposed by the creditors, in this case by the ECB. The actual cost of default is being paid already — in the form of shuttered Greek banks, the result of the refusal of the Bank of Greece to extend them the liquidity they need to honor depositors’ withdrawal requests. [1]

(2) On the other hand, Greece’s dependence on its official creditors is not, as most people imagine, simply the result of an unwillingness of the private sector to hold Greek government debt, but also of the ECB’s decision to forbid — on what authority, I don’t know — the Greek government from issuing more short-term debt. [2] This although Greek T-bills, held in large part by the private sector, currently carry interest rates between 2 and 3 percent — half what Greece is being charged by the ECB. And of course, it’s not so many years since other European countries were facing fiscal crises — in 2011-2012 rates on Portugal’s sovereign debt hit 14 percent, Ireland’s 12, and Spain and Italy were over 7 percent and headed upwards. At these rates these countries’ debt ratios — not much lower than Greece’s — would have ballooned out of control and they also would have faced default. Why didn’t that happen? Not because of fiscal surpluses, delivered through brutal austerity — fiscal adjustments in those countries were all much milder than in Greece. Rather, because the ECB intervened to support their sovereign debt markets, and announced an open-ended willingness to do “whatever it takes” to preserve their ability to borrow within the euro system. This public commitment was sufficient to convince private investors to hold these countries’ debt, at rates not much above Germany’s. Needless to say, no similar commitment has been made for Greek sovereign debt. Quite the opposite.

So to both questions — why is failure to reach agreement with its official creditors so devastating for Greece; and why is the Greek government in hock to those creditors in the first place? — the answer is, the policies of the central bank. And specifically its refusal to fulfill the normally overriding duties of a central bank, stabilization of the banking system and of the market for government debt, a refusal in the service of a political agenda. The problem so posed, the solution is clear: Greece must regain control of its central bank.

Now, most people assume this means it must leave the euro and (re)introduce its own currency. I don’t think this is necessarily the case. It’s not widely realized, but the old national central banks did not cease to exist when the euro was created. [1] In fact, not only do they continue to operate, they perform almost all the day to day operation of central banking in the euro area, with, on paper, a substantial degree of autonomy from the central authorities in Brussels. So what’s required is not “exit,” not a radical step by the Greek government. Rather simply a change in personnel at the Bank of Greece. The BoG only needs to halt what is in effect a politically motivated strike, and return to performing the usual functions of a central bank.

Now, I cannot exclude the possibility that if Greece takes steps to neutralize the creditors’ main weapon, they will retaliate in other ways, which will result in the eventual exit of Greece from the euro. (Though “exit” is not as black and white as people suppose. [2]) But this would be a political choice by the creditors, not in any way a result of economic logic. We should not speak of exit in that case, but embargo.

Here is my proposal:

 

1. The Greek government takes control of the Bank of Greece. It replaces the BoG’s current leadership — holdovers from the old conservative government, appointed at the 11th hour when Syriza was on the brink of power — with suitably qualified people who support the program of Greece’s elected government. The argument is made that the central bank has abused its mandate, and failed in its fundamental duty to maintain the integrity of the banking system, in order to advance a political agenda.

Either legislation could be passed explicitly subordinating the BoG to the elected government, or use could be made of existing provisions for removal of central bank officials for cause. The latter may not be feasible and we don’t want to get bogged down in formalities. Central bankers have critical public function and if they won’t do it, they must be replaced with others who will. Whatever the law may say.

 

2. The new Bank of Greece leadership commit publicly to maintain the integrity of the Greek payments system, to protect deposits in Greek banks and to prevent bank runs — the same commitment the ECB has repeatedly made for banks elsewhere in Europe. The Greek government asserts its rights to license banks and resolve bank failures. Capital controls are imposed. Greek banks reopen.

 

3. If necessary, the BoG resumes Emergency Liquidity Assistance (ELA) or equivalent loans to Greek banks. While the promise to do this is important, it probably won’t be necessary to actually resume ELA on any significant scale because:

– removing the previous threats to withdraw support from Greek banks will end the bank run and probably lead to the voluntary return of deposits to Greek banks.

– capital controls and, if necessary, continued limits on cash withdrawals, block any channels for deposits to leave the Greek banking system.

– resumption of Greek payments to public employees, pensioners, etc., to be soon followed by resumed economic growth, will automatically increase the deposit base of Greek banks.

 

4. The Greek government resumes spending at a level consistent with domestic needs, including full pay for civil servants, full payment of pensions, etc. Taxes similarly are set according to macroeconomic and distribution objectives. The resulting fiscal deficit is funded by issue of new debt to domestic purchasers. This new debt will be senior to existing debt to the public creditors.

It may be that this debt will end up being held by the banks, but that is no big deal. Greek government debt currently accounts for less than 6 percent of the assets of Greek banks, the lowest of many major European country and barely half the euro-area average. And in the absence of capital flight, bank assets and deposits will increase in line, so there is no need for any additional financing from the Bank of Greece. Even more: If resolution of the crisis leads to a repatriation of Greek savings abroad, then the increase in deposit liabilities of Greek banks will be balanced by increased reserves at (or rather reduced liabilities to) the Bank of Greece. The BoG in turn will acquire a more positive Target balance, or if it’s ejected from Target (see below), an equivalent increase in foreign exchange holdings.

