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The ECB’s stance is peculiar. One would have hoped that the banks might have managed the default risk on the bonds in their portfolios by buying insurance. And, if they bought insurance, a regulator concerned with systemic stability would want to be sure that the insurer pays in the event of a loss. But the ECB wants the banks to suffer a 50 per cent loss on their bond holdings, without insurance “benefits” having to be paid.
There are three explanations for the ECB’s position, none of which speaks well for the institution and its regulatory and supervisory conduct. The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency – and knows that investors know that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothers’ collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.
None of these explanations is an adequate excuse for the ECB’s opposition to deep involuntary restructuring of Greece’s debt. The ECB should have insisted on more transparency – indeed, that should have been one of the main lessons of 2008. Regulators should not have allowed the banks to speculate as they did; if anything, they should have required them to buy insurance – and then insisted on restructuring in a way that ensured that the insurance paid off.
There is, moreover, little evidence that a deep involuntary restructuring would be any more traumatic than a deep voluntary restructuring. By insisting on its voluntariness, the ECB may be trying to ensure that the restructuring is not deep; but, in that case, it is putting the banks’ interests before that of Greece, for which a deep restructuring is essential if it is to emerge from the crisis. In fact, the ECB may be putting the interests of the few banks that have written credit default swaps before those of Greece, Europe’s taxpayers, and creditors who acted prudently and bought insurance.
The final oddity of the ECB’s stance concerns democratic governance. Deciding whether a credit event has occurred is left to a secret committee of the International Swaps and Derivatives Association, an industry group that has a vested interest in the outcome. If news reports are correct, some members of the committee have been using their position to promote more accommodative negotiating positions. But it seems unconscionable that the ECB would delegate to a secret committee of self-interested market participants the right to determine what is an acceptable debt restructuring.