Tightening the screws - but on whom?

The timing was exquisite. Hours after meeting Greek finance minister Yanis Varoufakis, and hours before Varoufakis meets his German counterpart today, ECB president Mario Draghi and the governing council announced that Greek government-guaranteed securities could no longer be used to obtain loans from the euro’s central bank. This precipitated the original end-of-February deadline when the country's rescue programme expires; Frankfurt says it now cannot assume an extension will be agreed.

The FT reports on the decision and the market rout that ensued. Greek banks lost a quarter of their market value. Government bond yields soared:

FastFT rounds up reactions from market analysts, who largely interpret the decision as a sign the Greek government is losing its battle to restructure its debt and change its policy programme. Are they correct?

First, the economics. Karl Whelan has this right: in the short run, this changes very little and just amounts to muscle flexing by the ECB. Greek banks can still borrow euros against Greek government paper, though they have to do it from the Greek central bank and at a higher interest rate. But if it's objectively no big deal, not everyone understands this. So deposit flight and financial instability may well increase.

What about the politics? Most commentators judge from the ECB decision that the Draghi-Varoufakis meeting went badly. But that's a rushed judgment of what amounts to a very complex case of game theory played by two (literal) experts on the matter. Frances Coppola has an interesting and contrarian take: rather than weakening Greece's hand, she asks, could the target be Germany? Given Varoufakis's stated willingness to dare the ECB to kill the Greek banking system, Draghi is too smart to just be playing into his hand. Upping the ante in this way could better be read as a repetition of June 2012, when Draghi put the onus on the eurogroup after newly elected Antonis Samaras wanted to repudiate the rescue programme: if they wanted to prevent a Greek banking collapse, they had better agree something with Athens. That time, Samaras blinked first. Draghi may well reason that this time, the creditor countries will. And he may not care either way so long as one side does.

Alternatively, the endgame can be the Cyprus solution, sketched out by Dan Davies: let the Greek banking system fail and apply bail-in rules. Davies suggests this would be almost as devastating for Greece as a euro exit. I don't see why. Greek banks have enough non-deposit liabilities that most Greeks would not lose out. And done properly - as it should now, with the Cypriot experience to learn from - the new "good banks" emerging from the restructuring would be so well-capitalised that the deposit flight should stop. Even if it doesn't, they will have unfettered access to ECB liquidity, which (as we've known since Bagehot) is the best way to prevent a panic.

Other readables

  • The Chinese central bank did not hear premier Li Keqiang forswear stimulus policies in his Davos speech: it is freeing up reserve requirements so banks can lend more.
  • Public debt is rising almost everywhere, the FT reports.
  • The BBC and the FT report on the Institute for Fiscal Studies' latest unmasking of UK politicians' fiscal promises. Tax rises will be hard to avoid, the think-tank's green budget shows.

Numbers news

  • The European Commission's new economic forecasts are out today. It upgraded its growth outlook (thanks for buying bonds, ECB!) but predicts deflation (minus 0.1% price growth) and continued tight budgets (collective deficit at 2.2% of GDP) for the eurozone in 2015. Brussels stoically counts on 2.5% growth in Greece this year.

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