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Tag Archives: ECB

On Covered Bonds, Collateral Crunches, And The Circular Logic Of Central Banks

This post by Zero Hedge gives a subjctive interpretation of the current rush of covered bonds by Europeans banks, some of them soon approaching the limits for such issuance. Many banks retain large portion of the new bonds themeselves; which raises the interesting question if you can own your own debt!

The post goes on to argue that central banks are painting themeselve into a corner, where lack of collateral and requirement of collateralized lending (from CBs to banks) will finally meet.

If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time. 

At that point the system will collapse or central bank will be force to relax collateral requirements, ref. Tuckers discussion of this problem under the heading of “central banks’ time inceonsistency problem”, for a discussin of this dillemma see my Levy WP here on The Collateral Squeeze, p. 17

Alternatively (and better), central banks should let failing banks go into resolution and stop the collateral chasing. Better to start on this process before it becomes too late.

The EU Core remains massively exposed to the PIIGS

This table from Credit Suisse has recently updated the bank exposure (by country) to peripheral sovereign debt that shows just how massively dependent each peripheral nation’s banking system is on its own government for capital and more importantly, how the core (France and Germany) remains massively exposed (in terms of Tier 1 Capital) to the PIIGS.

See Zero Hedge for the full story.


LTRO will boost TARGET2 imbalances

This is technical stuff for the devoted, but still interesting background on the interactions between the new long term refinancing facility to ECB and the balances in the Euro payment system TARGET2.


Greek default is inevitable

According to Zero Hedge, who quotes several rating agencies, Greek default is by now inevitable. According to Handelsblatt, the agreement with private creditors (Private Sector Initiative) seems to be insufficient. Greece will then try to make the “voluntary” write-down mandatory, which will technically imply a default, with all the unforeseen ramifications.

… the rating agencies have long warned a Greek default is now inevitable, and a CDS trigger will follow. The only thing that there is massive confusion over is whether and how this event will impact everyone else, and whether it will lead to an expulsion of Greece from the Euro zone.

We are certainly heading into uncharted territory!

ECB collateral policy anno 2005: One size fits all!

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.

ECB’s heavy haircuts

FT Alphaville gives further details today on the regional variations in collateral requirements for the upcoming LTRO . As noted by Draghi yesterday, ECB will apply a hefty haircut of 2/3 on all pledged collateral. But national central banks have discretion within the new collateral rules to accept local assets depending on circumstances. Generally, the new guidelines imply that NCB’s will accept assets with ratings down to BB- instead of previously BBB-. But there are variations between NCBs as noted in this report, e.g. CB of Spain will accept mortgages, while the Irish CB will not.

The Germans think the ECB is giving away “easy money”. That can be debated, with such a heavy haircut.

EU moving towards political union

According to Monti, who spoke at the Peterson Institute in Wash DC today …

“We are moving perhaps even without being aware towards some form of political union”, Mr Monti said, adding that the Greek crisis has helped this along.

Interestingly, Monti is in the US while all his colleagues are in Brussels for tonight’s EU Council meeting. The distance allowed Monti to plead for flexibility for Greece. According to this WSJ story he urged the Trokia to award Greece an expanded loan package even with “a minimum of compliance”

Highlights from ECBs press conference today

Lots of interesting tidbits here from ECB chief Draghi’s press conference today. My favorite quote:

The new Fiscal Compact is a major political event. For the first time governments are giving up some of their sovereignty and are ready to put this into their primary legislation. This is a sign that the Euro is strong. It is a first timid step to fiscal union. This will not be a transfer union! All countries should stand on their own without continued subsidies from the others

But, what is the point of being together if you have to mange alone??

I have included my notes below. There are some new info about the LTRO coming up end of month. See also recent Zero Hedge post for more on the weakening collateral position and what it say about the banking sector in Europe.

