Draghi’s plan: Rescue fund to buy bonds on primary and ECB on secondary market
On Thursday, I mentioned that Mario Draghi’s comments regarding the ECB’s commitment to the euro were greeted by most with a sense of relief. Since that time both German Chancellor Angela Merkel and French President Francois Hollande have echoed Draghi’s language. All three leaders, Draghi, Hollande and Merkel, failed to clarify kind of ECB support was within the ECB’s institutional mandate, so we have to guess at what Draghi’s true intentions are.
Now, according to Bloomberg News, Mario Draghi has a specific plan in mind for how the ECB will be able to arrest the sovereign debt crisis. Two Bloomberg central bank sources told the news agency that ECB President Draghi will have talks with Bundesbank President Jens Weidmann in coming days as the Bundesbank is the "biggest stumbling block" to Draghi’s bond purchase plan. Under that plan, the European rescue funds EFSF and ESM would be permitted to buy European sovereign debt of issuers like Spain and Italy at auction. The ECB would then also be permitted to purchase those bonds on the secondary market, effectively monetising sovereign debt. ECB rate cuts and more LTRO loans to banks are also potential actions the ECB would take according to one of the Bloomberg sources.
Already on Thursday, German ruling coalition politicians voiced disquiet about potential ECB measures because of fears of inflation (which are unfounded given the lack of private credit demand). The Bundesbank has also come out with statements showing their opposition as well. But according to Bloomberg, Draghi has already secured the support of governments in France, Spain and Germany for his moves, which is why Merkel and Hollande have come out with statements. Therefore, Draghi is looking to convince the Bundesbank as the remaining leading opponent of the urgency in his meeting with Weidmann.
Draghi will speak with Weidmann before the ECB’s Governing Council convenes in Frankfurt on Aug. 2, the officials said. He has also reached out to other ECB policy makers in an effort to build consensus, they said. A Bundesbank spokesman declined to comment.
An ECB spokeswoman said in an e-mailed statement it is usual practice and nothing special for Draghi to meet or talk with members of the Governing Council. She declined to comment on the content of any talks.
They will take place against a backdrop of international financial diplomacy, with U.S. Treasury Secretary Timothy Geithner and German Finance Minister Wolfgang Schaeuble scheduled to meet July 30 on the North Sea island of Sylt.
Draghi has already secured the endorsements of Germany and France for a plan to reduce bond yields in Spain and Italy, which are threatening the existence of the euro.
I cannot say whether the Bundesbank would go along with this plan. But to my ears it sounds like a more guns blazing version of previous ECB moves. All of these actions have been taken before from ECB secondary market purchases to LTRO loans to ECB rate cuts. Only the ESM/EFSF purchases at auction are new, but then these funds were widely expected to perform this function. Moreover, they have very limited firepower. Once they run out of funds, this game is played out.
Separately, other rescue steps are being contemplated as well.
- Sources claim that Spain asked Germany to consider Europe offering Spain a credit line of 300 billion euros. Germany has apparently rejected this option.
- It is also being said that the ECB is considering taking writedowns in a second Greek debt restructuring.
- Finally, even Austrian central bank head Nowotny has given some lukewarm support for the ESM rescue fund receiving a banking license in order to facilitate greater leverage in buying sovereign debt assets.
JPMorgan Chase’s David Mackie has put together a useful list of 12 steps that Europe could take to arrest the crisis including all of these mentioned here plus others. Click here for FT Aplhaville’s post on this.
In my view, almost all of this is extend and pretend. The only real solution involves a permanent ECB backstop for euro area sovereign debt and I have written up a rules based approach called the ECB’s Bagehot Rule Policy that would accomplish this via explicit collateral yield ceilings. The ECB is not going to take this approach unless it is absolutely necessary. And so this crisis will continue (and get worse) until they do so.
Also see Jeremy Warner’s insights on the UK, saying "We’ll only know the economy is recovering when bond yields start rising again" for a case of yet another convert to the understanding that a central backstop matters most.
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