ECB Greek loss dodge heralds end of bond buying

February 17, 2012

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The European Central Bank will avoid losses on Greek bonds through a legal manoeuvre. Such special treatment will not please the private bondholders who are being asked to take losses on their Greek debt. It might also bring the ECB’s bond-buying programme to an end.

The programme was divisive from the start, angering those – mostly German central bankers – who saw it as breaching the principle that the ECB shouldn’t help finance budget deficits. The second Greek bailout, based on a 200 billion euro debt swap, has introduced a new controversy: would the ECB take losses alongside private creditors – thus de facto handing out money to Greece – or get paid back in full, thus angering the other bondholders, coerced into accepting to take losses?

The ECB is trying for the middle ground, but it won’t please everyone. The central-bank owned Greek bonds will be exchanged for new ones that won’t be legally included in the restructuring. So the ECB will be repaid in full. But it then stands to make a profit out of the debt crisis – which would look like a provocation. So the idea is that the bank would over time give those profits back to its shareholders – the euro zone governments. They then could in turn use the money to refinance Greece.

But the fact will remain that private creditors were forced to take losses while the ECB wasn’t. In that context future bond purchases will be self-defeating. The more bonds bought by the ECB, the greater the share of debt deemed untouchable, the greater the risks borne by the other creditors, and the higher the yields could be pushed as the proportion of private sector bondholders shrinks further.

Yet this may not ultimately matter too much. The ECB now owns about 219 billion euros of peripheral bonds, of which up to 100 billion are estimated to be Italian bonds – only 5 percent of that country’s outstanding public debt. The programme may have been rendered obsolete by the ECB’s other crisis-fighting tool – long-term ultra-cheap bank loans injections – which has proved more effective in fighting contagion. But it still means that one of the tools in the ECB’s crisis box has been blunted.

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Othe than domestic banks, it seems pretty clear that no one in their right mind can think seriously about buying euro sovereign debt -especially in the struggling PIIGS. Despite statements from officials and the ECB that a Euro credit event will be avoided, it seems clear this will not be the case. In fact not only will we see a CDS credit event (caused by the PSI through stuffing the private bond holders by retroactively changing their terms eg inserting CACs that don’t currently exist) we will now see that the ECB rank ahead of other creditors, which is bad enough but made worse by the fact that it is often impossible to know how much exposure they have at a point in time. The consequences of the Greek PSI have been severely underestimated by officials and the markets – time will tell if I am wrong.

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