 

5. The interest rate on the new debt needs to be comfortably less than the expected nominal growth rate of the Greek economy. I see no reason why this will not be true of market rates — there are already private holders of Greek T-bills with yields between 2 and 3 percent, and the combination of a Greek central bank committed to stabilizing the market for Greek public debt, and capital controls preventing Greek banks and wealth holders from acquiring foreign assets, should tend to push rates down from current levels. But if necessary, the Greek central bank will have sufficient hard and soft tools to get Greek banks to hold the new debt at acceptable rates.

 

6. The official creditors are offered a take-it-or-leave-it swap of existing loans for new debt. (I think this kind of forced restructuring is preferable to outright repudiation for various reasons.) The new debt will have a combination of writedown of face value of the current debt, maturity extensions and reduced interest rates so as to keep annual payments at some reasonable level. I think it might be better to avoid an explicit reduction of face value and simply offer, let’s say, 30 year bonds paying 2%, of equal face value to the current debt. It would be best if the new bonds were “Greek-denominated.” Perhaps it’s sufficient to say that the new bonds are issued under Greek law.

 

7. The Greek government must be prepared for declarations from the creditors that its actions are illegal, and for possible retaliation. Rhetorically, it may be helpful to emphasize that Greece remains sovereign and Greek law continues to control the Greek central bank and private banks; that the ECB (and its agents at the Bank of Greece) have abused their authority to advance a political agenda; and that the wellbeing of the Greek people must take priority over treaty obligations. But framing may not make much difference here and anyway these kinds of tactical-political questions are for the Syriza leadership and not for an American sympathizer.

What concrete form will creditor retaliation take? One possibility is they will stop deposits in Greek banks from being used to make payments elsewhere in Europe, by shutting off Bank of Greece access to Target2, the settlement system that currently clears balances between national central banks within the eurosystem. [3] Concretely, lack of access to Target2 needn’t be crippling. Payments within Greece won’t be affected, domestic interbank settlement can use accounts at the Bank of Greece just the same as now. Foreign payments will be made using deposits at banks in the exporting country, just as trade payments outside the euro area are already made. Since Greece currently has a small trade surplus, there is no need for anyone outside of Greece to accept a Greek bank deposit in payment. And even if foreign borrowing is desired, the resulting funds can take the form of deposits at a bank in the lending country — again, just as already happens for loan transactions outside the euro area. In effect, by cutting off Target2 the ECB will just be helping Greece enforce its capital controls.

Now one potential issue is the foreign obligations of private Greek units. Can they be paid with deposits in Greek banks? Let’s be clear that a negative answer requires a change in the law by the other euro countries — they are the ones that will redenominate, not Greece. But to be safe, Greece should pass a law clarifying that euro-denominated deposits at Greek banks are legal tender for all existing payment obligations by Greek households or businesses. And it would be good to have a sense of the scale of such obligations.

Assuming Greece loses access to Target2, its export earnings, going forward, will take the form of deposits in non-Greek banks or equivalent claims on non-Greek financial institutions. Which leads to…

 

8. It is critical to ensure that Greek export earnings are available to finance Greek imports. Many discussions of Greek default focus on what are, to my mind, non- or minor problems, while ignoring this major one. [4] If payment for Greek exports takes the form of deposits in foreign banks, as will presumably be the case of Target2 access is shut off, steps must be taken to ensure that those deposits are available for import payments rather being used to finance private acquisition of foreign assets.

Given Greece’s overall near-zero trade balance, access to foreign loans should not be necessary to finance continued imports. But this assumes that export earnings are available to finance imports. There is a danger that exporters will seek to evade capital controls by holding export earnings abroad, manipulating invoices if necessary to disguise noncompliance with the law. This is a serious problem in subsaharan Africa and elsewhere — individuals involved in foreign trade overstate the value of imports and understate the value of exports in order to retain foreign earnings abroad for their personal use. This kind of capital flight can leave a country that notionally has a positive trade balance nonetheless dependent on foreign borrowing to finance its imports. (Ireland is a recent example within the euro area.) The Greek government needs to have enforcement mechanisms to ensure that export earnings are used to finance imports and not to accumulate foreign assets. This should be straightforward where foreign sales are easily visible to regulators, as in tourism or refining, but may be challenging in the case of shipping.

Other European countries will presumably not be cooperative with Greece’s efforts to enforce capital controls. This is a reality that has to be planned for, but it also should be called what it is: Collusion with criminals to steal goods and services from Greece.

 

9. The government may need to ration foreign exchange. If capital controls are ineffective, or, in the first year or two, if seasonal variation in Greek exports swamps the overall balance, Greek export earnings may be insufficient to pay for current imports for some period, and foreign credit may not be available. This need not be a crisis. But it does mean that the government should be prepared to allocate scarce foreign exchange to particular sectors. The mechanisms to do this are already implicit in the imposition of capital controls. And the centralized allocation of foreign exchange is consistent with….

 

10. In the long run Greece should learn from the model of Korea and similar late industrializers. (This, also, is the argument for nationalizing the banks, rather than the fact that the “true” value of their assets, in some sense, leaves them insolvent.) Little if any boost to Greece’s net exports should be expected from devaluation. The goal rather must be to channel savings and foreign exchange to sectors that are not currently competitive, but that plausibly might become so.  Centralized allocation of credit and foreign exchange is needed to transform the industrial structure, rather than passively following current comparative advantage.

 

[1]  Those requests themselves are largely the result of the hysterical fear-mongering by the BoG and its masters in Greece, the exact opposite of the normal efforts of central bankers to prevent panics. In any case, the rules of the eurosystem give the ECB/BoG almost unlimited discretion with respect to liquidity assistance, so they can’t claim this decision is forced on them.

