I’ve already touched a bit on the subject of how the periphery sovereign crisis (and economic recession/depression) impedes the transmission of ECB monetary policy. Since reactivating (in one form or another) the SMP seems like a real possibility i ‘d like to make some comments on how it is implemented by the ECB.
The original idea was quite reasonable: Provide a distressed bond market with a buyer of last resort who has unlimited firepower and can move prices back to equilibrium. Nevertheless, after the Greek PSI, it became clear that the ECB was determined not to accept any haircuts on its claims and would just let its holdings mature with the sovereign having to borrow from other sources (EFSF/ESM or raise taxes) in order to pay maturing bonds, thus effectively subordinating private bondholders and increasing their haircuts.
If the ECB wants the SMP to be effective it must either accept haircuts on its portfolio (at least as large as the purchase discount) or rollover its holdings. If it requires to be paid at par on maturity (by someone else) it does not relieve any pressure on current holders since they are afraid that they will not be paid at par when their holdings mature. As a result, bond purchases only provide an exit strategy for current holders to dispose of their bonds without prices falling too much, a very short-term support for bond prices.
In my view what is needed is for the ECB to act in the same manner as the Fed. Since it regards the SMP as securities held for monetary policy purposes then it should maintain its portfolio as long as the monetary transmission channel is dysfunctional. It could even use the SMP portfolio to match banknotes in circulation, although such a strategy might hurt its profits in the long run (as long as banks have to borrow from the ECB to cover banknote demand). That would require the following:
- At a security’s maturity the ECB must place a non-competitive bid for an amount equal to its holdings at the auction of the bond that will rollover the maturing one.
- Rebate interest income (interest paid by the security – cost of SMP fixed term deposits) to the issuer. The most straight-forward way is to use the funds to make non-competitive bids in auctions (for bonds of similar maturities).
I know that the above would probably be regarded as monetary financing by the Bundesbank but it is the policy currently used by the Fed which is also not allowed by law to provide overdrafts to the US Treasury or participate in primary auctions as a bidder.
One additional step in the right direction of equalizing bond yields would be to also use the ECB debt certificate idea. The ECB should ‘sterilize’ its purchases by issuing short-term debt certificates. These would increase the supply of short-term safe assets (these mainly consist of zero coupon paper by Germany, Finland, Netherlands and probably France) which are in high demand, especially after the ECB zeroing of the deposit rate. That should probably push AAA short-term securities yields a bit higher by removing their liquidity premium:
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28 Ιουλίου, 2012 στις 12:19
Rik
Fully agree if you want seniority an SMP is hardly effective. It might not be 1 on 1 but very likley you need much more capacity to get the same effect as without seniority (as we have seen earlier).
The problem however you more or less directly run into is the fact that as we see now with he Greek discussion (haircut 3.0), this way the ECB will make losses. The only other option is holding till maturity I donot see that happening it means 10+ years owning the stuff. You should be able to get out. This would limit manoeuvring enormously.
First of all this is a big step and would need approval in its own right.
The losses will furthermore likely be huge and likely require a recap in certain CBs and likely the ECB itself. And there the whole problem starts, but now somewhere else. You open a new can of worms. Things getting over the budget (requiring cuts basically somewhere else (the national stuff)). And that will be highly unpopular.
The problem I see is that politicians have waited with asking their voters about this issue. However that question will anyway have to be asked. The crisis will take a decade or so and likley will remain on the top of the agenda.
Like we saw in Greece. The Catch22 is that the longer you wait the more unpopular it gets (both North and South). South, very likely we will see austerity fatigue (see Greece now effectively already). In the North we will see the dangerous combination of normal cuts starting to work (that is the moment when they get really unpopular. Nearly everybody sees it is necessary to make cuts but only with their neighbours. Things of course donot work that way.
There is every couple of months a further increase. When rescue operations start to run over the budget you probably have just seen the effect of the normal cuts. That is simply lousy timing. They started a job that most likely they cannot finish (as the electorate will not let them do it, not even mentioning some Courts).