The European Central Bank is being forced to print money to bolster banks in bailed-out Greece and Ireland, leaving the region’s taxpayers on the hook as the final guarantors of those nations’ debts.
Greek and Irish banks have issued at least 70 billion euros ($95 billion) of bonds to create the collateral required to get cash from the ECB, according to the International Monetary Fund and regulatory filings, a figure that may rise to 100 billion euros after Greece said Feb. 11 it may extend another 30 billion euros of guarantees to its banks.
“What you have here is micro-quantitative easing, or money printing,” said Cathal O’Leary, head of fixed-income sales at NCB Stockbrokers in Dublin. “The banks are issuing unsecured loans to themselves.”
The ECB has vowed to eschew the type of monetary policy implemented by the Federal Reserve, whose bond-buying to boost growth has left it owning more Treasuries than are held by China, the biggest foreign buyer of U.S. debt. By granting loans against bank debt, the ECB is adding to the monetary base and would be out of pocket were the guarantors to renege.
The yield premium investors demand to hold Irish 10-year bonds rather than German securities is 599 basis points, up from 153 basis points a year ago. The spread between Greek and German 10-year bonds is 850 basis points, up from 305 basis points a year ago.
‘Stressed Market Conditions’
Ireland’s banks have issued at least 17.4 billion euros of notes backed by government guarantees, with 9.2 billion euros going to Bank of Ireland alone. The program amounts to 11 percent of Ireland’s 2009 gross domestic product.
“Access to ECB operations allows the banks in question to obtain funding that is not currently available in the continued stressed market conditions,” the Irish central bank said in an e-mailed response to questions.
Greece’s current state-guaranteed liquidity program is 55 billion euros, according to the IMF country report, equivalent to more than 20 percent of the nation’s $330 billion output in 2009. That’s on top of the 8 billion euros of zero-coupon bonds Greece has lent to the banks and 15 billion euros of direct capital injections, according to John Raymond, an analyst at CreditSights Inc. in London.
‘Huge Credit Exposures’
“To a very significant extent, the ECB is taking the place of capital markets,” said Alan Dukes, the former Irish finance minister who is now chairman of Anglo Irish Bank Corp., which posted Ireland’s biggest-ever loss in 2010. “The ECB is no longer in a position to pursue a clear monetary policy because it is running huge credit exposures,” he said in a speech last week.
Ireland has put 46.3 billion euros into its debt-laden banks in the past two years as property prices collapsed and loan losses soared. Irish-based lenders, including foreign-owned banks, received 126 billion euros of ECB funding at the end of January and as much as an additional 51.1 billion euros of “exceptional liquidity” from the Irish central bank, figures published on Feb. 11 show.
“The own-bond issuances are a pragmatic response in exceptional circumstances,” said Donal O’Mahony, global strategist at Davy Capital Markets in Dublin. “While the notes are not backed by the banks’ own assets, they are backed by the government guarantee, which is an important point. State- guaranteed notes are ECB-eligible collateral.”
‘Expensive Emergency Liquidity’
Greek banks, with 1.5 percent of European banking assets, and the Irish, with 5.5 percent, account for 17 percent and 24 percent of ECB borrowing, according to a Feb. 7 report by Laurent Fransolet and Giuseppe Maraffino at Barclays Capital in London.
“The ECB accepts government-guaranteed bonds as collateral,” said Maraffino. “The Irish banks are replacing expensive emergency liquidity with cheaper ECB funding. It’s just the way it works.”
As the lender of last resort, the job of the ECB is to ensure the European banking system has the liquidity it needs to function. While the nascent European Financial Stability Facility probably will have the task of ensuring solvency, for the moment the ECB has that role, too.
“This is a great example of bank risk moving to national government risk, and now to ECB risk,” said Jean Dermine, professor of banking and finance at INSEAD business school in Fontainebleau, France. “The ECB is increasing the money supply and that is raising inflationary pressure. There is also credit risk, the fact that default would lead to a loss for European taxpayers.”
‘Difficult to Distinguish’
Monetary growth in the euro area, as measured by M3 money supply, which the ECB uses as a gauge for future inflation, turned positive in June and reached a 15-month high of 2.1 percent in November.
The ECB is calling on governments to step up efforts to restore confidence, to allow sovereigns and their banks to regain access to the capital markets.
“It’s difficult to distinguish banking and sovereign risk,” said Nicolas Veron, senior fellow at Bruegel, the Brussels-based economics research group. “What happens if there’s a default? Everyone would like to avoid testing that out in real life. Governments are really scared of the consequences of an actual restructuring.”