tag:blogger.com,1999:blog-43601300991105947112024-03-13T18:29:34.072-04:00Ante HocBefore the fact is appreciatedUnknownnoreply@blogger.comBlogger50125tag:blogger.com,1999:blog-4360130099110594711.post-22784387899195998322023-03-23T22:00:00.004-04:002023-03-23T22:02:10.349-04:00Turgidify, a Neologism<p>When recently I wrote an essay for a preschool application, I had to expand a perfectly good 100 word answer to the minimum required 500 words. My answer had to be turgidified. AI was useful for this. I fear it will be used for all manner of turgidification until people tire. </p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-54370888853532567032018-05-28T10:47:00.003-04:002018-05-28T10:47:34.742-04:00Time to Restart<span style="font-size: large;">It's time once again to engage with people who require technical understanding of the Eurosystem and the risks posed as a result of the current situation. We are available for your questions.</span>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-9831153535438568572014-06-23T15:47:00.001-04:002014-06-23T16:06:03.320-04:00US households' holdings of Agency and GSE backed securities went from over a trillion to effectively zero <br />
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<a href="http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf" target="_blank">Flow of Funds, L.100</a></div>
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The peak was in Q3 2008<br />
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*category includes non-profits, domestic hedge funds, private equity funds, and personal trusts<br />
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-62857600515979626982014-06-23T12:19:00.003-04:002015-01-21T15:07:22.027-05:00US Banks' Holdings of Government Obligations US Depository Institutions now hold, as a percentage of their balance sheets, far more government backed assets (Treasuries + Agencies + GSE backed mortgage securities + municipal securities and loans + reserves at the fed + vault cash) than in recent history. <br />
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And despite the large purchases of treasuries and GSE backed mortgage securities by the Fed since the start of the crisis, US banks have also increased their holdings of both. </div>
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Source: <a href="http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf" target="_blank">2014 Q1 Flow of Funds</a>, Table L.109 </div>
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<br />Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-57332218517143815162013-12-11T11:44:00.000-05:002013-12-15T10:53:01.541-05:00Blinder's Blunder<span style="font-family: Georgia, serif;">In a WSJ Op-Ed today, former Fed Vice-Chairman Alan Blinder <a href="http://online.wsj.com/news/articles/SB10001424052702303997604579238403178592262" target="_blank">writes</a> that the Fed should cut the interest it pays on excess reserves so that banks will have more incentive to lend them out: </span><br />
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<span style="background-color: white; color: #333333; line-height: 21px;"><i><span style="font-family: Georgia, Times New Roman, serif;">"At this point, you're probably thinking: 'Wait. If the Fed charged banks rather than paid them, wouldn't bankers shun excess reserves?' Yes, and that's precisely the point. Excess reserves sitting idle in banks' accounts at the Fed do nothing to boost the economy. We want banks to use the money."</span></i></span><br />
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<span style="color: #333333; font-family: Georgia, Times New Roman, serif;"><span style="line-height: 21px;">The topic was discussed at the Fed's most recent meeting, as noted by the <a href="http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20131030.pdf" target="_blank">minutes</a>:</span></span><br />
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<i><span style="font-family: Georgia, Times New Roman, serif;">"...most participants thought that a reduction by the Board of Governors in the interest rate paid
on excess reserves could be worth considering at some
stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal
of policy intentions." </span></i><br />
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<span style="font-family: Georgia, Times New Roman, serif;">Blinder's idea sounds good - but it's based on a misunderstanding. The presence of so many excess reserves is an accounting by-product of the Fed's asset purchases; it tells us virtually nothing about the state of bank lending or whether banks are "us[ing] the money". This identity was nicely described by NY Fed researchers Todd Keister and Jamie McAndrews in a <a href="http://www.newyorkfed.org/research/current_issues/ci15-8.pdf" target="_blank">2009 paper</a>. </span><br />
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<span style="font-family: Georgia, Times New Roman, serif;">Lets hope the current FOMC understands how this works. </span></div>
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-34086415987552800142013-11-22T09:33:00.003-05:002013-11-22T09:33:57.862-05:00ECB's Asmussen: "banking union is just the first start" toward fiscal union and then political union. "And that is what we are going to do in Europe" <div dir="ltr" style="text-align: left;" trbidi="on">
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<span style="font-size: 10.0pt; mso-bidi-font-size: 12.0pt;">Interviewer: ...[I]s there a message about the European Central Bank, about its
mission, its goals, and its outlook, that you want to make sure this audience
understands before you get on the plane and head back over the water?<o:p></o:p></span></div>
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<span style="font-size: 10.0pt; mso-bidi-font-size: 12.0pt;">Asmussen: ... We are deeply convinced that we need to integrate
Europe further, where we have an incomplete monetary area. It’s in economic
terms an unstable equilibrium. And we need to move this construction to a new
