ECB collateral policy anno 2005: One size fits all!
February 13, 2012
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Willem Buiter (LSE, now at Citigroup) was a fierce critic of ECB’s collateral policy back in the mid-2000. He claimed that the collateral policy did not differentiate between the underlying credit risk, and therefore papered over the convergence problems in the periphery countries. See his 2005 paper with Anne Sibert (Birbeck) on “How the Eurosystem’s Treatment of Collateral in its Open Market Operations Weakens Fiscal Discipline in the Eurozone
ECB Chief Economist Ottmar Issing responded in a speech the same year, and stated that:
Let me take the occasion to briefly comment on an idea that seems to gain more and more support. It has been recently argued that the ECB should use its collateral policy as a sanction to exert fiscal discipline on those euro area member states that breach the 3 % limit. One possibility would be for the ECB to impose haircuts on the bonds issued by those governments that fail to comply with the Pact, thereby making those bonds less attractive for counterparties to hold and use as collateral in the ECB’s regular operations.
Although superficially appealing, this suggestion would be misguided. First of all, such a measure would exceed the mandate of ECB’s collateral policy, which is to manage risk in monetary policy operations. Assigning additional roles to collateral policy would deflect it from its primary and crucial purpose.
Second, such a proposal ignores the differentiation already applied by the ECB in valuing collateral. All financial assets offered as collateral, including government bonds, are valued daily at market prices. In its collateral policy, the ECB therefore relies on the judgement of the market to distinguish among government bonds and, implicitly, the fiscal behaviour of member states. Moreover, the ECB sets credit standards for the eligibility of assets as collateral and is bound by the Treaty not to distinguish between government and private issuers in the implementation of these standards.
It is interesting to read his response today, with all the ongoing problems in the sovereign debt markets still unresolved. Buiter’s argument was that the ECB collateral policy was circular, as the market valuation reflected the ECB position that everybody was equal. Thus, the market for sovereign bond converged towards the common low denominator of the German Bunds, enabling periphery countries to borrow at low cost and delay the required real convergence. But that is all history now.