After nearly five years of kicking the can down the road, it appears as if the situation in Greece may be at an inflection point.
Yesterday, the European Central Bank (ECB) said that they would not provide any additional emergency funding to the nation’s banking system. Without the new funding, most people in and out of Greece believe that there will be a run on the banks.
People in Greece had been lining up at ATMs all weekend fully expecting what was announced yesterday: Banks won’t be open on Monday. Most of the cash machines were out of money (or ‘lefta telos’ as the signs on the ATMs say in Greek) when the ‘holiday’ was announced. The stock market will also be closed.
To prevent a run on the banking system, it’s likely that the Greek government will impose capital controls on the entire system. In 2013, the Republic of Cypress was in a similar situation and had to impose capital controls on their citizens, although they only had two banks.
In Cyprus, banks were closed for two weeks and when they opened withdrawals were limited to 300 euros, transfers to 5,000 euros and citizens weren’t allowed to take more than 3,000 euros out of the country.
Those controls started to lift within a few weeks, but in the meantime, the banks were ‘restructured,’ which simply meant that the bank took money from their largest depositors, up to 40 percent of their money. Those that were below the equivalent of the FDIC insurance limits were spared, but the large, uninsured depositors were stuck with meaningful losses.
Greece is a bigger problem than Cyprus, not only because the country is bigger and more money is at stake, but also because there is an increasingly higher chance that Greece will be forced out of the European Union and go back to the drachma.
While the problem in Greece is real, they would hardly be the first country to default on their debt obligations. In fact, according to Ken Rogoff, economist and co-author of This Time is Different: Eight Centuries of Financial Folly, which details financial crises, there are only six countries that have never defaulted: Australia, New Zealand, Canada, Denmark, Thailand and the United States.
The New York Times wrote that the Argentinean default in 2001 might provide a reasonable roadmap for what could happen in Greece. You can read the whole article here, but the short story is that there was even harsher austerity, capital controls, riots, currency devaluation and political instability (three presidents in four days at one point).
Yet, despite all of that, the country stabilized within a year and repaid the IMF in full by 2006. Granted, the Argentines got lucky because they are rich in resources and benefitted from a boom in commodity prices. The point, though, is that there is terrible pain but countries get through it over time.
Of course, it’s unclear what will happen in the coming days, both in Greece and in global financial markets. In theory, everyone is prepared for a Greek default – the whole world has seen this coming from a mile away and everyone has taken preventative measures to keep the problem contained.
That won’t be true for everyone, though, as it’s already been reported that some hedge funds have sizable investments in Greece, betting that there will be a deal. If those funds are leveraged, their lenders may require them to raise capital from selling other investments, potentially creating a bit of a fire sale in other markets.
While there will undoubtedly be market volatility to the downside, I think it’s important to say that we shouldn’t expect anything like 2008 barring any new information. Back then, the entire global banking system was in the position that only Greece and a few others find themselves in today.
When I first wrote about this back in April (which can be found here), I concluded by saying that the key to dealing with whatever happens is staying diversified and making sure that you’re comfortable with your asset allocation, which is as true today as it was then.