The European Central Bank has answered Greece's funding prayers with a resounding "no." By turning off its lending taps to the nation's financial system, the ECB is engaging in dangerous brinksmanship that could easily backfire unless the European Union finds common ground with Greece's new government.

?Late yesterday, the ECB effectively stopped Greek banks from using junk-rated government debt as collateral. The banks will now pay a penalty rate of 1.55 percent to get so-called Emergency Liquidity Assistance from their domestic central bank -- the ELA was supposed to be for emergencies, after all -- up from the 0.05 percent levied on ECB funding.

Greece's Fiscal Odyssey
The mechanics of the surprise move are less important than the signal it sends. It suggests a lack of patience at the ECB with Greece's new administration, which is still finishing its lap of honor around the capitals of the European Union and trying to persuade its creditors to renegotiate how it can pay its debts. It also suggests the central bank is supplanting politicians in trying to steer the European Union and its most recalcitrant member toward a resolution.  

Eoin Treacy's view

The negotiations between Greece’s new government and its creditors, not least the ECB remain tense but the reality is that Greece’s financial system cannot survive without access to ECB liquidity. 

This chart of the Greek Drachma shown inverserly against the Dollar offers some interesting perspective. (Please note that the Euro has been substituted from 1999). The currency trended consistently lower for twenty years before joining the Euro. This is a testament to the poor quality of economic governance which probably deteriorated rather than improve with the advent of the Euro. This also helps to illustrate just how much of change in behaviour is being demanded by the austerity program. Before joining the Euro, the Greek administration had routinely devalued its currency and this is no longer possible. 

By stating almost immediately after winning the election that Greece wanted to stay within the Eurozone, the new government ceded a major negotiating chip. In the event of a Eurozone exit, all of the banks, pensions and possibly insurance companies would be nationalised and the new drachma would collapse in value. Little wonder then consumers are padding their mattresses with Euro rather than hold bank deposits. 

Speculators pared the headline grabbing decline in Greek banks today on the assumption that the Greek government will have little choice but to acquiesce to its creditor’s demands. Nevertheless, considering the depth of the crisis facing the country there are serious doubts about whether it can stay within the currency union without concessions regardless of the moral hazard for the rest of the group.