[2] You can think of a continuum from current membership, to the situation of Cyprus with capital controls, to Andorra which prints its own euro currency but does not have shares in the ECB, to Montenegro which uses the euros as domestic currency without any formal participation, to Denmark which has its own currency but clears balances with euro-area central banks through a Target2 account at the ECB.

[3] The best discussions of Target2 I know of are by Philippine Cour-Thimann.

[4] Here as so often, the political authorities step in to do what “market forces” supposedly ought to be doing but aren’t.

[5] Don’t believe the stories you will hear that this is somehow a necessary or automatic reaction to replacement of BoG leadership. It is not. Countries that are not in the euro at all are still permitted to participate in Target2.

[6] When I was debating this stuff with the very smart Nathan Tankus a few days ago, he brought up the possibility that foreign ATM cards wouldn’t work in Greece, and of an adverse ruling from the European Court of Justice. Oh no!

Senior German Official: No Deal as Long as Syriza “Communists” in Office

From The Times, via The Australian:

Greece will not get a cent in new eurozone bailout loans while Alexis Tsipras and Yanis Varoufakis remain in power, because Germany will block any such deal, one of Europe’s most influential politicians has told The Times.

“Today there is the question of do we trust Tsipras and Varoufakis? The answer is clear to all parties, no,” the senior German conservative said.

He also lifted the lid on a European Union attempt to push Mr Tsipras’s left-wing Syriza out of power regardless of the outcome of the vote on July 5.

If Greece’s prime minister and finance minister remained in office, even after a “yes” vote in Sunday’s referendum, then Athens would stand no chance of a new bailout, he indicated.

Under the rules of the European Stability Mechanism, the euro’s bailout fund, the German parliament, or Bundestag, has a veto or blocking vote over any new program such as that requested by Greece at the 11th hour.

The senior German conservative said that Angela Merkel’s ruling Christian Democrat Union (CDU) and its Bavarian allies the Christian Social Union (CSU) would block any request made while the pair, described as “communists”, remained in power.

“In my party the CDU/CSU there would be a lot of colleagues who would vote ‘no’ if Varoufakis and Tsipras are asking. For sure. Because there is simply no trust any more. They say, I am not going to give taxpayers’ money to Greece without a reliable partner,” he said. Referring to Syriza, he added: “We need a reliable partner who wants to do the job.”

The EU’s plan is to back a “yes” vote strongly by posing it as an in/out question on membership of the euro rather than austerity measures and then, in the event of a victory, to oust Syriza after the expected resignation of Mr Tsipras.

“We will do everything to get a ‘yes’. Then we will need a new government, then we have to implement measures,” he said.

The politician revealed that the socialist Martin Schulz, the president of the European parliament, was involved in secret talks, possibly including Mr Tsipras — whom he sees as a moderate — to “split the Syriza movement”.

The aim was to create a “technical government” as a precondition for a new EU bailout, incorporating moderate MPs in Syriza to avoid new elections.

In the event of a “no” vote and Syriza continuing to hold the reins of power, the German conservative said, “it’s over” and Greece would have to leave the euro after defaulting on ECB loans on July 20. “We will talk about a humanitarian rescue program but not an additional [bailout],” he said.

h/t Harry Konstantinidis

OECD: Activist Shareholders Are Bad for Investment

The OECD has just released its new Business and Finance Outlook for 2015. A lot of interesting stuff there. We’ll want to take a closer look at the discussion of the problems that low interest rates pose for pension funds and insurance companies — I’ve thought for a while that this is the most convincing form of the “reaching for yield” argument. But what I want to talk about now is the OECD’s apparent endorsement of the “disgorge the cash” thesis.

Chapter 2, “Corporate Investment and the Stagnation Puzzle,” has a very interesting discussion of shareholder activism and its effects on investment. The starting point is the puzzle that while participants in financial markets are willing to accept unprecedentedly low returns, the minimum returns on new investment projects remain high, as evidenced by depressed real investment despite sustained low interest rates. I think this apparent puzzle is, precisely, a rediscovery of Keynes’ liquidity premium. (Perhaps I will return to this in a subsequent post.) There are a number of ways to think about this, but one dimension is the pressure corporate managers face to avoid investment projects unless the returns are rapid, large, and certain.

Stock markets currently reward companies that favour dividends and buybacks and punish those that undertake more investment … which creates higher hurdle rates for investment.

Here in one sentence is the disgorge the cash argument.

Private sector companies in market-based economies allocate capital spending according to shareholder value. Earnings may be retained for capital spending and growth, but only if the return on equity exceeds the cost of equity. If this is not the case then … they will choose to use their operating cash flow in other ways (by issuing dividends, carrying out cash buybacks…) … and in the limit may close plants and shed labor.

The bolded sentence is puzzling. Is it description or prescription? (Or description of a prescription?) The rest of the section makes no sense if you think either that this is how corporate investment decisions are made, or if you think it’s how they should be made. Among other reasons, once we have different, competing discount rates, the “return on equity” no longer has a well-defined value, even in principle. Throughout, there’s a tension between the language of economic theory and the language of concrete phenomena. Fortunately the latter mostly wins out.

