Monthly Archives: May 2010

EU lends to itself to bail itself out – ECB remains sidelined

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“While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union. Stephen Lewis from Monument Securities says Europe’s leaders have forgotten the lesson of the “Gold Bloc” in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal. We all know how it ended.”

Ambrose Evans-Pritchard

The meeting took 14 hours and produced numbers large enough and rhetoric credible enough to trigger today’s short covering that might continue at least through half of tomorrow.

But all the actual announced funding comes from the same nations that are having the funding issues. There is no external funding of consequence of national govt borrowing needs coming any source other than the euro governments, nor can there be, as the the funding needs are in euro. And the ECB, the only entity that can provide the euro zone with the needed net financial assets, remains limited to ‘liquidity’ provision which does not address the core funding issue.

Yes, the funding needs have been move evenly distributed among the national governments. But even the financially strongest member, Germany, is structurally in need of continually borrowing increasing quantities of euro to roll over existing debt and fund continuing deficits, with no foreseeable prospects of even stabilizing its debt to GDP ratio or debt to revenue ratio. Adding this new financing burden only makes matters worse, and do the austerity measures now under way in all the member nations.

The one bright spot is the ‘whatever it takes’ language that presumably includes the only move that can make it work financially- actual funding of national govt. debt by the ECB either directly or indirectly through guarantees. But there can be no assurance, of course, that it’s just another bluff to buy time, hoping for a large enough increase in net exports which would be evidence of the rest of the world deciding to reduce its euro net financial assets via the purchase of goods and services from the euro zone.

And with a meaningful increase in exports likely to happen in a meaningful way only with a much lower euro, the terms and conditions of today’s announcements introduce conflicting forces. The austerity measures work to strengthen the euro to the extent they succeed, and to weaken it to the extent they result in increased national govt debt and changes in portfolio preferences.

My best guess is that market forces will soon be testing this new package and its core weaknesses.

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ECB decides on measures to address severe tensions in financial markets

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10 May 2010 – ECB decides on measures to address severe tensions in financial markets

The Governing Council of the European Central Bank (ECB) decided on several measures to address the severe tensions in certain market segments which are hampering the monetary policy transmission mechanism and thereby the effective conduct of monetary policy oriented towards price stability in the medium term. The measures will not affect the stance of monetary policy.

Agreed.

In view of the current exceptional circumstances prevailing in the market, the Governing Council decided:

1. To conduct interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism. The scope of the interventions will be determined by the Governing Council.

This does not help with primary funding. It reads like it’s about defining acceptable collateral.

In making this decision we have taken note of the statement of the euro area governments that they “will take all measures needed to meet [their] fiscal targets this year and the years ahead in line with excessive deficit procedures” and of the precise additional commitments taken by some euro area governments to accelerate fiscal consolidation and ensure the sustainability of their public finances.
In order to sterilise the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.

This insures the overnight rate target is met.

2. To adopt a fixed-rate tender procedure with full allotment in the regular 3-month longer-term refinancing operations (LTROs) to be allotted on 26 May and on 30 June 2010.

3. To conduct a 6-month LTRO with full allotment on 12 May 2010, at a rate which will be fixed at the average minimum bid rate of the main refinancing operations (MROs) over the life of this operation.

Setting term rates.

4. To reactivate, in coordination with other central banks, the temporary liquidity swap lines with the Federal Reserve, and resume US dollar liquidity-providing operations at terms of 7 and 84 days. These operations will take the form of repurchase operations against ECB-eligible collateral and will be carried out as fixed rate tenders with full allotment. The first operation will be carried out on 11 May 2010.

Unsecured dollar loans from the Fed to the ECB to be reloaned to member banks vs eligible collateral. This is to keep dollar libor at the Fed’s target rate. It’s a very high risk strategy for the Fed.

