Defaulted Greece May Have to Aid Trichet to Save Face as ECB Stands Firm
European Central Bank President Jean-Claude Trichet might need to rely on Greece for assistance if the nation defaults.
Trichet’s threat to refuse defaulted Greek bonds as bank collateral for ECB liquidity remains in force after European finance ministers failed to agree on measures to stem the region’s debt crisis. In a default, Greek lenders could instead get Emergency Liquidity Assistance, a short-term loan program by national central banks in use in Ireland, said economists at Deutsche Bank AG, Barclays Capital and BNP Paribas SA.
That would leave the Greek central bank to firefight a banking crisis that Trichet has staked the ECB’s credibility on keeping clear of. The danger of such an event has gained credence as persistent speculation on the prospect of Greece defaulting transformed into regional contagion that sent bond yields soaring and stocks plunging from Portugal to Italy.
Emergency liquidity “would save Trichet’s face, at least in the short term,” said Gilles Moec, co-chief European economist at Deutsche Bank in London. “It’s relatively painless for the banks as they can just replace old collateral with new that will be accepted by the Greek central bank. The ECB can then stick to its guns.”
ECB Governing Council member Jens Weidmann from Germany told Die Zeit newspaper in an interview published today that “a red line had to be drawn” to protect the central bank from having its credibility undermined. “It’s not our job to finance insolvent banks, never mind countries” which is “why the Eurosystem only lends money against adequate collateral,” he was cited as saying.
The ECB is the main source of finance for Greek banks, which borrowed 97.5 billion euros ($136 billion) in May, up from 86.8 billion euros the previous month. The institution last year suspended the minimum credit-rating threshold for Greece’s bonds after its banks were shut out of credit markets. Lenders can now borrow as much as they need for up to three months against collateral determined at the central bank’s discretion.
ECB officials have insisted tougher austerity measures are the only way out of Greece’s debt quagmire, conflicting with a German-led bloc of finance ministers that sought to inflict part of the burden of a second bailout onto investors. At a July 7 press conference, Trichet repeatedly said that “we say no to selective default or credit event” as he faced a barrage of questions on whether the ECB would stick to its approach.
Ratings companies including Standard & Poor’s and Fitch Ratings have said Greece would be at least temporarily and partially rated in default if plans where implemented under which creditors would roll over bonds maturing until 2014.
Using liquidity assistance, banks could pledge “non- traditional ECB collateral such as mortgage loans, small-and- medium size company loans or shipping loans” to the Greek central bank in exchange for liquidity, said Laurent Fransolet, head of European Fixed Income Strategy at Barclays Capital in London. At the end of May, Greeks banks had 78.9 billion euros in household loans.
The program is very much run at the central bank’s discretion, “making it very flexible but also intransparent” leading to “concerns over the Greek central bank’s balance sheet,” Fransolet said.
The liquidity the central bank lends, which in the Greek case would likely exceed the central bank’s capital base of 1.7 billion euros, is created by expanding the bank’s balance sheet.
“It’s in effect printing money,” said Nick Matthews, an economist at Royal Bank of Scotland Group Plc in London. ‘it’s all a bit off the radar but in practice ELA could be financed by the central bank creating deposits or could also potentially be financed by selling other assets.”
In May, the Greek parliament passed legislation permitting the Ministry of Finance to guarantee the Greek central bank’s financial exposure stemming from support provided to credit institutions. That suggests the central bank was readying itself to step into the breach. A spokesman declined to comment on the matter yesterday.
While emergency liquidity is supposed to be provided in exceptional circumstances on a case-by-case basis to “temporarily illiquid but solvent institutions,” Irish banks have received about 50 billion euros in that so far, according to estimates in a Barclays Capital report on July 5.
Europe’s finance ministers failed to come up with a plan to contain the crisis at a two-day meeting in Brussels on July 11 and 12. That roiled financial markets, wiping $1 trillion off the value of global equities, sending 10-year Italian yields to a 14-year high and pushing the euro to a four-month low.
Irish bonds dropped for a sixth day today after Moody’s Investors Services cut the country’s credit rating to below investment grade last night. The 10-year yields increased 43 basis points to a euro-era record 13.78 percent as of 12:49 p.m. in London. The nation’s two-year note also slid, raising yields by 92 basis points to 18.65. They reached a record 18.68 percent earlier.
Italian 10-year bonds rose, pushing yields down 8 basis points to 5.48 percent, while yields on equivalent-maturity Spanish debt fell 10 basis points to 5.75 percent. Greece’s 10- year bonds fell, pushing the yield up eight basis points to 16.86 percent.
Using ELA for Greek banks is “feasible but this issue is turning into a side show now, the issue has gotten so much bigger,” said Ken Wattret, chief euro-area economist at BNP Paribas in London. “While one can have sympathy for the ECB’s position, it adds to the alarm in markets as political decisions take so much longer.”
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