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Following a Greek government default, and possibly before then, Greek banks
would likely be both insolvent and unable to make payments to creditors. What
should a government do?
A bank becomes “insolvent” when the value of its assets is less than its
total liabilities. In time, the bank also becomes “illiquid” – unable to
borrow money, and thus make payments – because people don’t like to lend to
insolvent entities. Greek banks have been getting by because they have been
able to borrow from the European Central Bank, but this may come to an end
soon, perhaps in a matter of days.
There are two basic ways to deal with this: one is to increase assets,
possibly through a government investment. This is called a
“recapitalization,” and when the government is involved, a “bail-out.”
Obviously, this takes money — €48 trillion in the case of Greece’s prior
government “bail-out” — and often the terms of the investment are so poor
that it amounts to a gift to the bankers and their creditors. The other way
is to decrease liabilities, which obviously means some pain for the bank’s
creditors, including depositors. But, once this accounting adjustment is done
– it amounts to a revision of ledgers, and could conceivably be accomplished
in a day or two – then the bank can reopen for business, in good financial
health. This process is sometimes known as a “bank holiday,” a euphemistic
term which shows that, when the financial system is temporarily shut down,
there isn’t much to do except spend the day at the park.
Bank insolvency and reorganization – a subset of bankruptcy – is one of those
things, like sovereign default itself, which is treated as something
conceivable, like a catastrophic earthquake in Los Angeles, but which never
actually happens. This is wholly incorrect. The Federal Deposit Insurance
Corporation, which oversees this process in the U.S., lists 513
failed banks since the start of 2008.
In the case of these U.S. banks, typically the insured depositors are made
whole; uninsured depositors and other creditors take a partial or complete
loss; and the assets, liabilities and operations of the banks are sold to
some larger bank. The bank quickly reopens, typically under the name of the
acquiring bank, but the branches are the same. People with deposits at the
bank at the time of its failure then have deposits at the acquiring bank. The
process typically costs the FDIC nothing, as insured deposits are well under
the value of remaining assets. Ultimately, it amounts to an adjustment of
ledgers. (I discussed
these topics in greater detail in a series of
items in 2008-2011. Also, a whole chapter is devoted to these topics in
my book Gold: the
Monetary Polaris.)
One of the largest banks to undergo this FDIC resolution process was
Washington Mutual, which was closed by the Office of Thrift Supervision in
September 2008. At the end of 2007, the bank had assets
of $328 billion, deposit liabilities of $188 billion, 2,239 retail
branches, and 43,198 employees. The bank was quickly sold to JP Morgan Chase;
former Washington Mutual branches reopened with Chase signage, and former
Washington Mutual customers became Chase customers.
As of March 2014, the entire Greek banking system had roughly €319 billion of assets
among 19 Greek institutions, with 93% of this held by the top four banks.
Including also branches of foreign banks, there were 2,688 branches and
45,654 employees.
In other words, the entirety of the Greek banking system is roughly
equivalent in size to one Washington Mutual – to say nothing of the other 512
banks the FDIC has reorganized in recent years.
As is the case in many kinds of bankruptcy, there is, alas, great potential
for criminality in these matters. This criminal element has already been
codified in the “bail-in” legislation passed in most developed countries
worldwide, including Greece. The “bail-in” legislation bypasses
already-existing bankruptcy court processes – in other words, the systems
formerly in place, flawed as they may be, to prevent widespread looting of
the un-rich, un-powerful, and un-connected.
Most overtly, recent “bail-in” guidelines
agreed to at the G20 meeting last November specifically make derivatives
liabilities senior to uninsured deposits. It is practically a guarantee that
noninsured depositors in large, derivatives-issuing banks will get screwed.
It would also be Armageddon for money-market funds, which today are mostly
conduits for junior bank financing. However, as ugly as
that is, it might not be such a problem with smaller banks such as those
in Greece, which typically do not have major derivatives involvement.
(The G20 agreement also makes “liabilities that the bank has by virtue of
holding client assets” junior to “any liability, so far as it is secured,”
which seems ripe for abuse.)
It would be good if the Greek government brushed up a bit on what all of this
means, before being led to slaughter by seemingly-helpful foreign advisors.
Greek banks need to go through their restructuring process. This will mean
losses for some bank creditors, although they may get equity in a debt/equity
swap, thus becoming shareholders in the new, healthy bank. The banks
themselves do not need to be merged, sold or liquidated, but can continue
much as they are, keeping the assets (loans) that they already have. They
should be able to reopen in as little as a few days, emerging from the
process as clean, healthy banks – perhaps among the healthiest in Europe.
There should be no cost to the government.
Governments do not need to fear this, or, for that matter, abandon it to the
guidance of foreign entities that do not have the best interests of Greeks at
heart. Instead, governments should guide the process towards its best
possible outcome: a tolerably fair distribution among creditors of the losses
that already exist, prevention of further criminal asset-grabbing or
liabilities-dumping, and a quick return to banking system normalcy.
It is a lot to ask a government to manage both a sovereign default and a
banking system reorganization, all the while keeping an eye on popular
support and amicable foreign relations. But, sometimes it needs to be done.
All the alternatives are worse. So, do it.
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