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Sunday, November 13, 2011

ECB - the (mostly secret) Bad Bank of Europe!

Remember the never-ending discussion about the question whether or not the ECB should buy sovereign bonds of the PIIGS states? It started over one year ago when the ECB decided to invest approximately 50 billion EUR in such bonds. Since then, this volume has reached the staggering level of, allegedly, 170 billion EUR.

Staggering level? Heck, no!

By the end of October, the ECB had lent a total of 465 billion EUR to the banking systems of the PIIGS countries, the largest ones being Ireland (140 billion EUR) and Greece (98 billion EUR). You did not know that? Don't feel ashamed; most people didn't!

The ECB, as any Central Bank, is a lender of last resort to the banking system. This used to be considered risk-free because borrowers had to pledge as collateral AAA-rated sovereign bonds. The ECB today holds collateral for these loans in a multiple amount of the 465 billion in loans. However, they are no longer AAA-rated sovereign bonds. One extreme example: one item on the list of eligible securities of the ECB is a Portuguese bond from the year 1943. It will be roughly 8,000 years before this money is due for repayment on Dec. 31, 9999. The bulk of the bonds are bonds of the borrowing banks' countries.

What would have happened if the ECB had not extended these loans? Very simple. The banking systems of these countries would have collapsed. Could that have been avoided? Yes, by simply imposing a freeze on deposits in these national banking systems. Would that have been a nice thing to do? Definitely not, but it would have been better to leave the risk with those who had assumed it in the first place (and who had earned profits on them). As it turned out, the risk takers could grab for the cookie jar and take their money out of the PIIGS-countries (including wealthy nationals of those countries like wealthy Greeks who took over 50 billion EUR out of the Greek banking system in the last 2 years).

The Bundesbank, for one, which holds by far the largest portion of those 465 billion EUR has the gall to argue that the risk for Germany has not increased because of that. Why? Because, they say, the Bundesbank's liability to the ECB is limited to the statutory 27%. That is true. But there is a difference whether that 27% is applied to the amount of zero or whether it is applied to over 300 billion EUR.

Central Bankers have the gall to argue that these loans aren't really loans (technical term: Target-2). They are just debit balances in a type of Eurozone cash management system. Well, they should call in some young bankers who have just completed their bank training program.

These junior bankers will explain to Central Bankers that every account receivable on the asset side of a bank's balance sheet represents risk. If the receivable does't get paid, the bank has to liquidate collateral (for example the above Portugiese bond). What is left open after that, is a loss. Another thing which the junior banker would explain to the Central Bankers: what is an "account payable to" on the balance sheet of one party is an "account receivable from" on the balance sheet of another party. The Greek banking system shows the 98 billion EUR as "accounts payable to foreign Central Banks". If the foreign Central Banks don't show them as an "account receiveble from Greek banks", that is a matter of creative bookkeeping and has nothing to do with reality!

By the way, the ECB has capital & reserves of approximately 10 billon EUR to absorb potential losses on those 465 billion EUR...

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