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looks like IMF will be using their Stand-By arrangement

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Looks like the plan is for a straight euro loan from the IMF to Greece:

“IMF support will be provided under a three-year €30 billion (about $40 billion)Stand-By Arrangement (SBA)—the IMF’s standard lending instrument. In addition, euro area members have pledged a total of €80 billion (about $105 billion) in bilateral loans to support Greece’s effort to get its economy back on track. Implementation of the program will be monitored by the IMF through quarterly reviews.”

FACTSHEET
IMF Stand-By Arrangement
November 23, 2009

In an economic crisis, countries often need financing to help them overcome their balance of payments problems. Since its creation in June 1952, the IMF’s Stand-By Arrangement (SBA) has been used time and again by member countries, it is the IMF’s workhorse lending instrument for emerging market countries. Rates are non-concessional, although they are almost always lower than what countries would pay to raise financing from private markets. The SBA was upgraded in 2009 to be more flexible and responsive to members countries’ needs. Borrowing limits were doubled with more funds available up front, and conditions were streamlined and simplified. The new framework also enables broader high-access borrowing on a precautionary basis.

Lending tailored to member countries’ needs

The SBA framework allows the Fund to respond quickly to countries’ external financing needs, and to support policies designed to help them emerge from crisis and restore sustainable growth.

Eligibility. All member countries facing external financing needs are eligible for SBAs subject to all relevant IMF policies. However, SBAs are generally used by middle income member countries more often, since low-income countries have a range of concessional instruments tailored to their needs.

Duration. The length of a SBA is flexible, and typically covers a period of 12–24 months, but no more than 36 months, consistent with addressing short-term balance of payments problems.

Borrowing terms. Access to IMF financial resources under SBAs are guided by a member country’s need for financing, capacity to repay, and track record with use of IMF resources. Within these guidelines, the SBA provides flexibility in terms of amount and timing of the loan to help meet the needs of borrowing countries. These include:

• Normal access. Borrowing limits were recently doubled to give countries access of up to 200 percent of quota for any 12 month period, and 600 percent of total credit outstanding (net of scheduled repurchases).

• Exceptional access. The IMF can lend amounts above normal limits on a case-by-case basis under its Exceptional Access policy, which entails enhanced scrutiny by the Fund’s Executive Board. During the current global economic crisis, countries facing acute financing needs have been able to tap exceptional access SBAs.

• Front-loaded access. The new SBA framework provides increased flexibility to front load funds where warranted by the strength of the country’s policies and the nature of its financing needs.

• Rapid access. Fund support under the SBA can be accelerated under the Fund’s Emergency Financing Mechanism, which enables rapid approval of IMF lending. This mechanism was utilized in several instances during the recent crisis.

Precautionary access. The new SBA framework has expanded the range of high access precautionary arrangements (HAPAs), a type of insurance facility against very large financing needs. Precautionary arrangements are used when countries do not intend to draw on approved amounts, but retain the option to do so should they need it. Three HAPAs, with Costa Rica, El Salvador, and Guatemala, were approved during the crisis.

Fewer conditions, focus on objectives

When a country borrows from the IMF, it agrees to adjust its economic policies to overcome the problems that led it to seek funding in the first place. These commitments, including specific conditionality, are described in the member country’s letter of intent (which often has a memorandum of economic and financial policies).

Building on earlier efforts, the IMF has further reformed the conditions of its lending to focus on criteria that are measurable and observable. These changes include:
Quantitative conditions. Member countries progress is monitored using quantitative program targets. Fund disbursements are tied to the observance of such targets. Examples include targets for international reserves and government deficits or borrowing, consistent with program goals.

Structural measures. The new SBA framework has eliminated structural performance criteria. Instead, progress in implementing structural measures that are critical to achieving the objectives of the program are assessed in a holistic way in the context of program reviews.

Frequency of reviews. Regular reviews by the IMF’s Executive Board play a critical role in assessing performance under the program and allowing the program to adapt to economic developments. The SBA framework allows flexibility in the frequency of reviews based on the strength of the country’s policies and the nature of its financing needs.

