Thursday, December 2, 2010

ECB Is Listening.. (?)

It's been just a few days since my "Modest Proposal" post and the ECB is (finally) poised to intervene in the government bond market, looking to buy PIG(S?) debt in the secondary market.  Excellent decision, if I may say so myself (insert false modesty).  And to be really effective it should be a massive, knock-out blow.  Hopefully ECB has some canny market operators in its staff who know how to act for maximum effect.

But as my proposal detailed, it's not enough for the ECB to just buy and hold existing government bonds on its books.  The second step in this process, the exchange of old bonds for new ones at cost resulting in a reduction of debt by 30-50%, ought to follow immediately.  The benefits to the national economies from a lower debt load and smaller interest payments would be very significant, making the market's reaction to the ECB operation even more pronounced.

Better yet, if the ECB exchanged the national bonds with Euro-bonds that are - almost certainly - coming, we would be talking about a Perfect Storm hitting the shorts.


  1. Good that you put a question mark on it.

  2. Can the Fed do this with the Treasury?

    That is have the the Treasury buy back bonds at face value?

  3. Is there any downside to your scheme?

  4. There are downsides to everything.

    The relevant question is this: is my scheme better than what is going on right now and is it viable over the next, say, 5 years?

    I believe so.

  5. Ooops, I meant to add something:

    Since you asked for downsides, however, here is one: if the ECB buys a significant amount of PIG debt it will be their single largest creditor. Sometimes it's a good idea to have one big powerful lender, instead of many small ones. But sometimes it isn't..

  6. Unfortunately lots of PIIGS bonds are in the books of financial institutions, e.g. insurances, banks, pension funds and so on. None of them can afford to receive considerable deficits from haircuts - otherwise the defaulting would spread. Fot the ECB acting like a pure "trader", oder really as a kind of speculator this is surely of no meaning. For the original bond holders, a reduction of their assets to "face value" is unacceptable. Just see the current debate concering junior debt of irish banks, where such a situation manifests. So the idea, as nice it is, is one of a trader's perspective, not of an investor's, who are the real protagonists. It is unworkable.

  7. Obviously not everyone would sell and accept the loss. This is purely voluntary, within the operation of the secondary bond market. It would be an open market operation, exactly as the ECB is doing right now.

    If you watched Mr. Trichet's press-conference last week, he was very vague about the Bank's bond purchase program. That's SMART, though the market initially reacted negatively.

    In my proposal the twist comes after the purchases, i.e. by the ECB exchanging the bonds with new ones at cost.

  8. Please don't forget, the ECB is a government (inter-government) institution. If it begins to restructure some of the debt, this has the same meaning as an openly declard partial default. If it pretends this to be something different, it will surely be sued, and that would end the procedure quickly.

    Asides from this the ECB has not even the legal authorisation to restructure debt and to define future face values and interest rates. This can only be done by an agreement of the creditors. Usually the organisation which deals with such problems is the "Pariser Club".

  9. I disagree. The bank would not be taking ANY loss under my proposal. I repeat the example:

    ECB buys from the open market 100 mio face 4.60% Greek bonds maturing in 30 years at 50, costing it 50 mio. It gives them back to the Greek state and gets back 50 mio 4.60% bonds maturing in 30 years.

    Being smart, the Greek state instead of issuing new bonds could just do a re-open of the SAME issue.

    If the CDS market doesn't like it that's its problem - and that's the point. If they want to sue the EU/ECB/Greece, well, go ahead. What would be their argument? That they lost money on a side bet?

    As presently structured and allowed to operate the sovereign CDS market is entirely immoral, in the wider sense of the word.

    Besides, I don't think they want to go to court. It could be revealed, for example, how much market manipulation, collusion and taking advantage of dominant position takes place.

  10. Thanks for the information..I really like your post..I will definitely look forward to it..I have bookmarked it..

  11. Simply, ECB is legally in no way entitled to restructure government debt. Believe it or not, division of powers and constitutional state does not allow a government organisation to do just what it wants. Otherwise woodsmen of your region could declare themselves tax collectors.

    ECB could probably not even take part in a conference of debtors and creditors. It's simply not her task. Reason: If she would be entitled to do what you propose, no one would sell Greek bonds, because the ECB now virtually guarantees them. No one would buy bonds either, because it is not clear if it really will do so, and under which conditions. The bonds' values would become uncalulable. Result: Greece could not refincance, as ever. You cannot fool markets. Market manipulation normally does not originate from markets, but from government organisations and their disbursements. See also

    But be assured, the ECB is already performing strong manipulations: Most southern European banks currently cannot raise funds in markets. Markets are closed for them, because confidence into southern Europe debt is lost. Command confidence? This is only believed in socialism.

    The real solution would be to allow Greek a partial haircut. And all the other problem debtors too. Officially, with all the bells and whistles. Then we can look, what will happen. And ECB can do what it loves to do: save something. Idea: Better sooner than later.