Counterparties: Draghi makes his move

September 6, 2012

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Mario Draghi has made his leaked proposal official: the European Central Bank will buy unlimited amounts of troubled euro zone debt on the open markets in an effort to push down sovereign borrowing costs. The NYT’s Jack Ewing and Steven Erlanger write that the plan puts the ECB’s “unlimited financial clout behind an effort to protect Spain and Italy from financial collapse” and “effectively spreads responsibility for repaying national debts to the euro zone countries”.

The plan, called “Outright Monetary Transactions” (OMT), will purchase bonds maturing in the next three years, after countries have made a request to the euro zone’s bailout fund and fully agreed to its conditions. If countries renege on their promises in areas like banking reform or fiscal policy overhauls, the ECB will terminate the bond purchases. Importantly, the ECB will not have seniority over private bondholders.

Draghi was coy in his press conference when asked who dissented, but Germany’s central bank later confirmed its dissenting vote and denounced the plan as “tantamount to financing governments by printing banknotes”. The reaction from the German press, as surveyed by Joe Weisenthal, ranges from nonplussed (“Alas, if that goes wrong”) to apoplectic  (“Black day for democracy”, “death of Bundesbank”). Half the German populace doesn’t trust Draghi, according to a recent poll.

IMF chief Christine Lagarde was chuffed, saying in a statement that the ECB’s plan will “support countries’ efforts to secure finance at a reasonable cost while they undertake sustained macroeconomic adjustment”. In non-monetary policyspeak, that means giving countries with steep borrowing costs, stagnant economies, large debts and fiscal deficits the time and money to sort themselves out. Markets, as Matt Levine points out in a simple graph, seem to agree with Lagarde.

The onus now is on Spain, as Reuters’ Paul Taylor notes, to “swallow its pride and apply for help to bring down crippling borrowing costs”. And the same applies to Italy. Both countries’ 3-year bonds are now yielding above 3%, while their German equivalent yields under 1%. Spanish Prime Minister Mariano Rajoy has not indicated that he will immediately seek the aid Draghi is offering.

As the Economist‘s Free Exchange blog points out, OMT will work if it lower borrowing costs long enough for Italy and Spain to regain their footing.  If it doesn’t, then the risk, and losses, will have been shifted to the ECB’s balance sheet. — Ben Walsh

On to today’s links:

UN says we’re heading toward the third major global food-price spike in five years – NYT

Growth Markets
Myanmar has no credit cards and installed its first ATM last year — and MasterCard wants in – WSJ

Oil and water: Drought pits fracking against farming – NYT
Three charts on why America’s debt problem is better (and worse) than you think – Ryan McCarthy

New Normal
Why the minimum wage doesn’t explain stagnant wages – NYT

An argument that you never really get who you vote for – HBR
What Bill Clinton wrote versus what he said at the DNC – The Atlantic Wire

Regulation is forcing JPMorgan to evaluate the financial strength of its counterparties – John Carney 

“As soon as you say the word ‘baseline,’ you might as well just pack up your bags and go home.” – Mother Jones

Infinite Atlas plots the locations in DFW’s novel on Google maps – Infinite Atlas

Risk Management
Your couch is literally killing you right now… or maybe not – The Billfold

A great Q&A with Katherine Boo on the conflicts of reporting on poverty – Guernica Mag


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