The ECB helped Europe in its hour of need. Now it is time for Europe to return the favour to the ECB.
This is
crunch time for Europe, Greece and the ECB. The PSI has reached an impasse not
because the coupons demanded by bondholders are too high but because
bondholders can afford to Free Ride along the ECB.
By insisting on a voluntary PSI with the largest bondholder the
ECB, exempted, a huge free riding problem has been created. This more than
anything else (coupon, English law etc) is the major obstacle for a successful
PSI. Europe must come up with the money to take the Greek holdings out of the
ECB’s SMP program NOW. It would do it anyway at some point in time. Let us see
why:
- ECB stays out, the PSI proceeds in a voluntary manner. Greece would have to find the money to repay fully this 45-55billion. This probably means the EU (Germany) providing new loans to cover these redemptions in the next 3years (market believes that the ECB holdings concentrate in the near maturities).
- ECB participates in the PSI and takes the losses. Then, barring magic tricks, the National Central Banks (ECB shareholders: Germany 19%, France 14%, Italy 12.5%) would have to cover the losses.
- Greece default through the use of CAC’s or otherwise. The ECB would have to write down the value of the Greek bonds again. Therefore shareholders pay again.
We thus see that in all plausible scenarios, the EU (Germany)
would have to come up sooner or later with the money to cover either the losses
or the redemptions at Par. It is better to do it now and change the odds in the
PSI offer and give Greece and Europe a fighting chance. By removing the ECB
early, holdouts would have very little to stand on. In addition, insisting on a
special status for the ECB, Europe risks contagion to other countries whose
bonds the ECB owns.
The ECB is NOT a creditor (preferred or otherwise) towards Greece (through
the SMP) but a bondholder who bought the bonds in the secondary market. Whatever
the reasons of the ECB, they cannot play a part in the decision process. If we
allow distinguishing holders of bonds with regards to their investment or
buying motives then we should grade the debt according to who owns. The ECB is
a supranational entity but does not enjoy unlimited immunity[1].
The relief can come either by giving the money to Greece to buy
(at cost) and destroy the bonds immediately or by exchanging the ECB holdings
(at cost) with EFSF paper and then passing the bill again to Greece if Europe
does not want to shoulder the pain.
Selling the bonds back at purchase price can be justified by the
size of the holding (20% of total outstanding) and also by the particular needs
of the buyer. The bond market is an OTC market.
Allowing during a default or through CAC’s a special status for
the ECB would be detrimental to the other peripheral countries. It would mean
effective subordination of every other bondholder since it would create a two
tier system. The European Government market would immediately re-price to
reflect the increased risk.
Europe must act fast to remove that risk factor from the market.
Doing so, would show leadership and the determination to deal with the European
Peripheral debt crisis.
Historical Context
Back in
2010 as the Greek debt tragedy was unfolding the ECB took the controversial
decision to support the Greek government bond market with outright purchases of
Greek bonds. The ECB had to act swiftly on the face of EU inaction and
squabbling. It justified this though their mandate on Financial Stability. Despite the fact that article 123 (TFEU)
explicitly prohibits Credit facilities or outright purchases of government debt
the ECB was allowed to violate the spirit of the law. The exact wording was “purchase directly from them by the European
Central Bank”. Since the purchases were in
the secondary market and not in the primary (at issuance) the ECB had only to comply
with the “without prejudice” it its other mandate i.e. Price Stability and
Monetary policy. This gave rise to the so called Securities Markets Program
(SMP) sterilization. Thus on a regular basis the ECB withdrew the same amount
of liquidity from the system as it was supplied by their direct purchases.
Despite the heavy intervention by the ECB to the tune of
45-55billion (in nominal) the Greek bonds continued their accelerated descend.
As a result the ECB silently suspended the purchases of Greek bonds and was
thus left with around 45-55billion of Greek debt. Bonds acquired by the ECB
were also marked at purchase price and amortized to Par at maturity.
Problem was however, that the ECB, as explained above, does not
mark the SMP holdings to market but at purchase price. Attempting to mark the
Greek bonds at the current levels would generate losses that would not be
covered by the equity (10.8billion). Unless the ECB waves a magic wand and
comes up with some revaluations or other accounting gimmicks it would need to
go back to its shareholders to raise the requisite capital. And this apart from
the humiliation of having a Central Bank going bankrupt also requires taxpayers’
money. As the largest shareholder is the Bundesbank this means German money.
JC Trichet very quickly identified this problem and tried in March
2011 to sell the SMP holdings to the newly created EFSF. Unfortunately, his
recommendation was not adopted by Europe’s politicians and this was also a
source of friction between the ECB and the EU. The EU politicians refused to
take responsibility of the losses that the Greek bonds generated.
In July 2011 the council of Europe decided to restructure the
Greek debt in a very unconventional way. In order to avoid default and the ECB
taking heavy losses it demanded the PSI restructuring to be voluntary. It also
assigned 100billion for bank recapitalization to soften the blow of the Greek
debt write-downs. This decision unfortunately turned the benign intention of
the ECB into a huge headache. Europe should deal with this first before any PSI
restructuring.
[1]
Gruber &
Benisch, ECB Legal Working Papers, No4, June 2007, Privileges and immunities of
the ECB
