By Nathan Lewis at Forbes
Following a Greek government default, and possibly before then, Greek banks would likely be both insolvent and unable to make payments to creditors. What should a government do?
A bank becomes “insolvent” when the value of its assets is less than its total liabilities. In time, the bank also becomes “illiquid” – unable to borrow money, and thus make payments – because people don’t like to lend to insolvent entities. Greek banks have been getting by because they have been able to borrow from the European Central Bank, but this may come to an end soon, perhaps in a matter of days.
There are two basic ways to deal with this: one is to increase assets, possibly through a government investment. This is called a “recapitalization,” and when the government is involved, a “bail-out.” Obviously, this takes money — €48 trillion in the case of Greece’s prior government “bail-out” — and often the terms of the investment are so poor that it amounts to a gift to the bankers and their creditors. The other way is to decrease liabilities, which obviously means some pain for the bank’s creditors, including depositors. But, once this accounting adjustment is done –