Oct 25 (Reuters) – Euro zone leaders will call on the European Central Bank to go on buying bonds in the secondary market to support the likes of Italy and Spain, according to draft conclusions obtained ahead of a summit on Wednesday…
So the eurozone won’t be relying on the rather meagre EFSF balance sheet after all… maybe. (See below.)
Governments will just use the ECB’s instead. Simple, right?
The thing is, even agreeing that the ECB is the only credible balance sheet left in Europe, we’re not sure why everyone thinks the central bank will agree.
This is a good time to point out that over on the FT A-List, George Soros has a seven-point plan to save the eurozone. Go read it!
Although here it is in summary:
1) The ECB
2) The ECB
3) The ECB
4) the ECB
5) The ECB
6) The ECB
7) Markets will be suitably impressed by the ECB
…We have summarised quite a bit. It’s more complicated than that, although it ultimately comes down to much greater ECB support to eurozone sovereigns.
Actually, the points of the plan are (in sequence): The ECB provides liquidity to the EFSF. The EFSF buys Greek bonds from the ECB and guarantees bank debt, not sovereign debt (remember, backstopped by ECB liquidity). Greece also secures some voluntary debt reduction. The EFSF guarantee is given in return for the ECB “instructing banks”. If instructions given by the ECB are not followed, access to ECB liquidity will be cut off. The ECB’s instructions will include, and not be limited to, maintaining loan books and avoiding deleveraging.
Governments are then told (by the ECB) to issue T-bills which banks buy up in their droves for their liquidity management. The EFSF provides protection on this paper. Everyone makes sure Italy doesn’t go nuts on the T-bill issuance. A happy ending ensues, with markets realising that the eurozone finally has a balance sheet to be reckoned with.
Which is, in the final analysis, the ECB’s.
(Coincidentally, wouldn’t this be the most amazing euro short?)
You might quibble with some parts of the plan but at least it is very clear about its starting point, the ECB. And of course many analysts have been calling for crisis solutions to move on from the EFSF’s finite balance sheet, to making use of the ECB’s omnipotent, effectively limitless balance sheet. Think of all the deep pockets of seigniorage, oodles of liquidity, et cetera. Only the ECB can absorb the quantum of sovereign losses, other analysts argue.
We definitely wouldn’t say this argument is wrong, or unworkable. It has an intellectual pedigree: the ECB should be a central bank straight out of Lombard Street, providing liquidity to a fundamentally decent, and solvent, sovereign credit like Italy. (Except did Bagehot say very much about lending to sovereigns? Do we know Italy is solvent?)
However…
What we will say is that the ECB would never go along with it – based upon what the ECB has been doing so far. For example, the Soros plan has nice workaround for a major ECB article of paranoia, the fear of write-downs on its Greek bond holdings, by simply having the EFSF buy them. In general however, the ECB is extremely driven to insist that governments “honour their sovereign signatures“. This is also a part of the ECB’s well-known resistance to the monetary financing of sovereign debt. Greece is only the tip of the iceberg for the ECB.
Soros is at pains to note that the ECB will not “print money” or lend to governments as part of his T-bills plan, but we seriously doubt the balance of opinion at the ECB board would see it like that. Put it this way: no one is resigning from the board because they want more sovereign bond purchases.
And to top it all off, even if the ECB converted overnight, the most powerful government in the union is next in line to be convinced. The next most powerful government can’t change Germany’s mind, why will anyone else?
Frankly, at this point we’re open to theories on why the ECB has resisted the calls to provide sovereign liquidity. If we were political scientists (or, er, back studying International Relations at our alma mater), we’d say the central bank would be a classic case study for Bureaucratic Politics Theory (or the Bureaucratic Politics Model).
BPT basically comes down to the principle that you stand where you sit. The ECB board sits down at every meeting to talk price stability, within its mandate. It cannot see the world apart from through the lenses of price stability. As a bureaucracy designed to deliver price stability, the ECB is extremely jealous of encroachments on its goal and/or outside actors forcing new goals on it. It’s a bit like how the military usually always favours going on the offensive in a crisis, and the diplomats usually favour negotiations. There are further aspects that recall BPT, such as the way the ECB largely (and unavoidably) works and meets in secret, and in isolation from other agencies.
We wonder if it is, frankly, as simple as that. You can freely point out that the ECB might actually often misjudge monetary policy (viz. the abortive interest rate hikes of 2008 and 2011) but no one says bureaucracies have to be good at their goal. Rather the point is that they privilege their goal above all else.
In short, there are a lot of eurozone plans out there which involve massive dollops of institutional complexity to work (such as EFSF leverage proposals). Which is fine. But when they smooth over the current, apparently intractable institutional complexity facing the eurozone, especially the ECB’s amour propre versus governments, it’s less likely that they would ever work.
Speaking of which, at pixel time:
RTRS-GERMANY’S MERKEL SAYS WE DO NOT WANT A DECLARATION FROM POLITICIANS TO THE ECB ON WHAT THEY EXPECT FROM IT
See what we mean? Intractable.
Related links:
You are neither dumb, nor stupid, Paul… – Kantoos Economics
You shall not default, the ECB commands it – FT Alphaville
Pressure grows on the ECB to cut rates – FT