Lending terms

Repayment. Repayment of borrowed resources under the SBA are due within 3¼-5 years of disbursement, which means each disbursement is repaid in eight equal quarterly installments beginning 3¼ years after the date of each disbursement.

Lending rate. The lending rate is tied to the IMF’s market-related interest rate, known as the basic rate of charge, which is itself linked to the Special Drawing Rights (SDR) interest rate. Large loans carry a surcharge of 200 basis points, paid on the amount of credit outstanding above 300 percent of quota. If credit remains above 300 percent of quota after three years, this surcharge rises to 300 basis points, and is designed to discourage large and prolonged use of IMF resources.

Commitment fee. Resources committed under all SBAs are subject to a commitment fee levied at the beginning of each 12 month period on amounts that could be drawn in the period (15 basis points for committed amounts up to 200 percent of quota, 30 basis points on committed amounts above 200 percent and up to 1,000 percent of quota and 60 basis points on amounts exceeding 1,000 percent of quota). These fees are refunded if the amounts are borrowed during the course of the relevant period. As a result, if the country borrows the entire amount committed under an SBA, the commitment fee is fully refunded, while no refund is made under a precautionary SBA under which countries do not draw.

Service charge. A service charge of 50 basis points is applied on each amount drawn.

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IMF fact sheet on SDRs

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FACTSHEET

Special Drawing Rights (SDRs)

January 31, 2010

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204.1 billion (equivalent to about $ 321 billion).

The role of the SDR

The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. A country participating in this system needed official reserves—government or central bank holdings of gold and widely accepted foreign currencies—that could be used to purchase the domestic currency in foreign exchange markets, as required to maintain its exchange rate. But the international supply of two key reserve assets—gold and the U.S. dollar—proved inadequate for supporting the expansion of world trade and financial development that was taking place. Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF.

However, only a few years later, the Bretton Woods system collapsed and the major currencies shifted to a floating exchange rate regime. In addition, the growth in international capital markets facilitated borrowing by creditworthy governments. Both of these developments lessened the need for SDRs.

The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR, serves as the unit of account of the IMF and some other international organizations.

Basket of currencies determines the value of the SDR

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF’s website. It is calculated as the sum of specific amounts of the four currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive Board to ensure that it reflects the relative importance of currencies in the world’s trading and financial systems. In the most recent review (in November 2005), the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services and the amount of reserves denominated in the respective currencies which were held by other members of the IMF. These changes became effective on January 1, 2006. The next review will take place in late 2010.

The SDR interest rate

The SDR interest rate provides the basis for calculating the interest charged to members on regular (non-concessional) IMF loans, the interest paid and charged to members on their SDR holdings and charged on their SDR allocations, and the interest paid to members on a portion of their quota subscriptions. The SDR interest rate is determined weekly and is based on a weighted average of representative interest rates on short-term debt in the money markets of the SDR basket currencies.

SDR allocations to IMF members

Under its Articles of Agreement, the IMF may allocate SDRs to members in proportion to their IMF quotas. Such an allocation provides each member with a costless asset. However, if a member’s SDR holdings rise above its allocation, it earns interest on the excess; conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall.
There are two kinds of allocations:

General allocations of SDRs. General allocations have to be based on a long-term global need to supplement existing reserve assets. Decisions to allocate SDRs have been made three times. The first allocation was for a total amount of SDR 9.3 billion, distributed in 1970-72 in yearly installments. The second allocation, for SDR 12.1 billion, was distributed in 1979–81 in yearly installments.

The third general allocation was approved on August 7, 2009 for an amount of SDR 161.2 billion and took place on August 28, 2009. The allocation increased simultaneously members’ SDR holdings and their cumulative SDR allocations by about 74.13 percent of their quota.