The last decade has seen the rising importance of activist investors who gain the support of other investors and proxy advisors to remove management, to gain influential board seats and/or to make sure that company strategy is in the best interest of shareholders… The question arises as to whether the role of such investors is working to cause short-termism strategies [sic] at the expense of long-term investment, by effectively raising the hurdle rate… Activists… favour the short-term gratification of dividends and share buybacks versus longer-term investment. Incumbent managers will certainly prefer giving in to shareholders desire for more ‘yield’ in a low-interest world to taking on the risk of uncertain long-term investment that might cause them to be punished in the share market. …

To test this idea, an index of CAPEX/(CAPEX + Dividends & Buybacks) was created for each company, and the following investment strategy was measured: sell the highest quartile of the index (capital heavy firms) and buy the lowest quartile of the index (Dividend and Buyback heavy firms). … Selling high capital spending companies and buying low CAPEX and high buyback companies would have added 50% to portfolio values in the USA, 47% in Europe, 21% in emerging economies and even 12% in Japan (where activists play little role). On balance there is a clear investor preference against capital spending companies and in favor of short-termism. This adds to the hurdle rate faced by managers in attempting to undertake large capital spending programmes — stock market investors will likely punish them. … it would be fairly logical from a management point of view to return this cash to shareholders rather than undertake uncertain long-term investment projects… The risks instead would be born more by host-country investment in capacity and infrastructure.

This is a useful exercise. The idea is to look at the ratio of investment to shareholder payouts, and ask how the stock price of the high-investment firms performed compared to the high-payout firms, over the six years 2009 through 2014. What they find is that the shares of the high-payout firms performed considerably better. This is  important because it undermines the version of the disgorge argument you get from people like Bill Lazonick, in which buybacks deliver a short-term boost the share price that benefits CEOs looking to cash in on their options, but does nothing for longer-term investors.  In Lazonick’s version of the story, managers are on one side, shareholders, workers and the rest of society on the other. But if high-payout firms perform better for shareholders over a six-year horizon (which in financial-market terms is almost geologically long term) then we have to slice things differently. On one side are shareholders and CEOs, on the other are us regular people.

The other thing that is notable here is the aggregating of dividends and buybacks in a single “shareholder payout” term. This is what I do, I think it’s unambiguously the right thing to do, but in some quarters for some reason it’s controversial. So I’m always glad to find another authority to say, a buyback is a dividend, a dividend is a buyback, the end.

Another way to see these two points is to think about so-called dividend recapitalizations. These are when a private equity firm, having taken control of a business, has it issue new debt in order to fund a special dividend payment to themselves. (It’s the private equity firm that’s being recapitalized here, not the hapless target firm.) The idea of private equity is that the acquired firm will be resold at a premium because of the productive efficiencies brought about by new management. The more or less acknowledged point of a dividend recap is to allow the private equity partners to get their money back even when they have failed to deliver the improvements, and the firm cannot be sold at a price that would allow them to recoup their investment. Dividend recaps are a small though not trivial part of the flow of payments from productive enterprises to money-owners, in recent years totaling between 5 and 10 percent of total dividends. For present purposes, there are two especially noteworthy things about them. First, they are pure value extraction, but they take the form of a dividend rather than a share repurchase. This suggests that if the SEC were to crack down on buybacks, as people Lazonick suggest, it would be easy for special dividends to take their place. Second, they take place at closely held firms, where the managers have been personally chosen by the new owners. It’s the partners at Cerberus or Apollo who want the dividends, not their hired guns in the CEO suites. It’s an interesting question why the partners want to squeeze these immediate cash payments out of their prey when, you would think, they would just reduce the sale price of the carcass dollar for dollar. But the important point is that here we have a case where there’s no entrenched management, no coordination problems among shareholders — and Lazonick’s “downsize-and-distribute” approach to corporate finance is more pronounced than ever.

Back to the OECD report. The chapter has some useful descriptive material, comparing shareholder payouts in different countries.

[In the United States,]  dividends and buybacks are running at a truly remarkable pace, even greater than capital expenditure itself in recent years. There has been plenty of scope to increase capital spending, but instead firms appear to be adjusting to the demands of investors for greater yield (dividends and buybacks). … [In Europe] dividends and buybacks are only half what United States companies pay … While there is no marked tendency for this component to rise in the aggregate in Europe, companies in the United Kingdom and Switzerland … do indeed look very similar to the United States, with very strong growth in buybacks. … [In Japan] dividends and buybacks are minuscule compared with companies in other countries. …

Here, for the US, are shareholder payouts (gray), investment (dark blue), and new borrowing (light blue, with negative values indicating an increase in debt; ignore the dotted “net borrowing” line), all given as a percent of total sales. We are interested in the lower panel.

OECD_fig
from OECD, Business and Finance Outlook 2015

As you can see, investment is quite stable as a fraction of sales. Shareholder payouts, by contrast, dropped sharply over 2007-2009, and have since recovered even more strongly. Since 2009, US corporations have increased their borrowing (“other financing”) by about 4 percent of sales; shareholder payouts have increased by an almost exactly equal amount. This is consistent with my argument that in the shareholder-dominated corporation, real activity is largely buffered from changes in financial conditions. Shifts in the availability of credit simply result in larger or smaller payments to shareholders. The OECD report takes a similar view, that access to credit is not an important factor in variation in corporate investment spending.

The bottom line, though the OECD report doesn’t quite put it this way, is that wealth-owners strongly prefer claims on future income that take money-like forms over claims on future incomes exercised through concrete productive activity. [1] This is, again, simply Keynes’ liquidity premium, which the OECD authors knowing or unknowingly (but without crediting him) summarize well:

It was noted earlier that capital expenditures appear to have a higher hurdle rate than for financial investors. There are two fundamental reasons for this. First, real investors have a longer time frame compared to financial investors who believe (perhaps wrongly at times) that their positions can be quickly unwound.