  • ECB has more optimistic outlook than IMF for Europe, especially for Germany
  • Don’t see substantial downside, but rather stabilization of economy at a low level
  • But lots of uncertainty!
  • EU (consolidated) is in much better fiscal shape than the US and Japan
  • Inflation expectations are well anchored and remain low
  • ECB is very concerned about the current credit crunch, especially to SME (account for 80 % of EU employment)
  • Normally large banks would take money from ECB and distribute locally, but with interbank market not working, we have to enable them to get it directly from us
  • Therefore the ECB has relaxed the eligibility criteria for LTRO collateral  to enable smaller bank direct access
  • This will expose the ECB to more risk, but the risk is very, very well managed
  • Loans will be over-collateralized by a lot (haircut of 2/3)
  • The first LTRO was used by many banks to refinance their own debt; also many are facing higher capital requirements
  • We expect more will be used for lending (and purchasing government bonds) in the next LTRO
  • What they use LTRO for will be their own business decision (we cannot force them to lend)
  • But we are looking very closely at what is happening (with lending) and will review our policy options in 6 month time
  • Size of next LTRO will be substantial and (probably) at around same level as the first one
  • LTROs are non-standard (extraordinary) monetary policy operations that should not be continued when we get back to normal (funding markets)
  • LTRO is not an alternative to a rate cut. LTRO is addressing quantity constraints and liquidity deficiencies. Interest rate changes would address pricing conditions, subject to normal functioning financial markets. Markets are not functioning now, therefore LTRO.
  • Difficult for us to say how large next operation will be. There is no stigma attached to LTRO borrowing! There has been some press reports that it is undignified to borrow from the new facility; such “manhood” statements are not correct. Actually many much better banks (than the one quoted) have taken funds under LTRO1. Since this crisis originated as a sovereign crisis, many banks in better placed countries will not need the money. They should thank their countries for being well managed.
  • TARGET2 imbalances are inherent in a monetary union. Some are in surplus while others are in deficit. These imbalances are usually not high under normal conditions. Since the interbank markets are not working now, some countries have accumulated balances and others have seen negative balances grow. However, this does not represent any more risk; it is part of the normal functioning of the ECB.
  • Greece should focus on reform, not refinancing
  • ECB will not take haircut; not our intention to violate monetary financing prohibition
  • European Financial Stability Facility (EFSF) is a Government institution, i.e. if we make a loss on a transfer of Greek debt to EFSF, it will be monetary financing (of Governments)
  • Another matter if ECB transfer part of its profits to EFSF (i.e. Governments); that is not monetary financing
  • The new Fiscal Compact is a major political event. For the first time governments are giving up some of their sovereignty and are ready to put this into their primary legislation. This is a sign that the Euro is strong. It is a first timid step to fiscal union. This will not be a transfer union! All countries should stand on their own without continued subsidies from the others
  • Q: Do you have a plan B for Greece? D: We never have plan Bs (we will work this out, but cannot say more until after the EU Council meeting tonight)
  • Whatever is decided of haircuts for Greece (Private Sector Initiative) should not lead to precedent for other countries (including Ireland)
  • Ireland should be commended for the bold and courageous measures that are being taken


€680Bn LTRO Take Up?

Zero Hedge reports today that Goldman has conducted a poll among among banks and investors about their views on the next ECB long term funding operation coming up end of February. The consensus is for a substantial increase, close to 680 trillion euro. But, as the post notes, if the banks use this to exchange weak assets for cash in ECB deposits account, it is essential paying interest to retain mirage of solvency. Question is how long this process can go on? Perhaps, as ZH notes, until hedge funds start shorting all the banks taking money in the LTRO? Time will tell.

Dramatic drop in Greek budget revenues

This recent report shows that the Greek economy is imploding:

Revenues posted a 7 percent decline compared with January 2011, while the target that had been set in the budget provided for an 8.9 percent annual increase.

Worse still, value-added tax receipts posted an 18.7 percent decrease last month from January 2011 as the economy continues to tread the path of recession: VAT receipts only amounted to 1.85 billion euros in January compared to 2.29 billion in the same month last year.

And while the economy collapses, the Troika wants Greece to cut another 150,000 people, and to cut minimum wage even more. Where will this end?