Holy cow, who knew the intricacies of the eurozone’s payment system could be so controversial?
Hans-Werner Sinn, a respected German economist, riffed on a point first made by John Whittaker, an economics professor at Lancaster University, on FT Alphaville. The idea was later picked up by FT columnist Martin Wolf, and Reuters blogger Felix Salmon, and exploded into a web-wonkfest.
In case you missed it — the basic theory was that Germany’s central bank is lending a whopping €300-325bn to other (mostly peripheral) central banks in the eurozone via the Target2 system of payments. Sinn went on to interpret the €300bn balance as representing a ‘bilateral claim of the Bundesbank on other central banks,’ mostly peripherals. A so-called ‘stealth bailout,’ which, he added, was likely to ‘crowd out’ the Bundesbank’s liquidity to German banks. Martin Wolf reckoned the flows equated to a “backdoor way of financing debtor [i.e. deficit] countries” in the eurozone.
On Wednesday, JP Morgan’s Greg Fuzesi has waded into the issue:
To clarify one issue upfront: the Bundesbank loans are not in addition to any lending by the “ECB”. They are the same thing. In fact, when people talk about the ECB’s balance sheet, they are really talking about the consolidated Eurosystem balance sheet (i.e. that of all national central banks and the ECB). The lending from the Bundesbank is simply the way that the well-known “addicted banks” problem and the peripheral banks’ reliance on “ECB” funding is accounted for. Given that any losses would be shared among the ECB and all national central banks, the fact that the loans have in practice come from the Bundesbank is almost irrelevant. More importantly, we disagree with the idea that we have almost reached the operational limit of how much more the Bundesbank can lend and that all of this is already hurting German growth. Here is our reasoning:
The Bundesbank’s €300bn debt to the periphery
The data at the center of this debate are intra-Eurosystem positions of the national central banks in the payment system. These show that the national central banks in the periphery owe well over €300bn to national central banks in core countries (and almost entirely to the Bundesbank). Hence, it appears that the Bundesbank has extended over €300bn of loans to the periphery, an amount which far exceeds the “official” aid packages.
These intra-Eurosystem positions arise naturally from the way payments are settled within the Euro area. If an Irish consumer purchases a German car, bank deposits will have to be transferred from the account of the Irish consumer (at an Irish bank) to the account of the German car manufacturer (at a German bank). As these banks hold reserves in accounts with their national central banks, rather than directly at the ECB, the settlement of the transaction requires the transfer of such reserves from the Central Bank of Ireland to the Bundesbank. In return, the Bundesbank receives a net claim on the Central Bank of Ireland (which is backed by collateral). The same effect results from a loss of confidence in the periphery, with savers transferring their bank deposits to “safer” banks in core countries, as in a bank run.
That the net exposure now sits on the Bundesbank’s balance sheet is simply because the deposits flowed to Germany, rather than to France or other core countries. As noted above, any losses would be shared among all national central banks (and the ECB), and hence ultimately among all taxpayers in the region. Therefore, these data simply illustrate in a different way just how much support the Eurosystem/ECB is giving to the periphery.
Well said. Critics are picking on a very technical point here.
The Bundesbank is technically not a €300bn creditor to eurozone peripherals like Greece — ultimately the eurosystem holds the claims. According to an old press release from the German central bank: “there is no immediate change in the level of risk to the Bundesbank due to the rise in its Target2 settlement accounts. This risk is not directly related to the Target2 positions and arises from the risks associated with the eurosystem’s liquidity supply.” But eurosystem losses are possible: “An actual loss will be incurred only if and when a eurosystem counterparty defaults and the collateral it posted does not realise the full value of the collateralised reﬁnancing operations despite … risk control measures.”
But guess who’s liable for eurosystem losses?
The national central banks — including Germany — whose share of ECB capital also happens to be the largest amongst the NCBs. According to ECB capital keys, Germany’s on the line for 28 per cent.
Now, the main point of Whittaker’s original paper was simply to demonstrate that states like Germany were already providing hefty support to Greece viz their eurosystem involvement. Sinn somewhat clumsily amplified this into a ‘secret German bailout,’ which it is not. Unfortunately he also connected it to a lack of Bundesbank support for Germany’s banks, which it also is not.
What it is, is a round-about indicator of the scale of liquidity provided by the eurosystem to compensate for outflows from peripheral states. Outflows which you can see in the below (JPM) charts:
On that note — one last word from Fuzesi:
The limit to all this is the ECB/Eurosystem’s willingness to lend more and more to peripheral banks against acceptable collateral. The ECB has already made it clear that it is the job of peripheral governments to recapitalise and restructure their banks so that they can re-attract private funding and thereby reduce their reliance on the central bank. In contrast, there is no operational constraint in Germany. German banks are currently borrowing €65bn from the Bundesbank. Should there be another wave of deposits flowing from the periphery to Germany, which is larger than this, then German banks would be unable to offset it in full, leaving them with more low-yielding excess reserves at the Bundesbank. This poses no immediate problem however. Ultimately, the only way to reverse this is for investors and banks to invest in the periphery again by purchasing their assets.
The argument about whether or not these eurosystem flows equate to backdoor financing is much more subtle, and dare we say, subjective. Clearly these are not ‘official’ loans, they’re the movement of deposits between eurozone countries, but neither do they happen without credit risk to other, stronger, European countries. In normal times, the depletion of funds in peripheral Europe would have been reversed with private capital flows, as JPM suggests. Now, with the crisis, not so much.
Lots more further reading, in reverse chronological order, below.
Felix Salmon smackdown watch, European central bank edition – Felix Salmon, Reuters
The stealth bailout that doesn’t exist: debunking Hans-Werner Sinn – Olaf Storbeck, Handelsblatt
Professor Sinn misses the Target – Karl Whelan, IIEA
How Europe’s central banks are staving off catastrophe – Felix Salmon, Reuters
The euro living dangerously – Paul Krugman, New York Times
Intolerable choices for the eurozone – Martin Wolf, FT
The ECB’s stealth bailout – Hans-Werner Sinn, VoxEU
Some intra-eurosystem inequality – FT Alphaville
Mechanics of a European capital flight – FT Alphaville