FRANKFURT (MNI) – Friday’s breakdown of Greek debt talks raises the
chances that the central banks of the Eurosystem may have to take a more
active role in the new Greece bailout to prevent an uncontrolled default
and avert potentially chaotic contagion when some E14.4 billion worth of
Greek bonds come due next month.
Departing from their previous position, the Eurosystem central
banks could decide to bridge the gap between the total sum the
International Monetary Fund (IMF) is demanding to remain committed to
saving Greece and the money that the private sector and Eurozone
governments are willing to put up. The central bank would do this, if
their help is needed, by accepting haircuts on their own Greek bond
holdings.
The Eurozone leaders’ decision to insist on private sector
involvement (PSI) in a new Greek bailout is seen as the main driver
behind spiraling borrowing cost in Italy, Spain and elswhere that
induced rating agency S&P on Friday to downgrade more than half of the
Eurozone’s 17 countries, including France and Austria.
An uncontrolled Greek default could spook investors even more, with
grave consequences for the region. The recent optimism following
successful sovereign debt auctions in Europe and a massive ECB injection
of three-year money into the system could quickly turn to unprecedented
pessimism with regard to the outlook for Europe.
ECB policy-makers have repeatedly warned that a Greek default would
be a disaster. Market News International understands that the Eurosystem
may now be willing to put up its own cash to avert this disaster.
Should IMF demands for significantly higher private bondholder
losses or a boost to the E130 billion bailout plan by Eurozone
governments not be met, the Eurosystem central banks could contribute to
the overall debt relief for Greece by accepting haircuts on their own
holdings of Greek bonds.
Even before news of a breakdown in Greek debt talks on Friday,
options discussed at last week’s Governing Council meeting included
accepting a haircut on bonds bought by national central banks for their
own books before the European Central Bank launched its Securities
Market Programme (SMP) in May 2010.
According to a senior Greek official, the haircut would be much
smaller than the 50% reduction in nominal value expected of the private
sector — namely 25% to 30%. The ECB, which oversees certain activities
of the national banks in the Eurosystem, has signed off on that plan
should it need to be used, the Greek official said.
Another option discussed at the central bank is the possibility of
a haircut on the roughly E40 billion worth of Greek bonds purchased
under the SMP, but it is not clear that approval was given for this.
MNI understands that if the SMP-purchased bonds were also to be
included in the haircut plan, the national governments of the Eurozone
would be required to reimburse their central banks for any losses on
them. Given governments’ reluctance to put up more cash, any eventual
Eurosystem contribution would likely exclude SMP holdings.
Interestingly, however, ECB President Mario Draghi on Thursday was
not prepared to reiterate his predecessor Jean-Claude Trichet’s strong
objection to ECB participation in a private sector deal. Draghi twice
avoided giving a direct answer Thursday when asked if the ECB would
accept a haircut on Greek bonds in its possession.
Political leaders’ agreement at their summit late last year to drop
the idea of forcing private creditors to share the burden in any future
sovereign insolvencies may have contributed to a change of heart in the
Eurotower.
Having witnessed the massive fallout from the private sector
involvement, Eurosystem policy-makers may well believe that accepting
losses on central bank holdings would indeed be the less costly option.
Market tensions following an uncontrolled Greek default could force
the central bank to further expand bank support measures and to
massively step-up government bond purchases in the SMP program.
Should a be default be coupled with Greece’s exit from the
Eurozone, the Eurosystem could also be exposed to losses from the
roughly E100 billion that the Greek central bank owes other Eurosystem
central banks as a result of the internal settlement system TARGET 2.
There is also no guarantee that the Eurosystem can protect its own
bond holdings in case of an outright default. Analysts have warned that
ECB demands for full debt repayment even in the face of a more coercive
restructuring could have dire side-effects for the Eurozone.
Such demands would turn the ECB into a de factor senior creditor
and could turn the SMP into a double-edged sword: The more Italian or
Spanish debt held by the ECB, the bigger the risk for private sector
investments in those bonds. In such a scenario, the SMP may no longer
serve as a tool to jump-start the market, but may have to replace it
entirely.
Eurosystem participation in the private sector involvement for
Greece, on the other hand, could send the exact opposite signal. If the
Eurosystem is ready to share the pain of private creditors on condition
that Greece remain a unique case, private investors might be more
willing to take a chance on high-yielding debt from other peripheral
Eurozone countries.
As the Eurozone moves closer to the abyss, its future may once
again lie in the hands of the Eurozone’s central bankers. Despite much
criticism to the contrary, the ECB appears to have taken a pragmatic
approach — at five minutes before midnight.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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