Everything you need to know about why Greece might leave the euro

The Washington Post

By Matt O'Brien June 20 at 8:00 AM

Greece's government doesn't have enough money to pay back what it owes, but the bigger problem is that Greece's banks might not either. And that's the real reason Greece might be forced out of the euro.

The years change, but the Greek crisis stays the same. Greece borrowed too much money, lied about it, and then, when the subterfuge was revealed, couldn't borrow any more from banks that didn't want to lend to a government that already couldn't pay back what it owed. Default loomed. But if it happened, it would have dragged down French and German banks—and who knows how many others—at a time when the financial system was already in bad shape. So Europe lent Greece the money it needed to, well, pay Europe back. They eventually agreed to write down most of Greece's private-sector debt, but the spending cuts they insisted on in return decimated Greece's economy so much that, by this point, its debt burden isn't any lower than before. So the question now is whether they can agree to a new old deal that would give Greece the money it needs to make its debt payments, this time in return for cutting pensions more than the 40 percent they already have been. If they don't, default looms again—and Greece would presumably leave the euro.

But wait a minute. Why would Greece have to trade in its euros for drachmas if it defaulted on its debt? In theory, there's nothing that would stop it from using the common currency even if it stopped paying its peers. Sure, France and Germany wouldn't exactly be pleased to, between the two of them, be out €100 billion, but they couldn't throw Greece out for that. The problem, though, is the European Central Bank could. Greece's banks are already in a precarious position—they rely on emergency loans from the ECB to stay afloat—and they'd be in even more of one if the government defaulted. That's because they hold a lot of Greek bonds and deferred tax assets that would probably be worth a lot less, if anything, in the case of default. Greece's banks, in other words, would basically be bankrupt, and there'd only be three ways to fix it.

1. The ECB gives Greece's banks as many emergency loans as they need. This is what's happened so far, but the question is how much farther the ECB is willing to go. The answer on Friday, at least, was another €2 billion. That's how much more emergency credit the ECB approved in the wake of a slow-motion bank run—a bank jog, really—that's starting to pick up the pace. Indeed, Greek depositors pulled €3 billion out of their banks this week, with €1 billion of that coming on Thursday alone; that's three times as much as normal.

Why the panic? Well, before the latest emergency loans, a European official had leaked that the ECB wasn't sure if Greece's banks had enough cash on hand to open on Monday. That's not so much yelling fire in a crowded theater as starting one. The idea was probably to put so much pressure on Greece's banks that Greece's government felt like it had no choice but to back down in this latest game of financial chicken. That, after all, is what Ireland's government thinks Europe did to it during its own bailout talks. The risk here, though, is that things can have a way of spiraling out of control. That's why the ECB immediately stepped in with the extra loans—although those loans only last through Monday. If there's not a deal then, the ECB will have to decide whether it's willing to cut Greece loose from the eurozone or give its banks more time so its government does too.

2. Greece bails in its banks and institutes capital controls. What's the difference between a bailout and a bail-in? Well, the first is when the government gives a bank the money it needs, and the second is when the bank takes the money from its lenders—including depositors. That's what happened to Cyprus two years ago, when any deposits over the insured limit of €100,000 were turned into bank stock. Of course, people would try to move their money out of the country if they thought that you were about to take it away, so you'd need to put capital controls in place too. Cyprus also did that.

But what's a euro if you can't use it anywhere but Greece? It's not quite a euro, but not quite not-a-euro, either. It's Schrödinger's euro. In other words, Greece would be reduced to being a once and future full member of the eurozone, and in the meantime, its economy would be even more stuck. Nobody's going want to invest in a country they can't take their money out of. The best-case scenario would be that after another horrible few years, Greece would be able to get rid of its capital controls, like Cyprus just did, and resume life as a, relatively-speaking, normal country with 25 percent-plus unemployment.

3. Greece leaves the euro and bails out its banks with newly-printed drachmas. If the ECB won't bail out Greece's banks and Greece's government won't bail them in, the only option is it to bail them out itself. But, as you might have noticed, the entire problem here is that Greece's government doesn't have enough money. Where would it get it? Well, the only place it could: the printing press. It'd have to leave the euro, turn everyone's old euros into new drachmas, and then gives the banks as many drachmas as they needed to be whole. But, again, people would try to move their money out of the country if they thought that you were about to devalue it, so you'd still have to use capital controls. Not only that, though, but the price of essentials like food and oil—which Greece imports—would explode overnight. There might be rationing.

The next two years would be even worse than the last two—finance minister Yanis Varoufakis has said it would send Greece "back to the Neolithic Age" in the short-term—but Greece would at least have a real chance to recover after that. A cheaper drachma would boost tourism and exports, and stop the self-defeating cycle of wage cuts and unemployment that's made debts harder to pay back for the people and the country.

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The easy way to stop Greece's Groundhog Day from giving way to its Judgment Day is for Greece to promise to cut its pensions for future, but not current, retirees, and for Europe to say yes. For all the acrimony—and there's been plenty of that—something like this is still the most likely outcome. But the longer they go without a deal, the worse Greece's banks get, and the bigger a chance that either side miscalculates.

Greece's economy has a lot of Achilles' heels, but its banks are its biggest one.

Matt O'Brien is a reporter for Wonkblog covering economic affairs. He was previously a senior associate editor at The Atlantic.