— Fresh ECB/Bundesbank Spat Won’t Alter Policy Course
FRANKFURT (MNI) – Eurozone finance ministers on Thursday took a
big, if reticent, step towards final approval of a second Greek bailout
package that should enable Greece to avoid defaulting on E14.5 billion
worth of sovereign bonds falling due on March 20 and allow for a
significant reduction in the country’s debt stock.
The debt reduction portion of the package, primarily consisting of
a bond swap with private creditors (PSI), is not expected — at least
for now — to cause a much feared credit event.
Even if a credit event does eventually occur, triggering payments
on credit default swaps, the E1 trillion of new 3-year ECB money
floating around in the banking system could take much of the horror out
of it — though the situation clearly remains fragile.
The International Swaps and Derivatives Association on Thursday
determined that neither the voluntary private sector agreement between
Greece and its private bondholders nor the ECB’s decision to exclude
itself from collective action clauses will trigger credit default swaps.
However, the decision could yet be reversed in mid-March should
Greece enforce collective action clauses on private investors in the
absence of sufficient voluntary participation in the current PSI offer.
Any special treatment of the Eurosystem central banks at that time could
be considered subordination of other bondholders and thus deemed a
credit event.
The ECB has previously stressed that Greek bailout policies must
avoid triggering credit default swaps, given fears that this could
encourage investors to bet on other European defaults and provoke
another eruption of the Eurozone debt crisis.
Should it indeed remain protected against losses in a forced
restructuring that would leave the ECB in a weaker position to address
any possible bond market tensions, since its senior creditor status
could leave the bond buy program ineffective by increasing risks for
private investors.
The success of the ECB’s three-year tenders, coupled with a
positive reaction to the ongoing reforms by national governments and the
EU itself, has significantly reduced the risk that a payout of Greek CDS
might spark large-scale gambling on an Italian or Spanish default.
Since the first three-year tender, Italian and Spanish bond yields
have dropped significantly. Just before the New Year and shortly after
the first three-year LTRO, Spanish 10-year yields stood at around 5.43%.
They then fell to 5.02% just prior to the second three-year operation on
February 29. In the same period, Italian yields dropped from around 7.0%
to 5.3%.
Helped in part by looser ECB collateral rules, banks’ demand in the
February 29 operation rose to E530 billion. The number of bidders surged
to 800, up from 523 in December’s operation, as new collateral allowed
smaller banks access to ECB funding. The additional funds are expected
to further reduce refinancing costs for the peripheral Eurozone states.
Meanwhile, a fresh spat between the Bundesbank and the ECB
regarding the Eurotower’s risk management may highlight divisions on the
Governing Council but is unlikely to alter the ECB’s policy, which has
proven vital in easing debt market tensions and addressing credit crunch
concerns.
Germany’s Frankfurter Allgemeine Zeitung reported Thursday that
Bundesbank President Weidmann wrote a letter to ECB President Mario
Draghi warning about the risks associated with lax collateral rules and
calling for a return to the pre-crisis framework. The Bundesbank said
that the letter was part of an ongoing exchange between Governing
Council members.
Despite much noise about Weidmann’s letter, which reflects
disagreements on the Governing Council, it is not particularly
surprising or new.
The Governing Council’s decision in December to keep some new
collateral rules at the national central bank level, along with the
associated risk, had already made clear that not all Council members
were happy with idea of looser rules.
Still, convinced that the ECB “will manage the risks entailed” and
haunted by fear of a severe credit crunch, the Council did agree to
change the rules. Draghi on Friday welcomed the strong pick-up in LTRO
uptake by smaller banks — which probably used newly eligible collateral
— noting that they “mainly finance small and medium enterprises, which
account for 80% of employment in the euro area.”
Given tight lending conditions and persistent fear of a credit
crunch in the Eurozone, the central bank should not be expected to
reverse its decision before the set review date in six months time. The
central bank would risk losing credibility if it were to reverse its
decision too quickly.
The Bundesbank’s avowed opposition to the new policy could
theoretically stop a third three-year LTRO from taking place. But a
third operation was never likely anyway. The central bank decided last
year, in an environment far grimmer than today’s, to conduct two — not
three or more — tenders. There is no convincing reason why the ECB
should scale up its policy reaction as the tensions wane.
There is no doubt that the Eurosystem has taken on severe risks and
the Bundesbank’s warning serves as an important reminder that a timely
exit is key. But now is not the time, and the ECB will certainly be
cautious to avoid a second premature exit.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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