12 October 2012

Karl Whelan: Draghi making a big mistake on Greek bonds

At last week's press conference, Mario Draghi made a comment about Greek bonds that has received relatively little attention. However, the comment completely undermines a crucial feature of the ECB's new plan to save the euro, comments Whelan in his Forbes blog.

This key feature of the Outright Monetary Transactions (OMT) plan is that bonds purchased by the Eurosystem will rank equally with those owned by private investors. The announcement of the OMT programme stated:

The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

The ECB’s position on its holdings of sovereign debt is extremely hard to understand. When ECB originally purchased bonds under its Securities Market Programme (SMP) it purchased standard bonds (generally with pari passu clauses) and these purchases entitled the ECB to no special treatment.

However, when asked last week about whether the ECB would be willing to restructure its holdings of Greek bonds, Draghi responded that this would “qualify as monetary financing”, meaning it would be a legal violation of the ECB’s prohibition from financing euro area governments.

It was fully understood by everyone that the ECB was taking on credit risk when these bonds were purchased. But when Greece organised a restructuring of its debt earlier this year, the ECB refused to cooperate in restructuring its €56 billion in Greek bonds. Now, the ECB says that it accepts the same treatment as other bondholders while at the same time asserting that having its bonds restructured is illegal.

The purpose of the supposed change of policy on equal treatment was to assure investors that if a debt restructuring took place, the losses would not fall solely on the private bond owners.  Without this assurance, large-scale ECB bond purchases could scare away private investors altogether. Now, the ECB says that if a bond restructuring occurs—the only time when the equal treatment clause matters—they can’t participate.

Perhaps the ECB’s lawyers believe it is illegal to restructure their Greek bonds but not their Italian or Spanish ones.  If this is the ECB position, then they should explain its legal basis. Otherwise, investors in Spanish and Italian bonds have every reason to be nervous about ECB bond purchases.

Full article

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