From a social standpoint, therefore, it matters how much authority is exercised by wealth-owners, who embody the “M” moment of capital, and how much is exercised by the managers or productive capitalists (the OECD’s “real investors”) who embody its “P” moment. [2] Insofar as the former dominate, fixed investment will be discouraged, especially when its returns are further off or less certain.

Second, managers … operate in a very uncertain world and the empirical evidence … suggests that equity investors punish companies that invest too much and reward those that return cash to investors. If managers make an error of judgement they will be punished by activist investors and/or stock market reactions … hence they prefer buybacks.

Finally, it’s interesting what the OECD says about claims that high payouts are simply a way for financial markets to reallocate investment spending in more productive directions.

It is arguable that if managers do not have profitable projects, it makes sense to give the money back to investors so that they can reallocate it to those with better ideas. However, the evidence … suggests that the buyback phenomenon is not associated with rising productivity and better returns on equity.

Of course this isn’t surprising. It’s consistent with the academic literature on shareholder activism, and on the earlier takeover wave, which finds success at increasing payments to shareholders but not at increasing earnings or productive efficiency. For example, this recent study concludes:

We did not see evidence that targets’ financials improved… The targets’ leverage and payout, however, did seem to increase, suggesting that the activists are unlocking value by prompting management to return additional cash to shareholders.

Still, it’s noteworthy to see a bastion of orthodoxy like the OECD flatly stating that shareholder activism is pure extraction and does nothing for productivity.

 

UPDATE: Here’s James Mackintosh discussing this same material on “The Short View”:

 

 

[1] It’s worth mentioning here this interesting recent Australian survey of corporate executives, which found that new investment projects are judged by a minimum expected return or hurdle rate that is quite high — usually in excess of 10 percent — and not unresponsive to changes in interest rates. Even more interesting for our purposes, many firms report that they evaluate projects not based on a rate of return but on a payback period, often as short as three years.

[2] The language of “M and “P” moments is of course taken from Marx’s vision of capital as a process of transformation, from money to commodities to authority over a production process, back to commodities and finally back to money. In Capital Vol. 1 and much of his other writing, Marx speaks of the capitalist as straightforwardly the embodiment of capital, a reasonable simplification given his focus there and the fact that in the 1860s absentee ownership was a rare exception. There is a much more complex discussion of the ways in which the different moments of capital can take the form of distinct and possibly conflicting social actors in Capital Vol. 3, Part 5, especially chapter 27.

The European Crisis in Sixteen Tweets

Much confusion comes from the idea that “a single currency” is a straightforward, normal state and “exit” from it a dramatic rupture.

Ensuring that claims on all banks are treated as equivalent is a utopian dream even in a single political unit; it requires constant intervention to even approximate.

“Greece” is simply the label currently put on the underlying contradictions of euro project.

Whether Greece” exits” or not, that project remains allowing unlimited financial flows based on the unanchored expectations of financial markets…

… and then demanding that real productive activity and standards of living adjust to accommodate them.

Since this would destroy society if really adhered to, the system is buffered with offsetting public flows, on conditions set by unaccountable authorities.

 

 

There is no sense in which default “leads to” exit. Creditors will attempt to force exit, as punishment for default.

Greek default will stress banks throughout Europe. In response ECB says it will increase liquidity for non-Greek banks, cut off liquidity for Greek banks.

Recall that in 2011-2012, sovereign debt yields reached 7% in Spain and Italy, 12% in Ireland, 14% in Portugal. Certain default if they had stayed there.

Rates fell only after ECB intervened in markets & explicitly promised to prevent defaults. ECB commitment convinced private holders to accept lower yields.

ECB continues to support markets for sovereign debt of countries other than Greece, in order to keep them at small premium to German debt.

Recall that after 2011, Spain and Italy both accumulated Target balances that dwarfed official aid to Greece…

… in part because ECB loosened collateral requirements for banks there. Meanwhile, collateral requirements for Greek banks have been tightened.

If ECB treated Greece the same as Spain, Italy etc, there would be no crisis. With “whatever it takes” guarantee, markets would be happy to hold Greek debt.

If ECB treated Spain, Italy, Portugal, Ireland as they’ve treated Greece, those countries would have crises like Greece, including defaults.

There is a crisis in Greece and not the other deficit countries because the authorities have chosen for the crisis to be in Greece.

 

 

The Myth of Reagan’s Debt

BloomCounty
… or at least don’t blame him for increased federal debt.

 

Arjun and I have been working lately on a paper on monetary and fiscal policy. (You can find the current version here.) The idea, which began with some posts on my blog last year, is that you have to think of the output gap and the change in the debt-GDP ratio as jointly determined by the fiscal balance and the policy interest rate. It makes no sense to talk about the “natural” (i.e. full-employment) rate of interest, or “sustainable” (i.e. constant debt ratio) levels of government spending and taxes. Both outcomes depend equally on both policy instruments. This helps, I think, to clarify some of the debates between orthodoxy and proponents of functional finance. Functional finance and sound finance aren’t different theories about how the economy works, they’re different preferred instrument assignments.

