Reading about Draghi’s comments that the ECB would not be engaging in quantitative easing (QE) because this would amount to ‘monetary financing’ prompted a burst of nostalgia for the time when Willem Buiter was writing his ‘Maverecon’ for public consumption, and not selling his wares privately for Citi’s clients. There was no more entertaining way to begin the day at the BoE than by reading his central bank tongue-lashing. And surely he would be moved to fury or sarcasm now [since, in general, it did not take much].
So, to recap. The ECB will expose itself to unlimited capital losses, potentially, by buying short-term bonds from troubled sovereigns, but won’t buy bonds of undetermined maturity from any old well-behaved sovereign – for example the one that hosts its headquarters. Yet, if some way can be found to securitise ‘bank loans’ [those wouldn’t be the same bank loans that are troubling the sovereigns whose bonds might be bought under OMTs would they?] the ECB would buy those as a measure to fight deflation.
First, it’s pretty shocking that the ECB are simply musing about this, rather than explaining an already worked-up contingency plan. If they are worried about deflation, I don’t see how there is going to be time to devise a continent-wide bank-loan securitisation program of sufficient magnitude for the ECB to make any difference.
Second, why is it ok to buy potentially worthless short-term bonds of troubled sovereigns, but not probably reliable bonds of any maturity from other sovereigns? The mention of the Treaty [of Rome] ban on ‘monetary financing’ doesn’t seem like an adequate answer to that. The Bank of England’s legal team – the Bank also being bound, despite not participating in the euro, by that same treaty – concluded that provided those purchases were from the secondary market, QE would not leave it falling foul of the Treaty ban on monetary financing.
Ah, you might say, the fact that the troubled sovereign has sought fiscal help from the European Stability Mechanism (ESM), thus supposedly extinguishing any potential fiscal gap, makes it ok for the ECB then to buy its bonds, safe in the knowledge that it won’t be left on the hook. However, as I’ve pointed out before, the fact that the threat of OMTs are needed at all is testament to the worry that markets might not believe that the fiscal support offered by the stability fund would be adequate. What distinguishes the ECBs OMTs from the stability fund is the speed with which a potentially unlimited balance sheet protection can be offered to a troubled sovereign. OMTs may be dubbed not to be ‘monetary financing’, but they certainly are the use of an institution that prints an accepted means of settlement and exchange [a ‘monetary institution’ no less] to convince markets that there will be no trouble ‘financing’ the sovereign.
The other side of the implicit contention about QE euro style is also intriguing. They can’t by any old bond from any old sovereign, because of the chance that the ECB itself won’t reverse the transaction, and will, under its own definition, have financed that sovereign with money. Eh? Why won’t this transaction be reversed? Will the ECB not be able to resist the temptation to lock the money financing in once the bonds are on its balance sheet? Perhaps because of the votes wielded by Governors from potentially troubled sovereigns? Or is that not the problem, in which case, are we being reminded that the bonds it buys might not be worth anything when it comes to reselling them and unwinding QE?
Recall [and thanks to unnamed friend in the City for pointing this out to me] that the ECB is using proxies to buy these same bonds. The ECB is lending to counterparty retail banks who are buying the self-same bonds which the ECB says it will not buy itself. And exposing itself in the process. That’s not ‘monetary financing, though’. Of course not. That’s just monetary financing of a private institution that is ‘financing’ [governments]. And partly under the resultant coercion of new banking regulations regarding the need for those institutions to hold adequate liquidity.
Another thing. If it’s not ok to buy bonds from sovereigns not sufficiently troubled to seek help from a potentially inadequate stability fund, why is it ok to by securitised bank loans? Where is the balance sheet protection for the ECB to undertake that policy? The second phase of the financial crisis has essentially blurred the distinction between the large troubled banks and the sovereigns that are forced to stand behind them. The ECB’s policy toolkit does not seem to make sense in this new world.
The ECB might wish that it could construct an indemnity in the same way that the Bank of England did before it embarked on QE. QE is not actually carried out on the Bank’s balance sheet, but on the balance sheet of a company, the ‘Bank of England Asset Purchase Facility Fund’, against whose losses the Bank is indemnified. If the Government chooses to default on gilts that the Bank has bought, it gains nothing. And with its own balance sheet intact, the Bank won’t be suspected of being tempted to engage in extra inflation busting seigniorage. Constructing such an agreement right now would be a nightmare in the euro area. Even if agreement could be found, could signatory sovereigns make credible promises that would leave the ECB in the same position as the Bank of England? I doubt it. Another example of the general problem with having monetary unions in the absence of a fiscal union.
Come back, Maverecon. Its absence deprives us of the European nominal and fiscal anchor.