Sovereign debt bubble thread

[Sheilbh]

My understanding is the ECB has an issue with haircuts because of all the shyte bonds they bought up.

I don't think this isn about haircuts in general, it's only about private sector haircuts. 

[Admiral Yi]

I don't think this isn about haircuts in general, it's only about private sector haircuts.

If the ECB is holding a bunch of Greek debt that gets written off at 50 cents on the dollar, presumably the stuff they are holding will fetch less than par in an auction.

[MadImmortalMan]

According to these guys, Germany is paying for it all anyway.


http://www.voxeu.org/index.php?q=node/7391


Figure 4. Claims on the Eurosystem (up to September 2011)

[Sheilbh]

If the ECB is holding a bunch of Greek debt that gets written off at 50 cents on the dollar, presumably the stuff they are holding will fetch less than par in an auction.

Actually I don't think that's the case.  My understanding, I think confirmed by MIM's link (which is worth a read), is that the ECB and EFSF bond purchases are like the IMF's they won't get cut and they haven't with Greece so far, from my understanding.

[Admiral Yi]

What does "claims on the Euosystem" mean?

[Sheilbh]

What does "claims on the Euosystem" mean?

I'm not sure.  I've read another perspective on the assets of the Bundesbank (another chart in that link) that said the Bundesbank's position right now looks like the BofE before the speculative attacks on Black Wednesday - the ERM disaster.  Although they suggested it could be resolvable because the ECB can print more Euros the BofE couldn't print more DMarks.

[MadImmortalMan]

Basically, the gist is that the Bundesbank is expending most of its lending power in this effort.

[Zanza]

What does "claims on the Euosystem" mean?

It's about TARGET2 ("Trans-European Automated Real-time Gross Settlement Express Transfer System"), the cross-border clearing system in Europe.

If a Greek buys something from Germany and no Germans buy anything in Greece, the involved banks will clear the transaction via their respective central banks. The massive claims the Bundesbank has on other ESCB banks mean that the current account balance of the various Eurozone states is no longer balanced (unlike before 2009 when the money earned from German exports was reinvested in the periphery).

JR mentioned this before here. Here is the post:
http://languish.org/forums/index.php?topic=4699.msg266495#msg266495 (#62)

[The Minsky Moment]

What does "claims on the Euosystem" mean?

Claim of a national central bank (like the Bundesbank) on the ECB.

Let's say Germany exports goods to Greece but Greece does not export back goods of equivalent value.  The difference must be financed. Let's further say that instead of paying cash immediately, the importer finances the purchase on credit.  Assuming the vendor wants to receive cash, the financing is achieved by the Greek importer borrowing the euros from the importer's local Greek bank so that the euros can be transmitted to the German exporter's bank in Germany.

But if Greece runs a large current account deficit (and it does and did) - then over time there is big flow of euros coming out of Greece to Germany, raising the risk of euro (liquidity) shortage in Greece.  The way this is handled is that the central bank infrastructure steps into place as an intermediary.  So the Greek central bank borrows Euros from the ECB and uses those Euros to supply the needed liquidity to the Greek banking system.  But where does the ECB get those Euros from?  It must be from another member state central bank - in this case this Bundesbank.  If this continues over time, then the ECB will end up owing the Bundesbank lots of money (ie the Bundesbank will have claims on the ECB) and there will be a corresponding amount the Greek central bank owes the ECB (i.e. the Greek Central Bank will have negative claims on ECB).

What is really happening here is that the Bundesbank has been effectively underwriting or subsidizing German exports to the eurozone periphery by providing cheap trade finance to the importer, but the true nature of that economic reality is hidden by the layers of intermediaries in the Eurosystem.  The consquence is that the Bundesbank is exposed in the event of an economic meltdown in the PIIGS.

EDITL noticed Zanza's intermediate post but kept this anyway for additional explanation.

[Zanza]

By the way, the ECB does not think it creates any risk:

http://www.ecb.int/pub/pdf/mobu/mb201110en.pdf

In EMU, a claim in TARGET2 does not, in itself, refl ect the relevant NCB's exposure to fi nancial risk. The risk exposure of the central banks forming the Eurosystem (i.e. the NCBs and theECB) relates to the monetary policy operations themselves, not to the associated TARGET2 balances. As always, a central bank faces counterparty risk when implementing monetary policy.
The risk associated with the provision of central bank liquidity as part of the implementation of monetary policy is mitigated by a risk management framework.10 The Eurosystem's collateral framework is based on a public list of securities fulfi lling the relevant eligibility criteria, together with risk control measures. In particular, securities pledged as collateral are valued on a daily basis, at market prices (where available) or using conservative valuation methods, with haircuts also being applied. The residual risk associated with the provision of central bank liquidity that may emerge despite the risk mitigation measures, is, as a rule, shared among the NCBs of the Eurosystem in accordance with their respective shares in the ECB's capital and is not related to the TARGET2 positions of individual central banks.

[Admiral Yi]

If counterparties have to pledge collateral then of course there's risk, the risk that your national central bank has to forfeit big chunks of its reserves.

Anyone know the motivation for this system?  Why not just let importers pay for stuff like normal countries do?

[Zanza]

You can't have a monetary union without such a clearing system. Otherwise an Euro in Greece wouldn't be the same as an Euro in Germany.

[The Minsky Moment]

By the way, the ECB does not think it creates any risk:

Yeah  . . . that's the ticket.

The ECB is saying that in the event of a default by a borrowing NCB, the ECB bears the credit risk, and not the lending NCB.  It is also saying the risk it mitigated by requiring pledges of good collateral.

However:

1) A principal form of collateral accepted by the ECB is member state government bonds.  Which means the collateral securing the obligations of the Greek Central bank is . . . Greek government bonds.  How's that working out for ya, ECB?

2) If the ECB takes a big loss, it either has to print a ton of money to cover it, or get refunded by the solvent members of the Eurosystem.  I.e by Germany.  Either way, it is a bad outcome for Germany.

[The Brain]

You can't have a monetary union without such a clearing system. Otherwise an Euro in Greece wouldn't be the same as an Euro in Germany.

Why would anyone have a monetary union with Greece?

[The Minsky Moment]

If counterparties have to pledge collateral then of course there's risk, the risk that your national central bank has to forfeit big chunks of its reserves.

But sticking with the Greek example, other than a few bars of gold, what reserves does it have?  The latest balance sheet shows over Euro 100 billion in TARGET2 liabilities.  The largest two items on the asset side of the balance sheet availble to cover this are: (1) Euro 72 billion in "Long-term refinancing operations" - long term loans to Greek private banks, and (2) Euro 41 billion in "Sundry" assets (!)

Good luck getting blood out of that stone.