How Bad Is It In Greece – Europe Resorts to a Shell Game to Keep the Country Afloat

Financial Shenanigans That Would Be Illegal in a Normal Society

As everyone knows Greece is bankrupt, except they cannot be bankrupt because then all of the European banks that hold Greek debt and the European Central Bank and the other government related institutions that hold Greek debt would be in terrible shape.  So in order to keep Greece afloat the Europeans have called in consultants.  The consultants are apparently the folks who set up the shell games on the street to fleece unwitting tourists.

In Europe it works this way.  First of all Greece must pay back a loan in order to qualify for the next series of bailout funds from the European authorities.  So Greece is borrowing money to do that.

Most of the funds will go to repay €3.1 billion in bonds held by the ECB that mature Aug. 20. That will ensure that the country avoids a default that would make it impossible for Greek banks to continue borrowing from the ECB, on which they currently depend for their survival.

But if Greece is bankrupt where are they getting that money?  They are borrowing it of course.

A Pictorial Depiction of the Greek Economy

Greece completed its largest debt sale in two years Tuesday, ensuring that it will have the money to repay bonds held by the European Central Bank next week.

The Greek Public Debt Management Agency said it sold €4.063 billion ($5.01 billion) of 13-week treasury bills at an auction, which included a 30% noncompetitive tranche. The uniform yield was 4.43%.

But if Greece is bankrupt, who in their right mind is lending them money? They are borrowing it from the very people they have to pay back of course.

The apparent success of the auction mainly reflected Greek banks borrowing from the Eurosystem at one window to repay it at another. The banks have used Emergency Liquidity Assistance from the Bank of Greece to buy the bills, and are expected to pledge them immediately at the Bank of Greece as collateral for more such loans.

Emergency Liquidity Assistance, or ELA, is a credit line provided by the ECB to the Greek central bank, and has been used particularly heavily by Greek banks since the ECB stopped accepting the country's sovereign bonds as collateral at its main monetary policy operations last month.

 So essentially the Greek banks are lending the money to Greece then turning around and pledging the loans as collateral to the European Central Bank to get back the money they just loaned Greece.  And the banks get to borrow at a much lower rate then they have invested in the Greek bonds, so they make money off the spread.  And if Greece is unable to pay, well, the ECB not the banks are stuck with the bad debt.

If you think all of this smells like a backed up sewer, then you understand what is going on here.

Interest-rate strategists remained skeptical that Tuesday's auction would do more than buy some much-needed time.

"The fact that Greece issued €4 billion gives them a bit of extra cash. But it needs a lot more than 90-day bills. This is simply an extension of the life support," said Richard Kelly, an interest-rate strategist at TD Securities in London.

Others also worried that the auction didn't reduce in any durable way the threat posed by Greece to the euro zone as a whole.

"What this operation does, however, is temporarily shift the Greek risk away from the whole euro area to the Greek central bank. Once the bailout funds have been paid and the T-bills redeemed, of course, the risk is back at the euro-area nations," RBC Capital Markets analysts said in a note to clients before the auction.

European policy makers are now violating a basic rule of finance.  It’s okay to fool others but a horrible mistake to fool yourself at the same time.