Special allocations of SDRs. A proposal for a special one-time allocation of SDRs was approved by the IMF’s Board of Governors in September 1997 through the proposed Fourth Amendment of the Articles of Agreement. Its intent is to enable all members of the IMF to participate in the SDR system on an equitable basis and correct for the fact that countries that joined the Fund after 1981—more than one-fifth of the current IMF membership—had never received an SDR allocation.

The Fourth Amendment became effective for all members on August 10, 2009 when the Fund certified that at least three-fifths of the IMF membership (112 members) with 85 percent of the total voting power accepted it. On August 5, 2009, the United States joined 133 other members in supporting the Amendment. The special allocation was implemented on September 9, 2009. It increased members’ cumulative SDR allocations by SDR 21.5 billion using a common benchmark ratio as described in the amendment.

Buying and selling SDRs

IMF members often need to buy SDRs to discharge obligations to the IMF, or they may wish to sell SDRs in order to adjust the composition of their reserves. The IMF acts as an intermediary between members and prescribed holders to ensure that SDRs can be exchanged for freely usable currencies. For more than two decades, the SDR market has functioned through voluntary trading arrangements. Under these arrangements a number of members and one prescribed holder have volunteered to buy or sell SDRs within limits defined by their respective arrangements. Following the 2009 SDR allocations, the number and size of the voluntary arrangements has been expanded to ensure continued liquidity of the voluntary SDR market.

In the event that there is insufficient capacity under the voluntary trading arrangements, the Fund can activate the designation mechanism. Under this mechanism, members with sufficiently strong external positions are designated by the Fund to buy SDRs with freely usable currencies up to certain amounts from members with weak external positions. This arrangement serves as a backstop to guarantee the liquidity and the reserve asset character of the SDR.

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corrected post on IMF operations

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I now understand it this way:

The IMF creates and allocates new SDR’s to its members.

There is no other source of SDR’s.

SDR’s exist only in accounts on the IMF’s books.

SDR’s have value only because there is an informal agreement between members that they will use their own currency to lend against or buy SDR’s from members the IMF deems in need of funding who also accept IMF terms and conditions.

Originally, in the fixed exchange rate system of that time, this was to help members with balance of payments deficits obtain foreign exchange to buy their own currencies to keep them from devaluation.

The system failed and now the exchange rates are floating.

Currently SDR’s and the IMF are used by members needing help with foreign currency funding needs.

Looks to me like Greece will be borrowing euro from other euro nations using its SDR’s as collateral or selling them to other euro nations.

Either way it’s functionally getting funding from the other euro members.

Greece is also accepting IMF terms and conditions.

The only way the US is involved is if a member attempts to use its SDR’s to obtain $US.

The US is bound only by this informal agreement to accept SDR’s as collateral for $US loans, or to buy SDR for $US.

SDR’s have no intrinsic value and are not accepted for tax payments.

It’s a lot like the regional ‘currencies’ like ‘lets’ and ‘Ithaca dollars’ that are also purely voluntary and facilitate unsecured lending of goods and services with no enforcement in the case of default.

It’s a purely voluntary arrangement which renders all funding as functionally unsecured.

There is no IMF balance sheet involved.

While conceptually/descriptively different than what I erroneously described in my previous post, it is all functionally the same- unsecured lending to Greece by the other euro nations with IMF terms and conditions.

The actual flow of funds and inherent risk is as I previously described.

No dollars leave the Fed, euro are transferred from euro members to Greece.

I apologize for the prior incorrect descriptive information and appreciate any further information anyone might have regarding the actual current arrangements.

Prior post:

I understand it this way:

The US buys SDR’s in dollars.
those dollars exist as deposits in the IMF’s account at the Fed.

The euro members buy SDR’s in euro.
Those euro sit in the IMF’s account at the ECB

The IMF then lends those euro to Greece
They get transferred by the ECB to the Bank of Greece’s account at the ECB.

