The European Central Bank should draft commercial lenders as allies in its fight to stem the euro-region financial crisis by giving them incentives to buy bonds of debt-swamped governments, Deutsche Bank AG says.
In his proposed “Plan B,” London-based Deutsche Bank economist Gilles Moec said the ECB would limit collateral for one-year central bank loans to investment-grade sovereign paper rated less than AAA, encouraging purchases of debt sold by Spain, Italy, Portugal and Ireland. He also suggested a “margin-call holiday,” freeing banks from providing more collateral if the value of the swapped bonds falls.
“Investors still don’t know whether to buy from the periphery,” Moec, a former Bank of France official, said in a telephone interview. “But the rates the periphery are paying should be quite tempting so it wouldn’t take much for investors to start buying their debt.”
German 10-year bonds rose for the first time in three days today, as France backed Germany in refusing to add to the European Union’s 440 billion-euro ($580 billion) rescue fund and rejecting joint euro-area debt securities. Spanish bonds fell, widening the extra yield investors demand to hold the securities instead of German bunds.
Moec’s proposal would take the pressure off the Frankfurt- based ECB to keep buying the bonds of Ireland, Portugal and Spain to calm markets as European policy makers squabble over how to contain spreading debt losses. The ECB bought the most bonds since June last week, helping reverse debt-market declines.
The ECB said last week it would continue to keep offering banks as much cash as they want through the first quarter over periods of up to three months at a fixed interest rate. Moec’s plan, which he said could complement the current liquidity programs, would reduce the collateral the ECB would be willing to accept when lending for a year. Among the assets excluded would be the government bonds of the six euro-area nations with AAA ratings such as Finland and Germany.
In addition to helping reduce yields in the most-strained markets, the plan would give governments breathing room to cut their budget deficits, yet not let them off the hook for doing so because the collateral would re-enter the market after a year, Moec said.
“Governments would in effect be given 12 months to demonstrate to the market their capacity to address their fiscal issues, which reduces the moral hazard,” he said.
Curbing the ECB’s bond buying may prevent further divisions among policy makers concerned that the central bank’s balance sheet is growing too much, Moec said.
The ECB bought almost 2 billion euros of bonds last week as President Jean-Claude Trichet pledged to fight “acute” financial market tensions. Bond purchases total 69 billion euros since the program began in May.
The central bank said today a “small” number of euro-region banks are too reliant on its emergency liquidity as the sovereign debt crisis jeopardizes financial stability in the euro region.
One risk to the Deutsche Bank proposal is that the ECB will have to renew the plan in a year’s time just as it has delayed withdrawal of emergency liquidity measures, Moec said. Germany, whose central bank chief Axel Weber has already questioned the bond buying program, also may object to the ECB’s taking on extra risk by not making margin calls, he said.
For its part, Deutsche Bank’s total net exposure to central and local governments in Portugal, Ireland, Italy, Greece and Spain totaled 10.1 billion euros at the end of March, according to a July 27 presentation.
To address potential weaknesses in his proposal, Moec suggested the plan be combined with governments making long-term commitments such as strengthening the rules for fiscal discipline in the euro-area. The ECB also may first require Portugal to accept a bailout before following through on his idea, Moec said.
The central bank should indicate it will raise its benchmark interest rate from a record low 1 percent in 2011 if the overall 16-nation economy merits such a shift, he said.
“The anticipation of higher interest rates would appease the authorities of the core countries,” Moec said.
While the idea requires coordination challenges, Moec said the May rescue of Greece in which the ECB began buying bonds for the first time shows overcoming those are “not unachievable in times of extreme pressure.” Any new action may first require clarity on how the euro-area will address any debt woes beyond 2013, he said.
“The Governing Council is unlikely to take the risk of seeing the far-reaching measures it may be ready to take to support the sovereign bond market undermined by further noise coming from the currently confusing discussions” over what to do after 2013, Moec said.