The depth of the Greek crisis is best measured in Texas
As Greece’s economic drama moves towards its final stage, investors are anxious to see how it will end.
This is not the first time Greece has been in financial hot water.
Following its recognition as a state in 1832, Greece spent most of the remainder of the 19th century under the control of creditors.
The pattern started with a default in 1832. In consequence, Greece’s finances were put under French administration. Following Greece’s defeat at the hands of Turkey in 1897, Greece’s fiscal house was entrusted to a Control Commission.
During the 20th century, the drachma was one of the world’s worst currencies. It recorded the world’s sixth highest hyperinflation. In October 1944, Greece’s monthly inflation rate hit 13,800 per cent.
Fast forward to Greece’s entry into the European Monetary Union (EMU) on January 1, 2001, two years after the 11 original members established the EMU.
Athens entered under a cloud because most either knew or suspected that it came with some accounting trickery. Still, the Greeks were enthusiastic new members of the “club.” If it could enter without following the rules and free ride — the other members of the “club” would have to pay the bill. Greece got into trouble when others stopped picking up the tab.
This is a classic recipe for a fiscal time bomb, and time is running out.
The International Monetary Fund (IMF), as well as the European Union (EU) and other creditors have supplied plenty of fissionable material for the bomb.
The IMF has never before extended credit to any country on such a scale. Under normal conditions, the IMF is supposed to be limited to lending up to 200 per cent of a country’s quota in a single year and 600 per cent in cumulative total.
Under the IMF’s “exceptional access” policy, however, Greece has secured IMF credit worth an astounding 1,860 per cent of its quota, or about $30 billion.
The creditors have a Greek problem. And here’s why.
Changes in the money supply, broadly determined, cause changes in nominal national income and the price level. The growth of broad money and nominal GDP are closely linked.
The broad money measure for Greece (M3) has contracted dramatically since the onset of the 2009 financial panic. It’s been contracting at a 6.04 per cent annual rate. The monetary approach to national income predicts a serious contraction in GDP – just what has occurred in Greece. During the 2008-13 period, GDP dropped almost 30 per cent.
Further contraction is already baked in the cake as M3 growth has been in negative territory since December 2014 and is currently contracting at a 9.77 per cent rate.
Money supply can be broken down into its state money and bank money components. Bank money makes up 84.26 per cent of the total money supply in Greece. Greece’s four largest banks account for 87 per cent of the total bank assets in the country.
The “Texas Ratio” – used during the US savings and loans crisis – is the measure of the likelihood of bank failure. It is the book value of all non-performing assets divided by equity capital plus loan loss reserves. Only tangible equity capital is included in the denominator. Intangible capital – like goodwill – is excluded.
The ratio compares a bank’s bad assets to its available provisions for bad loans plus its capital. When the ratio exceeds 100 per cent, a bank does not have the capacity to absorb losses from troubled assets. It will either require a capital injection, or it will fail.
At the close of business last year, the Texas Ratios exceeded 100 per cent for Piraeus Bank, Alpha Bank, and Eurobank Ergasias. The national bank of Greece wasn’t much better, with a ratio of 98.7 per cent.
Since the first of the year, the deposit bases of the banks have deteriorated markedly, suggesting that the Texas Ratios have also deteriorated. The banks are in big trouble. Their stock prices trade well below book value and thus render ridiculous the idea of raising fresh capital in the private markets.
The state could inject new capital into the system, but the state has no funds. So the Greek banking system, which produces about 85 per cent of Greece’s money supply, is on the verge of being forced to shut down. The spectre of an economic collapse is not out of the question.
Steve Hanke is professor of applied economics at Johns Hopkins University in Baltimore