The IMF’s dollars stay in the IMF’s account at the Fed.

They can only be transferred to another account at the Fed by the Fed.

U.S. taxpayers are helping finance Greek bailout

By Senator Jim DeMint

May 6 — The International Monetary Fund board has approved a $40 billion bailout for Greece, almost one year after the Senate rejected my amendment to prohibit the IMF from using U.S. taxpayer money to bailout foreign countries.

Congress didn‚t learn their lesson after the $700 billion failed bank bailout and let world leaders shake down U.S taxpayers for international bailout money at the G-20 conference in April 2009. G-20 Finance Ministers and Central Bank Governors asked the United States, the IMF‚s largest contributor, for a whopping $108 billion to rescue bankers around the world and the Obama Administration quickly obliged.
Rather than pass it as stand-alone legislation, President Obama asked Congress to fold the $108 billion into a war-spending bill to send money to our troops.

It was clear such an approach would simply repeat the expensive mistake of the failed Wall Street bailouts with banks in other nations. Think of it as an international TARP plan, another massive rescue package rushed through with little planning or debate. That‚s why I objected and offered an amendment to take it out of the war bill. But the Democrat Senate voted to keep the IMF bailout in the war spending bill. 64 senators voted for the bailout, 30 senators voted against it.

Only one year later, the IMF is sending nearly $40 billion to bailout Greece, the biggest bailout the IMF has ever enacted.

Right now, 17 percent of the IMF funding pool that the $40 billion bailout is being drawn from comes from U.S. taxpayers. If that ratio holds true, that means American taxpayers are paying for $6.8 billion of the Greek bailout. Although the $108 billion extra that Congress approved for the IMF in 2009 hasn‚t yet gone into effect, you can bet that once it does Greek bankers will come to the IMF again with their hat in hand. And, if other European Union countries see free money up for grabs they could ask the IMF for bailouts when they get into trouble, too. If we‚ve learned anything from the Wall Street bailouts it‚s that just one bailout is never enough.
To hide the bailout from Americans already angry with the $700 billion bank bailout, Congress classified it as an „expanded credit line.‰ The Congressional Budget Office only scored it as $5 billion because IMF agreed to give the United States a promissory note for the rest of the bill.
As the Wall Street Journal wrote at the time, „If it costs so little, why not make it $200 billion. Or a trillion? It‚s free!‰

Of course, money isn‚t free and there are member nations of the IMF that won‚t be in a hurry to pay it back. Three state sponsors of terrorism, Iran, Syria and Sudan, are a part of the IMF. Iran participates in the IMF‚s day-to-day activities as a member of its executive board.

If the failed bank bailout and stimulus bill wasn‚t enough to prove to Americans the kind of misguided, destructive spending that goes on in Washington this will: The Democrat Congress, aided by a few Republicans, used a war spending bill to send bailout money to an international fund that‚s partially-controlled by our enemies.

America can‚t afford to bail out foreign countries with borrowed dollars from China and certainly shouldn‚t allow state sponsors of terror a hand in that process.

This has to stop if we are going to survive as a nation. Congress won‚t act stop such foolishness on its own. The only way Americans can stop this is by sending new people to Washington in November who will.

Sen. Jim DeMint is a Republican U.S. Senator from South Carolina.

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Fighting back against the move to slash Social Security

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Social Security is not being attacked on its merits.

Therefore the bleeding heart arguments will not prevail.

The protagonists believe the problem is that the federal government is on the road to financial ruin, and not merits of Social Security per se .

My conclusion is the only message that will work is that operationally social security is not broken as the protagonists believe.

Their central premise is simply wrong and they can be proven wrong on that central contention.

Government checks don’t bounce- all Federal spending is done by using their computer to mark up numbers in bank accounts (Bernanke quote)

The Federal government will always be able to make all its payments including Social Security payments (Greenspan quote)

Federal spending is in no case operationally dependent on revenues from taxing or borrowing and everyone in Fed operations knows it.

