The European Central Bank has reportedly come under pressure to “participate” in the haircuts being negotiated for Greek bonds.
Institute of International Finance managing director Charles Dallara, who has been representing private sector creditors, has insisted that all creditors should share in adjustments. There were unconfirmed rumors—quickly denied—that the International Monetary Fund was pushing the ECB to take a haircut on the Greek bonds it has purchased.
Reuters reported that one source “close to talks among ECB policymakers” had said that “while France, Italy and the ECB board in Frankfurt were against accepting losses, some national central banks, which have expressed reservations over the bond purchases from the start, now accepted that losses may be unavoidable.”
Officially, however, the ECB insists that it will be repaid in full. It is even said to be exploring legal options in case Greece tries to force it to take a haircut.
To some observers it seems unfair that the ECB is likely to get treated differently from private creditors. Why should its status as a central bank exempt it from involvement in the losses?
The answer is that the ECB is not like other creditors. Its purchases of Greek bonds are different from all other purchases. And repayment to the ECB is different from all other repayments.
All other purchasers of Greek debt do so with currency they have received from someone else—an investor, a depositor, or even a loan from the ECB. When they get a haircut, they suffer a loss. If an institution owns too many Greek bonds, the losses could be so severe as to put its financial viability at risk. If it needed the funds from the repayment of the Greek bonds to pay its own creditors, it would be insolvent.
When the ECB purchases Greek bonds, however, it does so with newly created currency. It makes the very currency it uses to buy the bonds.
So ECB purchases are not investments—they are exercises of monetary policy. They involve the creation of new money, an expansion of the money supply.
When Greece repays the ECB, the euros used to make those payments will go out of circulation. A haircut for the ECB would mean that the supply of euros was permanently expanded by the amount of the haircut.
For the ECB, getting paid back in full is not about avoiding losses on the bonds. The ECB never has to worry about losses because it can never run out of euros. Instead, it wants to be paid in full as a matter of monetary policy—to avoid expanding the supply of euros.
Look at it this way. Suppose that Greece doesn’t repay one single euro to the ECB. Unlike an ordinary investor, the ECB doesn’t need the euros for anything. It can always make fresh euros when it needs it.
The ECB does a terrible job of explaining itself on this matter, which is one reason there is so much confusion. It’s various mouthpieces talk about not wanting to take “losses” on the bonds, as if that were a real concern.
By habit the ECB is anti-transparent. It doesn’t say how many Greek bonds it has purchased or what price it paid. We’re left guessing. (Most people “familiar with the matter” think the ECB has between 40 and 60 million euros of bonds that it purchased at a discounts of as much as 25 percent.)
I’m not even sure the ECB totally understands what it is doing. If the ECB bought the bonds at a discount but receives 100 cents on the euro, it is actually shrinking the money supply. That’s right: repayment in full would be a contractionary monetary policy.
Think about it this way. Let’s say the ECB bought a bond with a face amount of 1,000 euros for 750 euros. If it is repaid 1,000 euros, that is a net monetary contraction of 250 euros.
I’d like to think that the ECB is fully cognizant of the effects on the money supply of a central bank buying bonds at a discount to face value and then being repaid in full. Unfortunately, I see no sign that the ECB understands this very basic math.
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