Thursday 6 September 2012


The ECB always had an uneasy relationship with the Securities Market’s Program (SMP). There were many problems both theoretical and practical.


· The Maastricht treaty forbids the ECB from financing governments or government entities. In this light any government bond buying from the ECB would be seen as a violation of the treaty. However, the ECB was able to get away with it by a clever sleight of hand. They noticed that the actual wording forbade buying in the Primary markets (at issuance). So they felt that the letter of the law was not breached. Only the spirit.

· Next problem was that it was not part of the accepted monetary policy. So with an even greater audacity they christened the purchases as a Monetary policy tool. One of the common excuses was the financial stability of the markets. However, financial stability IS NOT a primary objective of the ECB. Price stability is. If financial stability was a primary objective then the ECB would have been the pan-European regulator.  Article 127 (TFEU) defines the ECB’s role as a “contribution” to the Financial stability not as a watchdog. The ECB’s role one could argue is more to consult rather than interventionist. Nevertheless, they did so.

· In order not to be accused of endangering the prime objective of Price Stability the ECB decided to make it money-neutral by sterilizing the program. This meant withdrawing an equivalent amount using a regular deposit. Since the introduction of the SMP, the ECB has moved into printing 1trillion of 3Y money with the LTRO. So much for the Price Stability excuse. By the way, printing money in this way may in practice not be inflationary for different reasons (deleveraging in Repo, rehypothication) but this was not in the minds of the ECB policy makers.


· Major problem was and still is the insistence of the German central bank in the policy of outright bond purchases. We have seen Axel Weber go and Jurgen Stark seems to have changed his mind after the program was initiated.

· Seniority is another huge-huge problem.  The ECB calls the SMP program a Monetary policy tool and in doing so it has resisted any restructuring. We have criticized this anomaly many times before. If the ECB is not allowed to take losses on their Bond holdings then it becomes a very novel and weird animal. It becomes a “preferred investor”. Not a preferred creditor, but a preferred investor. And as far as I know there is no such category in the bond market practice or finance.

· Another practical problem is the disappearance of collateral and the malfunctioning of the market. As soon as the ECB buys these bonds they get out of circulation. In other words the stock of bonds is reduced. Of course the same happens with the 3Y LTRO. This may have the unintended consequence of disrupting the bond market causing further deleveraging, further falls in the prices and more negative rates for Germany.

Anchoring Rate Caps or Upper bound purchasing limits.

There is a well-known practice in marketing that is called anchoring. When you do not know a price or value of something the first number you mention or utter it immediately becomes the anchor. After that everything revolves around or near that number.

If the ECB mentions or even allows the market to know that there is a yield rate that above which it would intervene then the market would immediately pull to that level. The same goes for putting a limit to the bond buying. That mistake was done by the EFSF which announced a capacity of 440billion and the market moved to use the full capacity.

So, if there is a hint of a number expect the market to fill that number to the outmost capacity.


The ECB is not the gatekeeper of fiscal policy. Yet in the past it has only acted after certain steps were taken by governments. For example, the Greek purchases started after the first bailout and after the Greek government signed the MOU. Similarly with the others. In Italy, Draghi sought a secret agreement but it seems that it has backfired.

In other words, conditionality would prove a much bigger problem . The ECB does not want to do the dirty laundry of the governments. In this light, one should not expect much this month from the ECB. Conditionality can only be imposed by the Commission and the Council not by the ECB. Unless we have a clear sign of progress in this the ECB can do very little other than play with the Refinancing rate, the Deposit rate the regulatory reserves etcetera which in any case do very little in addressing the European debt problem.