Spending begins to cause inflation only after all the unemployed have been hired and all the excess capacity is used up.

Government deficit spending = world dollar savings, to the penny and everyone in the CBO and OMB knows it.

If government spending isn’t enough to allow the economy to pay its taxes and meet its savings desires
the result is unemployment, excess capacity, and deflationary forces in general.
All as a point of logic.

The wholesale interest rates for the banking system, which also determines interest rates the Treasury pays, are set by the Federal Reserve Bank, not market forces.

The move to cut Social Security is an innocent fraud coming from a position of ignorance of monetary operations.

It is coming from those who mistakenly believe that the federal government has run out of money,
that federal spending is dependent on borrowing that our children will be left to repay,
and that any deficit spending always risks hyper inflation.

It is driven predominately by people who would support Social Security if they didn’t believe the federal government was on the road to financial ruin.

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rotten to the core

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Here we go, and this is without additional austerity measures already in progress from the euro zone and other economies:

Germany to Lose $61 Billion in Tax Revenue by 2014, Bild Says

By Tony Czuczka

May 6 (Bloomberg) — Tax revenue for German federal, state and local authorities will decline by a total of 48 billion euros ($61 billion) until 2014, the Bild newspaper reported, without saying how it got the information.

The German Finance Ministry plans to announce its latest tax-revenue estimate later today.

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ECB meeting preview / ECB intervention?

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In case you had not seen this.

If the ECB bought Greek bonds in the secondary market and issued an ECB bond as suggested below,

that could be a reasonable solution out of this mess?

They don’t need to issue the ecb bonds unless the money markets have excess reserves driving short rates below target rates

It doesn’t solve much any more than the Fed buying Lehman bonds in the secondary market would have helped Lehman.
It just lets some bond holders get out, presumably on the offered side of the market.

That’s why it’s allowed in the first place- it does not support the member nation and introduce that moral hazard.

To keep things fair, they could state that they would buy up to a maximum of a certain amount of bonds per capita (or even the average of the last 5 years of GDP) for all EUR denominated countries on a discretionary basis.

As above.

It sort of accomplishes what you suggested but with tools already in place and most importantly with the mainstream economists actually discussing it?

I don’t think so, as above. The member nations would still be in Ponzi, where they have to sell debt to make an expanding amount of debt payments.

The ECB might even make money if Greece paid off; just like the FED did with mortgages and bank stocks.

The ‘profits’ are similar to a tax, removing net financial assets form the private sector. They made money because the Federal deficit spending was sufficient to remove enough fiscal drag to allow the private sector to return to profitability.

The Fed and Tsy profits simply somewhat reduced the deficit spending.

— Original Sender: —

From our Economics Team…..

ECB meeting preview / ECB intervention

The current market action has prompted many questions on the ECB possible interventions and what Trichet might say/announce tomorrow at the ECB press conference. I think an ECB intervention is indeed now becoming very likely. Remember that the ECB “printed” 500Bn EUR in just 2 weeks in October 2008 to fund the money market which had became dysfunctional after Lehman. The primary mandate of a central bank is to maintain financial stability; hence the Oct 2008 change in repo rule and the 500Bn of money created; de facto, the ECB made teh clearing of the money market. The same might happen for the sovereign market.

Yes, but as above, it doesn’t address solvency or credit worthiness of a member nation in Ponzi, which is all of them.

The real problem is austerity probably won’t bring down deficits, as it weakens the economies, cutting into tax revenues and adding to transfer payments.

The following is a quick summary.

*** Fundamentals:

– The problem with Greece was a problem of sustainability of public finances. Lending more was not the solution, the solution was to cut dramatically the deficit to reduce it to a level at which public finances are sustainable. Hence the need for an IMF plan, i.e. loan and more importantly an ambitious fiscal consolidation.

Except that the cutting can actually increase deficits, as explained above.

