The ECB will have to yield on Greece

The widening dichotomy between what is being asked of private sector bond-holders in Greece and the stance of the ECB looks ever more untenable and, if some reports are to be believed, this is one of the sticking points that is preventing a resolution of the talks.

It all comes down to the fact that the ECB is sitting on around EUR 40bln or so of Greek government bonds, bought since the start of its securities buying program (SMP) back in 2010. We don’t know exactly how many it holds or their maturities. That said, some rough back-of-the-envelope calculations suggest that it could make somewhere between EUR 20 – 25bln if all were held to maturity (and with no haircut). In contrast, participants in the current private sector initiative are looking at haircuts of 70% or more, but even this may not be enough to put Greece’s debt onto a sustainable footing (which the IMF sees as debt/GDP ratio of 120% by 2020).

The pressure being brought to bear on the ECB is therefore understandable from a pure numbers viewpoint. The bank’s defence is two-fold. Firstly, its purchases were made primarily for monetary policy purposes and as such should not be seen in the same light as private sector purchases based on credit considerations. Secondly, and more crucially, the ECB views taking a loss on its holdings as breaking the constraint under which it operates regarding the monetary financing of deficits.

But should the ECB stick to its guns the eventual outcome would be a transfer from the ECB to its shareholders of the gains, assuming that such gains are not used to offset losses elsewhere from its ever-expanding balance sheet. For Germany (specifically the Bundesbank), this could amount to EUR 3.0 – 3.5bln on the above bond purchase assumption, also assuming that the ECB ploughs the maximum amount allowable into its own reserves before distributing to shareholders.

Herein lies a major issue with the ECB’s bond buying program; it has the potential to slowly but surely benefit the larger eurozone nations. The offset, of course, would be the impact on yields of peripheral nations. But should the ECB resolutely stick with its assumed preferred creditor status, private bond-holders will demand an ever-greater discount for taking on the risk, even though politicians have assured them that the Greek private sector bond deal will be the last. The larger the ECB’s holdings become, the flakier the pledge will look.

The ECB is going to have to give ground at some level, either via the re-allocation of gains from bond purchases, the transfer of bonds to another vehicle or crossing the Rubicon and taking a haircut itself. As laudable as its current stance may be from a central banking perspective, it is looking untenable from nearly every other angle.