We started working on the paper with the idea of clarifying these issues in a general way. But it turns out that this framework is also useful for thinking about macroeconomic history. One interesting thing I discovered working on it is that, despite what we all think we know,  the increase in federal borrowing during the 1980s was mostly due to higher interest rate, not tax and spending decisions. Add to the Volcker rate hikes the deep recession of the early 1980s and the disinflation later in the decade, and you’ve explained the entire rise in the debt-GDP ratio under Reagan. What’s funny is that this is a straightforward matter of historical fact and yet nobody seems to be aware of it.

Here, first, are the overall and primary budget balances for the federal government since 1960.  The primary budget balance is simply the balance excluding interest payments — that is, current revenue minus . non-interest expenditure. The balances are shown in percent of GDP, with surpluses as positive values and deficits as negative. The vertical black lines are drawn at calendar years 1981 and 1990, marking the last pre-Reagan and first post-Reagan budgets.

overall_primary

The black line shows the familiar story. The federal government ran small budget deficits through the 1960s and 1970s, averaging a bit more than 0.5 percent of GDP. Then during the 1980s the deficits ballooned, to close to 5 percent of GDP during Reagan’s eight years — comparable to the highest value ever reached in the previous decades. After a brief period of renewed deficits under Bush in the early 1990s, the budget moved to surplus under Clinton in the later 1990s, back to moderate deficits under George W. Bush in the 2000s, and then to very large deficits in the Great Recession.

The red line, showing the primary deficit, mostly behaves similarly to the black one — but not in the 1980s. True, the primary balance shows a large deficit in 1984, but there is no sustained movement toward deficit. While the overall deficit was about 4.5 points higher under Reagan compared with the average of the 1960s and 1970s, the primary deficit was only 1.4 points higher. So over two-thirds of the increase in deficits was higher interest spending. For that, we can blame Paul Volcker (a Carter appointee), not Ronald Reagan.

Volcker’s interest rate hikes were, of course, justified by the need to reduce inflation, which was eventually achieved. Without debating the legitimacy of this as a policy goal, it’s important to keep in mind that lower inflation (plus the reduced growth that brings it about) mechanically raises the debt-GDP ratio, by reducing its denominator. The federal debt ratio rose faster in the 1980s than in the 1970s, in part, because inflation was no longer eroding it to the same extent.

To see the relative importance of higher interest rates, slower inflation and growth, and tax and spending decisions, the next figure presents three counterfactual debt-GDP trajectories, along with the actual historical trajectory. In the first counterfactual, shown in blue, we assume that nominal interest rates were fixed at their 1961-1981 average level. In the second counterfactual, in green, we assume that nominal GDP growth was fixed at its 1961-1981 average. And in the third, red, we assume both are fixed. In all three scenarios, current taxes and spending (the primary balance) follow their actual historical path.

counterfactuals

In the real world, the debt ratio rose from 24.5 percent in the last pre-Reagan year to 39 percent in the first post-Reagan year. In counterfactual 1, with nominal interest rates held constant, the increase is from 24.5 percent to 28 percent. So again, the large majority of the Reagan-era increase in the debt-GDP ratio is the result of higher interest rates. In counterfactual 2, with nominal growth held constant, the increase is to 34.5 percent — closer to the historical level (inflation was still quite high in the early ’80s) but still noticeably less. In counterfactual 3, with interest rates, inflation and real growth rates fixed at their 1960s-1970s average, federal debt at the end of the Reagan era is 24.5 percent — exactly the same as when he entered office. High interest rates and disinflation explain the entire increase in the federal debt-GDP ratio in the 1980s; military spending and tax cuts played no role.

After 1989, the counterfactual trajectories continue to drift downward relative to the actual one. Interest on federal debt has been somewhat higher, and nominal growth rates somewhat lower, than in the 1960s and 1970s. Indeed, the tax and spending policies actually followed would have resulted in the complete elimination of the federal debt by 2001 if the previous i < g regime had persisted. But after the 1980s, the medium-term changes in the debt ratio were largely driven by shifts in the primary balance. Only in the 1980s was a large change in the debt ratio driven entirely by changes in interest and nominal growth rates.

So why do we care? (A question you should always ask.) Three reasons:

First, the facts themselves are interesting. If something everyone thinks they know — Reagan’s budgets blew up the federal debt in the 1980s — turns out not be true, it’s worth pointing out. Especially if you thought you knew it too.

Second is a theoretical concern which may not seem urgent to most readers of this blog but is very important to me. The particular flybottle I want to find the way out of is the idea that money is neutral,  veil —  that monetary quantities are necessarily, or anyway in practice, just reflections of “real” quantities, of the production, exchange and consumption of tangible goods and services. I am convinced that to understand our monetary production economy, we have to first understand the system of money incomes and payments, of assets and liabilities, as logically self-contained. Only then we can see how that system articulates with the concrete activity of social production. [1] This is a perfect example of why this “money view” is necessary. It’s tempting, it’s natural, to think of a money value like the federal debt in terms of the “real” activities of the federal government, spending and taxing; but it just doesn’t fit the facts.

Third, and perhaps most urgent: If high interest rates and disinflation drove the rise in the federal debt ratio in the 1980s, it could happen again. In the current debates about when the Fed will achieve liftoff, one of the arguments for higher rates is the danger that low rates lead to excessive debt growth. It’s important to understand that, historically, the relationship is just the opposite. By increasing the debt service burden of existing debt (and perhaps also by decreasing nominal incomes), high interest rates have been among the main drivers of rising debt, both public and private. A concern about rising debt burdens is an argument for hiking later, not sooner. People like Dean Baker and Jamie Galbraith have pointed out — correctly — that projections of rising federal debt in the future hinge critically on projections of rising interest rates. But they haven’t, as far as I know, said that it’s not just hypothetical. There’s a precedent.

