Friday, May 20, 2011

The Self Preservation Society

AKA the ECB...

There’s been a lot of handbags between the ECB and EU leaders this week, after some leading EU politicians admitted that there could be some form of debt restructuring of Greek debt. Both Olli Rehn, EU Economics Commissioner, and Jean-Claude Juncker , Prime Minister of Luxembourg, suggested that there could be an extension of loans given to Greece (although its not clear whether this would just involve the official loans or private sector loans as well).

Needless to say, this did not sit well with the ECB, particularly ECB board member Jurgen Stark. After suggesting that any form of restructuring would be a catastrophe, Stark also accused “vested interests in the US and the UK” of undermining the economic adjustment programme in Greece. He also issued what seemed somewhat like a veiled threat, saying that the ECB may not accept Greek bonds as collateral for ECB lending to banks after a restructuring – a move which would probably push Greek banks into bankruptcy.

At first glance it is surprising just how removed the ECB is from the views of the rest of Europe (as we've argued for some time, restructuring is probably inevitable - an increaing number of people are coming around to this view). But ultimately, the ECB's posturing simply comes down to self interest. The ECB is holding masses of Greek bonds (we’d reckon around €60bn in nominal value) in addition to €140bn in state related collateral it has accepted from Greek banks. This €200bn exposure to Greece then presents the potential for large losses for the ECB under a Greek restructuring.

You may ask: why does the ECB care? It’s backed by eurozone governments, and therefore taxpayers, so they will ultimately foot the bill.

True – and another unfortunate potential hidden cost for eurozone taxpayers – but going cap in hand to eurozone governments to ask to be recapitalised after these losses would be incredibly humiliating for the ECB. It would also give eurozone leaders huge leverage over the ECB on future economic decisions and policy. The only other choice for the ECB is even worse though - printing money to cover its losses. This would mean abandoning its raison d’ĂȘtre (price stability) instead going down a path that could lead to pretty scary levels of inflation.

Arguing anything other than staying the course would therefore probably have dire consequences for the ECB, highlighting the impossible situation it’s managed to get itself into.


Build A Home Brewery said...

I would not call that a mistake. The objective was to bail out banks exposed to Greece. That objective has been achieved.

Anonymous said...

The Telegraph's Andrew Lilico has assessed what may happen if & when Greece defaults. The blogsite zerohedge also has a similar analysis. See:

Here is what may happen:
•Every bank in Greece will instantly go insolvent.
•The Greek government will nationalise every bank in Greece.
•The Greek government will forbid withdrawals from Greek banks.
•To prevent Greek depositors from rioting on the streets, Argentina-2002-style (when the Argentinian president had to flee by helicopter from the roof of the presidential palace to evade a mob of such depositors), the Greek government will declare a curfew, perhaps even general martial law.
•Greece will redenominate all its debts into “New Drachmas” or whatever it calls the new currency (this is a classic ploy of countries defaulting)
•The New Drachma will devalue by some 30-70 per cent (probably around 50 per cent, though perhaps more), effectively defaulting 0n 50 per cent or more of all Greek euro-denominated debts.
•The Irish will, within a few days, walk away from the debts of its banking system.
•The Portuguese government will wait to see whether there is chaos in Greece before deciding whether to default in turn.
•A number of French and German banks will make sufficient losses that they no longer meet regulatory capital adequacy requirements.
•The European Central Bank will become insolvent, given its very high exposure to Greek government debt, and to Greek banking sector and Irish banking sector debt.
•The French and German governments will meet to decide whether (a) to recapitalise the ECB, or (b) to allow the ECB to print money to restore its solvency. (Because the ECB has relatively little foreign currency-denominated exposure, it could in principle print its way out, but this is forbidden by its founding charter. On the other hand, the EU Treaty explicitly, and in terms, forbids the form of bailouts used for Greece, Portugal and Ireland, but a little thing like their being blatantly illegal hasn’t prevented that from happening, so it’s not intrinsically obvious that its being illegal for the ECB to print its way out will prove much of a hurdle.)
•They will recapitalise, and recapitalise their own banks, but declare an end to all bailouts.
•There will be carnage in the market for Spanish banking sector bonds, as bondholders anticipate imposed debt-equity swaps.
•This assumption will prove justified, as the Spaniards choose to over-ride the structure of current bond contracts in the Spanish banking sector, recapitalising a number of banks via debt-equity swaps.
•Bondholders will take the Spanish Banking Sector to the European Court of Human Rights (and probably other courts, also), claiming violations of property rights. These cases won’t be heard for years. By the time they are finally heard, no-one will care.
•Attention will turn to the British banks. Then we shall see…

Rollo said...

No it has not. When Greece defaults, all its banks will go; and they are mostly owned by European banks, mainly french.
The idea of Christine Lagarde is to make sure all the europeans chip in to save french banks.