What’s new in the latest plan to change the EFSF?
The ECB has already been back in the market with the securities markets programme, buying Italian and Spanish govvies. In the new version floated at the IMF last weekend, the EFSF would guarantee the first 20% of the ECB’s losses. Fine. But this just re-routes the guarantee problem.
Instead of blowing a hole in the ECB’s balance sheet, (ultimately guaranteed by the central banks, and ultimately the taxpayers of the Eurosystem) a large country sovereign default would blow a hole in the EFSF’s balance sheet (ultimately guaranteed by the taxpayers of the Eurosystem).
So is the plan worthless? Not quite.
The difference between the two plans is political risk. If the new plan is structured to raise all of the money now, markets can stop trading on political paranoia. Credit won’t blow up every time the German parliament meets. Rates analysts can stop watching the German courts system. Buyers can emerge, confident that the ECB will stand behind the market.
But to do this means taking tough decisions immediately — something that Europe has not excelled at so far. The €2tr bond buying fund must exist, in segregated form. If the market has to trade based on political willingness, either inside the ECB or outside, no new structure will stop the rot.
Buying bonds ad hoc is more dangerous. For every bond the ECB buys, it will either need to create euros or attract deposits.
The market could get worried about either prospect — either €1.5tr of unsterilised money creation, or the practicalities of draining €1.5tr from the banking system. The ECB’s deposit auctions have already failed on occasion (a €55bn auction last June attracted only €31bn). What if the credibility of the bond buying programme is imperilled by the challenge of attracting deposits on this scale?
But with precommitted funds, existing on deposit, there shouldn’t be much need for actual bond buying. The confidence that bonds can be bought, in all circumstances, to the size needed, is more important than the bonds actually purchased. This means no sterilising problem and no inflation problem — the only way the increased money supply could feed through into inflation is when bonds get bought.
The ECB could buy long-term senior liabilities of an SPV with printed euros, while the EFSF buys the junior liabilities, drawing all of its commitments immediately. The SPV gets cash, and the ECB gets senior liabilities for a fixed term. This means printing €1.5tr without sterilising, but who cares if it stays on deposit at the ECB?
It also means drawing down all of the EFSF commitments at once, which will be the most politically sensitive part. But showing that the commitments are real and ready to bear risk is the best way to boost confidence — and avoid using the money to buy bonds.
If the great and good of Europe manage all that, then there’s the tiny matter of who gets to control it. But showing off the bazooka would be a good start.