– The other countries are in a very different economic and fiscal situation, the situation is manageable (for e.g. see our weekly last Friday comparing Greece and Portugal). So the problem for the other countries is essentially a problem of market liquidity. This means ECB intervention.

If that’s all it was, fine. But seems to me they also can’t bring down deficits with austerity, but only increase them, for the reasons above.

*** ECB intervention: When?
– Probably early next week.

– Usually markets react when money is provided, not when the plan is announced. This is what happened for e.g. with the TARP. So there is a case for waiting until the IMF plan is enacted to see market reaction and design the measures accordingly.

Agreed. And the IMF plan requires the member nations to buy SDR’s with ‘borrowed money’ to fund the IMF loans, so there is no help from the IMF balance sheet regarding credit worthiness.

No matter how they slice it, without the ECB doing the lending, any package for Greece diminishes the other member nation’s credit worthiness

– The German Parliament votes Friday. It is probably not desirable from the ECB perspective to act before.

They don’t have popular support as seems German’s don’t want to pay for Greek public employees salaries and benefits which are higher than their own.

*** ECB intervention: How?

There are probably an infinite number of intervention mechanisms available. The following bullet points list the most obvious ones. These bullet points are based on the note published Monday “Greece after the IMF plan”.

– The ECB could deploy its balance sheet, initiating expansionary liquidity provisioning. This would be pure QE with the ECB buying directly governments bonds. Note that this is not against the status of the ECB: the ECB (or any central bank of the Eurosystem) cannot “finance a public deficit” hence cannot buy on the primary market, but there is no limits on the secondary market.

This is allowed for a good reason- it doesn’t do much, as described above.

Note also that the intervention can be sterilized, the ECB has the possibility (although it never used it so far) to issue a bond, it could thus issue an ECB bond of the same size as its intervention on the market; having then a zero effect on the net liquidity provided. We though QE was unlikely given past ECB policy, but under the current circumstances it would definitely be a possible option.

‘Liquidity’ only matters if it drives the overnight rate below ecb target rates. They can then ‘offset operating factors’ as they call it as needed to keep the interbank rate on target.

This is purely technical and of no monetary or economic consequence.

– In theory, the ECB could deploy reserves under management, about €350Bn, to buy bonds of the country at-risk. Here, however, we doubt the ECB would respond in this fashion. The fund would be limited and it would imply that a disproportionate part of the reserves would be invested in the “trouble” countries.

Operationally they can readily buy anything they want.

– Rather, most ECB policy intervention is channeled through banks. Various options are available to the ECB, including adjusting repo rules or collateral rules on existing sovereign paper. One option would be to accept the paper at par instead of accepting it at market value. This would mean that a bank could buy a sovereign paper at 70cents and repo it at 100cents.

Yes, but still full recourse- the bank remains on the hook if the collateral goes bad, and it has to report its net capital accordingly- recognizing full ownership of the collateral.

Another option would be to argue current market failure and, as a consequence, repo at the average price of the past year (same logic, note that this option has been used for e.g. by the SFEF in the financing of French banks). The ECB could also accept as collateral banks loans to governments.

Bank liquidity is not an issue. The price of the repo is of no consequence until bank liquidity is an issue.

– Financing could even be channeled via supranational institutions. In that case the intervention would not need to need to be made public.

*** ECB press conference tomorrow: what will Trichet say?

– Difficult to preannounce the measures and give details even if ECB is planning an intervention.

– Impossible to say nothing about the current situation.

– Trichet is likely to say “we have the tools to intervene and will not hesitate to do so”.

Agreed!

This is unlikely to calm the market much.

Agreed!

The question is, does he care? The ECB still has the single mandate of price stability.

Technically they would intervene to stop deflation, or something like that.

But with higher prices pouring in through the fx window that’s now problematic as well.

Warren Mosler

UTFITF (unheard tree falling in the forest)

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