Somewhere ages and ages hence:
Two roads diverged in a wood, and I,
I took the one less traveled by,
And that has made all the difference.
It is my understanding that the ECB has hatched a plan to exchange its nominal 55bn euros of GGB's with Greece at par value for new bonds which would have some type of indemnification against loss, and immunity from any retroactive CAC's. These new bonds would then be distributed to the NCB's that are the shareholders of the ECB. What the NCB's would do with them is not yet known.
There are several important inferences we can draw from this move by the ECB.
- The ECB is serious about not allowing monetary financing of sovereigns. A choice to sell the bonds either back to Greece, or to the EFSF, at anything less than par would have been just that. Still looking for ECB Fed/BOE/BOJ style QE? Stick a fork in it!
- The ECB is loss averse, and is trying to establish itself as a super-senior creditor on par with the IMF. There is no precedent for a central bank to make such a claim, which is part of the reason their lending is usually very short term. What the ECB is attempting to do goes against the precedents set by the Paris Club and may not be defensible.
- It puts the PSI deal at great risk. At the very least, it may incentivize PSI-ravaged private bondholders to seek legal remedy, as it means a larger haircut for the private sector if the public sector can claim loss immunity.
- It blows a mile-wide hole into the defensibility of retroactive CAC's. Retroactive CAC's are a highly experimental concept to begin with. What is the legal precedent that would allow the ECB to pull off some type of exchange that gives it "non-CAC-able" bonds at par value? If I happened to be an evil hedge fund manager holding GGB's, I might be inclined to ask this very question in court.
- If the precedent holds, it would likely have a very chilling effect on private sector investment in any sovereign in which the ECB has holdings. This has implications for Spain and Italy, as well as for EZ-wide sovereign debt should the ECB launch QE based on capital keys. Furthermore, it may have a chilling effect on IMF participation, particularly if the concept of some type of public sector seniority were to be overturned in the legal system.
- By extension of point 5, it may have a chilling effect on bank sovereign debt purchases in the next LTRO, particularly in those countries in which the ECB has conducted extensive bond purchases through its SMP.
- It speaks to the loss aversion of the EFSF. The fact that the bonds were not swapped with the EFSF, with haircuts subsequently taken by the EFSF, speaks volumes. EFSF loans are NOT bailouts - they are blood claims. They are a claim on your virgins, more akin to ransom than to a loan!
- In of itself, this move does absolutely nothing to reduce Greece's debt burden. It remains to be seen what the NCB's could or would do in this regard, once they obtain the bonds from the ECB. The NCB's that would have the greatest self-interest in seeing Greece's debt burden reduced are also the NCB's least able to fore go potential profits.
- It highlights the lack of a federalized profit and loss distribution system in the Eurozone, which is really the core of the current problem.
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