by Don Alexander, MBA
Associate, RSD Solutions Inc.
Charles Wyplosz in a recent communique discusses the shift in risk from various European countries to a “de facto” implied guarantee by the ECB (The ECB’s Trillion Euro Bet, VOXEU, Feb. 13th.). The amounts could be staggering as the ECB is taking enormous risk. Currently, the ECB is holding over euro 200 billion in sovereign bonds from recent intervention and will face nearly euro 1 trillion rollover of European sovereign debt in 2012.
Eurozone sovereign spreads have recently declined with the exception of Greece. Charles Wyplosz argues that a good part of the drop in spreads is due to the perception that the ECB is “de facto” acting as the guarantor for Eurozone government debts. The ECB leadership suggests that the decline in sovereign spreads is the result of country reforms.
There is a link between bond spread contraction and the ECB’s long-term refinancing operations (LTROs). The LTRO bought euro zone leaders time to get their act together. Fiscal deficits are slowly declining as the sovereign debt overhang persists, the EU banking system remains undercapitalized (current estimates of euro 100 – 200 billion), and a euro-wide recapitalization facility for banks is missing. Analysts suggest one method for crisis resolution is through the explicit guarantee of government debt.
Previously, ECB officials argued this was not their mandate; it created moral hazard, exposed the system to increased financial risk and reduced politician’s incentive to make the necessary cuts. The new ECB regime made the LTRO available to commercial banks, but does not do enough to resolve the crisis such as providing a long-term growth strategy. Greece and Portugal will be unable to grow with their existing debt burden and this may also be the case risk for Italy and other countries as contagion takes hold.
LTROs could make things more dangerous, especially if banks use LTRO cash to acquire more sovereign bonds. Banks could borrow money from the ECB at very low rates (about 1%) and buy bonds whose yields are much higher. A wave of sovereign default could turn these bonds into toxic assets and a trillion-euro problem. The more the banks accumulate these bonds the riskier the situation becomes. The problem is compounded by the fact that banks are regulated by national authorities and under pressure to increase their domestic bond holdings.
The ECB seems to be making a bet that the market is swayed by its recent action and provides a stable equilibrium. Holding sovereign debt will be seen as safe and the ECB has saved the euro at a minimal cost. However, the reversion to a stable equilibrium is not guaranteed. Should markets conclude crucial policy actions are missing, the debt defaults will spread and Eurozone banks might fail imposing a massive cost to taxpayers and leading to further euro problems.
The ECB has bought time for authorities and has involved taking on enormous risks. The lack action on long-term restructuring of the underlying euro treaty and the promotion of a long-term growth strategy could negate their action.
For more information on this follow the link: http://www.voxeu.org/index.php?q=node/7617
1 comment:
would like to contribute some of my points with regards to the above topic on guarantor loans as it is I'm also quite involved and interested in the term of Guarantor loans are unsecured by nature. Secured loans online are loans in which an item of worth will be put up as a guarantee for any credit. Collateral is really an item that's put up as an alternative form of surety for your credit.
Post a Comment