Exhibit one, the Greek default.
The European Central Bank will not take losses on Greece. It will not even have to do anything tricky with ‘purchase prices’ etc under the latest bailout deal. The ECB simply hands over profits on the bonds that it makes over time (accrued coupons, “pull to par”, so on) to eurozone governments – a perfectly normal operation – who can then commit the (pretty meagre) proceeds to Greece.
While private bondholders justifiably howl about subordination, that leaves the bank not financing sovereigns. Governments, and by regression the ECB, don’t have to hand debt relief to Greece with these profits. Having to would violate EU Treaty law. So a legal quandary for the ECB, of not transferring its resources to Greece, is gone.
Well, sort of.
There’s a good point in a WSJ piece on Wednesday:
With its holdings safe from losses, the ECB’s Greek bonds should generate profit of around €5 billion over the next three years. But Athens will likely get less than that. Under the first bailout in 2010, governments made bilateral loans to Greece. With those rates now cut as part of Tuesday’s agreement, countries such as Spain and Italy have higher borrowing costs than the interest rate Greece will now pay them. These countries will be able to use profits from their central banks to make up the difference so they don’t lose money on the deal.
It’s like transfers to compensate for transfers, no? Both Spain and Italy would have been making fiscal transfers to Greece from the deadweight losses on their loans. The rate change is surely just the harbinger of more transfers down the line, as the price for allowing the Greece to default within the eurozone. Euroland bankrolling the Greek current account indefinitely, negotiated official writedowns to come, etc
How much will the ECB be an agent in those future transfers, we wonder?
Exhibit two, the second LTRO.
More evidence/forecasts of bank demand for sovereign debt under the auspices of the ECB’s last three-year liquidity op on Wednesday, by the way. As well as noting the successes of the first three-year LTRO in December - €93bn of unsecured bank debt issued since the start of 2012, bank stocks levitating off their distressed lows – Morgan Stanley’s analysts also looked at the prospects for further government bond carry trades from Italian and Spanish lenders.
We’ll go back to their findings in a full post later, but this stuck out (charts via MS, click to enlarge):
In our note ahead of the first 3 year LTRO (December 13), we estimated Spanish banks may buy €20-60bn of government bonds from the two LTROs put together vs. €86bn of government refinancing needs. So far we believe they have bought €27bn from the first 3 year LTRO… where are we now? If we assume our base case LTRO range and the same % taken down by Spanish banks and the same % put to work in government bonds, we may see a further €25-60bn of buying off government bonds in Spain. This could mean Spanish banks alone could help Spain fully fund for 2012.
Though from Deutsche’s Thomas Mayer on Wednesday…
In principle, profits from carry trades with government bonds would seem to be an easy way to repair banks’ balance sheets and they were used by Japanese banks in the decade after the burst of the bubble economy in the early 1990s to this effect. However, one should have no illusion that these profits would not represent transfers from the tax payer, who has to pay the interest on government bonds, to the banks. The latter get central bank money at very low cost and hence deprive the central bank and in turn the tax payer from seigniorage income, which arises from central bank lending at positive interest…
Seems the entwining’ll go on.
Related links:
So, what would your plan for Greece be? – Crooked Timber
ECB seniority and dirty hands - FT Alphaville
On balkanisation and credit claims – FT Alphaville
Bagehot, bailouts and banks — the entwining continues – FT Alphaville