 

[1] Or in other words, I want to pick up from the closing sentence of Doug Henwood’s Wall Street, which describes the book as part of “a project aiming to end the rule of money, whose tyranny is sometimes a little hard to see.” We can’t end the rule of money until we see it, and we can’t see it until we understand it as something distinct from productive activity or social life in general.

The End of the Supermanager?

Everyone is talking about this new paper, Firming Up Inequality. It uses individual-level data from the Social Security Administration, matched to employers by Employer Identification Number (EIN), to decompose changes in earnings inequality into a within-firm and a between-firm component. It’s a great exercise — marred only modestly by the fact that the proprietary data means that no one can replicate it — exactly the sort of careful descriptive work I wish more economists would do.

The big finding from the paper is that all the rise in earnings inequality between 1982 and 2012 is captured by the between-firm component. There is no increase in the earnings of a person in the top 1% of the earnings distribution within a given business, and the earnings of someone at the median for that same business. The whole increase in earnings inequality over this period consists of a widening gap between the firms that pay more across the board, and the firms that pay less.

I’m not sure we want to take the results of this study at face value. Yes, we should be especially interested in empirical work that challenges our prior beliefs, but at the same time, it’s hard to square the claims here with all the other evidence of a disproportionate increase in the top pay within a given firm. Lawrence Mishel gives some good reasons for skepticism here. The fact that the whole increase is accounted for by the between-firm component, yet none by the between-industry component, is very puzzling. More generally, I wonder how reliable is the assumption that there is a one to one match between EINs and what we normally think of as employers.

That said, these findings may be pointing to something important. As a check on the plausibility of the numbers in the paper, I took a look at labor income of the top 1 percent and 0.01 percent of US households, as reported in the World Top Incomes Database. And I found something I didn’t expect: Since 2000, there’s been a sharp fall in the share of top incomes that come from wages and salaries. In 2000, according to the tax data used by Piketty and his collaborators, households in the top 0.01 percent got 61 percent of their income from wages, salaries and pensions. By 2013, that had fallen to just 33 percent. (That’s excluding capital gains; including them, the labor share of top incomes fell from 31 percent to 21 percent.) For the top 1 percent, the labor share falls from 63 percent to 56 percent, the lowest it’s been since the 1970s.

Here is the average income of the top 0.01 percent over the past 40 years in inflation-adjusted dollars, broken into three components: labor income, all other non-capital gains income, and capital gains.

01percent_income
Average income of top 0.01% of US households, from World Top Incomes Database. 3-year moving averages.

As you can see, the 1990s look very different from today. Between 1991 and 2000, the average labor income of a top 0.01% household rose from $2.25 million to $10 million; this was about 90 percent of the total income increase for these households. During the 1990s, rising incomes at the top really were about highly paid superstars. Since 2000, though, while average incomes of the top 0.01% have increased another 20 percent, labor income for these households has fallen by almost half, down to $5.5 million. (Labor income has also fallen for the top 1 percent, though less dramatically.) So the “Firming” results, while very interesting, are perhaps less important for the larger story of income distribution than both the authors and critics assume. The rise in income inequality since 2000 is not about earnings; the top of the distribution is no longer the working rich. I don’t think that debates about inequality have caught up with this fact.

Fifteen years ago, the representative rich person in the US was plausibly a CEO, or even an elite professional. Today, they mostly just own stuff.

 

Default ≠ Drachma

I’ve been saying for a while that people should stop assuming that a Greek default implies leaving the euro for a new currency. Much of the media coverage of the negotiations continues to assume that the two are inseparable — that, in effect, the negotiations are over Greece remaining in the euro system. But there is no logical necessity for a default to be followed by the creation of a new currency; indeed it’s hard to see any reason why the former should lead to the latter.

Finally the consensus that default must mean exit seems to be breaking down. Here’s John Cochrane:

Please can we stop passing along this canard — that Greece defaulting on some of its bonds means that Greece must must change currencies. Greece no more needs to leave the euro zone than it needs to leave the meter zone and recalibrate all its rulers, or than it needs to leave the UTC+2 zone and reset all its clocks to Athens time. When large companies default, they do not need to leave the dollar zone. When cities and even US states default they do not need to leave the dollar zone.

Cochrane’s political views are one thing, but he is a very smart guy. And in this case, I think the Walrasian view of money as numéraire is helpful. It’s important to remember that euros are not physical things, they are simply units in which contractual commitments are denominated.

And now in today’s FT, Wolfgang Munchau writes:

The big question — whether Greece will leave the eurozone or not — remains unanswerable. But I am now fairly certain it will default. My understanding is that some eurozone officials are at least contemplating the possibility of a Greek default but without Grexit. … 

On whom could, or should, Greece default? It could default on its citizens by not paying public-sector wages or pensions. That would be morally repugnant and politically suicidal… it could default on the two loans it received from its EU partners, though it is not due to start repaying those until 2020… Defaulting on the IMF and ECB is the only option that would bring genuine financial relief in the short term. … 

Default is not synonymous with exit. There is no EU ruling that says you have to leave the eurozone when you default on your debt. The link between default and exit is indirect; if a country defaults, its defaulting securities are no longer eligible as IOUs for the country’s banks to tender at ECB money auctions.… 

So to default “inside the eurozone” one only needs to devise another way to keep the banking system afloat. If someone could concoct a brilliant answer, there would be no need for Grexit. 

