Photo: AP/Michael Probst
According to reports from the WSJ yesterday, the European Central Bank has conceded that it would accept writedowns on the face value of its €50 billion ($66.3 billion) in Greek bond holdings, fueling optimism that EU leaders are willing to take more drastic steps to address problems of debt sustainability in the struggling country.On one hand, this move does little to actually accomplish that goal. On the other, it amounts to a form of debt monetization, setting the precedent for further mor drastic ECB action.
The important fact is that the ECB purchased those bonds at a highly discounted price—just €38 billion—and has said it won’t accept losses on its holdings. Therefore, the ECB’s maximum involvement will amount to €12 billion ($15.9 billion).
To give you a better idea of how much this matters, Greece’s debt amounted to €329.4 billion in 2010, and is thought to have grown significantly since then, and the country is currently facing a €15 billion (€19.9 billion) hole in funding needs even with the selective default that has been outlined by EU leaders to date.
Not to mention that Greece’s private creditors are going to put up a stiff fight if they have to accept losses of 70 per cent or more on their holdings of Greek bonds without receiving the insurance they bought to hedge these investments, potentially complicating the whole bailout plan.
On the other hand, the ECB’s willingness to participate in the debt restructuring means it is setting the precedent for monetizing sovereign debt. This plan amounts to the central bank giving Greece purchasing power of €50 billion, regardless of whether or not it’s taking losses on the investment.
If the ECB is willing to monetise debt here, it might also be willing to monetise debt elsewhere by purchasing sovereign bonds on primary markets. Analysts have speculated that this would create a more effective backstop against contagion spreading to Italy and Spain.
The ECB has repeatedly vowed not to take such actions, but this could be a sign that these promises—like many others it has made since the crisis began—have ultimately been shallow.
NOTE: I’ve received a lot of criticism for calling this debt monetization (something that, I admit, appeared pretty obvious). In truth, there is some debate on this matter. Therefore, a forthcoming post will argue just why the ECB’s actions here would actually constitute debt monetization.