… The economic case for a debt default is overwhelming. … Full servicing would require huge primary surpluses — that is, surpluses before payment of interest on debt. It would leave Greece trapped in a debt depression for a long time. The scheduled primary surplus for 2016 is 4.5 per cent, which is bordering on the insane. Athens absolutely needs to default. At the same time, there is a strong case for remaining in the eurozone.

This hits all the key points. First, there is no logical connection between defaulting and creating a new currency. (Probably better to use that wording, rather than “exit.”) Second, default would open up significant space in Greece’s fiscal position, and would not hurt the its external position. This follows from the fact that Greece currently has a substantial primary surplus and a slight positive trade balance. [1] Third, the only reason there is any link is that default might cause the ECB to cease accepting new liabilities from Greek banks, and it might be hard for the Bank of Greece and/or Greek government to take the ECB’s place under the existing rules of the eurosystem. So, fourth, the real problem with default is the need to ensure that the Greek payments system continues to operate even if the ECB tries to sabotage it. 
The phrasing of that last point might seem hyperbolic. But imagine if, during the Detroit bankruptcy negotiations, the Fed had announced that if the city did not pay off its creditors in full, the Fed would use all its regulatory tools to shut down any banks operating in the city. That’s a close analogy to the situation in Europe.
Maintaining interbank payments within Greece does not necessarily require the Greek government to issue any new liabilities. And it certainly doesn’t require that Greek bank accounts be redenominated. All that is necessary is that if someone with a deposit in Greek bank A wants to make a payment to someone with an account at Greek bank B, there is some system by which bank A can transfer a settlement asset to bank B, acquiring the asset if necessary by issuing a new liability. The technical aspect of this is not challenging, and even the practical aspect, since the Bank of Greece already performs exactly this function. As far as I can tell, the only problem is a political one — given that the Bank of Greece is run by holdovers from the former Greek government, it’s possible that if the ECB told them to stop facilitating payments between Greek banks they would listen, even if the Greek government said to carry on. 
Now some people will say, “oh but the Treaties! oh but the Bank of Greece isn’t allowed to accept the liabilities of Greek banks if Brussels says no! oh but the ELA rules!” [2] Obviously I think this is silly. In the first place, the “rules” are hopelessly vague, so if the ECB’s does shut off liquidity to Greek banks in the event of a default, that will be a political choice. And on the other side, Greece is a sovereign nation. It may have delegated decisionmaking at the Bank of Greece to the ECB, but that also was a political choice, which can be reversed. More to the point, the rules definitely don’t allow for exit. Nor for that matter do they allow for default — and as Munchau correctly points out, cuts to the salaries and pensions of public employees are also a form of default. Rules are going to be broken, whether Greece creates a new currency or not. And it is not at all clear to me that the demands on the Greek state from recreating the drachma, are any less than the demands from maintaining payments between Greek banks in the absence of ECB support — which is all it takes to default and continue using the euro. If anything, the former seems strictly more demanding than the latter, since Greece will need its own central bank either way.
This all may seem pedantic, but it is important: The threat of ejection from the euro is one of the most powerful weapons the creditors have. And let’s remember, the only direct consequence of a breakdown in negotiations, is a default on Greek government debt.
Now there is another argument, which is that exit is positively desirable since a flexible currency would allow Greece to reliably achieve current account balance even once income growth resumes. I think that is wrong — but that’s a topic for another post. (I discussed the issue a couple years ago here.) But even if, unlike me, you think that a flexible exchange rate would be helpful for Greece, it  doesn’t follow that that decision is bound up with the debt negotiations.
[1] It is possible that the apparent primary surplus is due to manipulation of the budget numbers by the previous government. I think that the arguments here would still apply if there were really a primary deficit, but it would complicate things.
[2] Or, “oh but that would be ungrateful.” In one of its more disingenuous editorials I can recall, the FT last month wept crocodile tears over the fact that “default on Greek debts would deter wealthier voters from ever again helping their neighbours in financial distress.” Apparently German banks didn’t care about the interest on all the Greek government bonds they bought; they only lent so long out of kindness, I suppose. Also, it doesn’t seem to have occurred to the editorialists that deterring the financing of large current account deficits might be a good thing.

UPDATE: This seems important:

A country that defaults would not have to leave the euro, the European Central Bank’s vice president said on Monday…  

Vitor Constancio discussed the possibility of a debt default and controls on the movement of money, saying neither necessarily meant a departure from the currency bloc. “If a default will happen … the legislation does not allow that a country that has a default … can be expelled from the euro,” he told the European Parliament… 

Constancio also touched on the possibility of capital controls. “Capital controls can only be introduced if the Greek government requests,” he said, adding that they should be temporary and exceptional. “As you saw in the case of Cyprus, capital controls did not imply getting out of the euro.” … 

“We are convinced at the ECB that there will be no Greek exit,” he said. “The (European Union) treaty does not foresee that a country can be formally, legally expelled from the euro. We think it should not happen.” … 

“If the state defaults, that has no automatic implications regarding the banks, if the banks have not defaulted, if the banks are solvent and if the banks have collateral that is accepted,” Constancio said.

Maybe they were worried that Greece would call their bluff. Or who knows, maybe the culture of the place has changed under Draghi and they are no longer ready to serve as austerity’s battering ram. In any case, it’s hard to see this as anything but a big step back by the ECB.

UPDATE 2: Martin Wolf is on board as well. (Though he doesn’t like my Detroit analogy.)