stable equilibrium, and this in my view means more integration. <b>And banking
union is just the first start. We then need to continue… a true economic union,
a fiscal union, a democratically legitimized political union, so to really, to
complete EMU.</b> And if one is not willing or not able to go down this route, it
can be both, willing and able, then we will disintegrate. This could lead in
economic terms to a stable equilibrium, but in my view at much lower welfare
levels. So I would really say, let’s go down the whole way, banking union is
just the first step. We should not stop there. I of course know all the
skepticism towards more European integration.<b> I can read polls as you can read
polls for the European elections. But in my view political leadership is not
that you look at the polls, say, ‘oh this is very difficult, the people don’t
want it, so we don’t do it.’ I think political leadership is exactly the
opposite, that one has a goal, explains why this is a good goal, names the pros
and the cons and then simply then goes out and fights for it. And that is what
we are going to do in Europe. </b><o:p></o:p></span></div>
</div>
</div>
Makepeacehttp://www.blogger.com/profile/10265065409491214619noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-76790141428092455412013-10-02T09:13:00.000-04:002013-12-05T12:17:36.511-05:00Euro Zone Capital Flight - NY Fed Blog Post - Award for Solving the Riddle<div dir="ltr" style="text-align: left;" trbidi="on">
<span style="font-family: Georgia, Times New Roman, serif;">The New York Fed, on its well-written blog, <i>Liberty Street Economics</i>, has posted <a href="http://links.govdelivery.com/track?type=click&enid=ZWFzPTEmbWFpbGluZ2lkPTIwMTMxMDAyLjIzNjI1MTcxJm1lc3NhZ2VpZD1NREItUFJELUJVTC0yMDEzMTAwMi4yMzYyNTE3MSZkYXRhYmFzZWlkPTEwMDEmc2VyaWFsPTE3ODAyMjYyJmVtYWlsaWQ9amFjb2JAbmV0Z2xpZGUuY29tJnVzZXJpZD1qYWNvYkBuZXRnbGlkZS5jb20mZmw9JmV4dHJhPU11bHRpdmFyaWF0ZUlkPSYmJg==&&&100&&&http://libertystreeteconomics.newyorkfed.org/2013/10/capital-flight-inside-the-euro-area-cooling-off-a-fire-sale.html">Capital Flight in the Euro Area - NY Fed Research</a>. The post describes capital flight in the euro area during the crisis, and the accommodation of the flight in the Target2 payment system. Their description is hard to square with the graph below which shows capital flight from Spain to be negatively correlated with the level of stress. For example, capital flight in a low stress month, March, was four times as large as during November, the highest stress month in the period shown. The data for all of 2011 and 2012, for Spain and Italy, more broadly show unexpected timing of capital flight.</span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br />
We will pay $5,000 to the first person who, in the next week, correctly explains the conceptual error in the blog post that is highlighted by this riddle. (Persons who have heard the explanation from us aren't qualified for payment but are most welcome to respond.) Please submit answers to wolfgang@antehoc.com. </span><br />
<span style="font-size: large;"><br /></span>
<span style="font-size: large;"><br /></span>
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<a href="http://4.bp.blogspot.com/-F9TaCUma2Uc/UWcw_dmL-WI/AAAAAAAAAdA/KDDe13UGCXg/s1600/Spain+Capital+Flight.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="464" src="http://4.bp.blogspot.com/-F9TaCUma2Uc/UWcw_dmL-WI/AAAAAAAAAdA/KDDe13UGCXg/s640/Spain+Capital+Flight.jpg" width="640" /></a>
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-52199356717290454952013-07-18T10:41:00.004-04:002013-12-05T12:11:43.050-05:00From the Archives, this circulated in April, 2010 - A Parody of the SEC's Goldman Sachs Complaint. (The footnotes are factual, as is the Bloomberg quote on Paulson and the graph of subprime prices.)<html>
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<span style="background-color: #6aa84f;"><b><span style="color: white; font-family: "\0027Times New Roman\0027"; font-size: 18pt;">A</span></b><b><span style="background-position: initial initial; background-repeat: initial initial; color: white; font-family: Arial; font-size: 18pt;">C</span></b><b><span style="color: white; font-family: "\0027Times New Roman\0027"; font-size: 18pt;">E</span></b></span><b><span style="font-size: 18.0pt;"> Portfolio
Selection, Inc. </span> </b> </div>
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<span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">Regulated
by MIA<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-1"><span style="color: blue;">1</span></a></sup> </span><span style="font-family: "georgia\, sans-serif";"> (</span><span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">Maryland Insurance
Administration</span><span style="font-family: "georgia\, sans-serif"; font-size: 7.5pt;"> - </span><span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">www.mdinsurance.state.md.us</span><span style="font-family: "georgia\, sans-serif";"> )</span> </div>
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<b><span style="font-size: 18.0pt;">Sublime Securities Fund
</span></b> </div>
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<span style="font-family: "times\, sans-serif";">(c) 2007</span> </div>
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<b><span style="font-size: 13.5pt;">Our Firm</span></b> </div>
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<span style="font-size: 10.0pt;">We select sublime securities for
our clients and ourselves. We have dedicated substantial resources to the
analysis of sublime securities and have one of the world’s largest portfolios,
outside of Federal Reserve System regulated banks. We are proud of our
record, having taken no write-downs on any of the securities we have purchased.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-2"><span style="color: blue;">2</span></a></sup> </div>
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<span style="font-size: 10.0pt;">We seek to purchase entire
portfolios of sublime securities opportunistically with particular focus on
motivated sellers. We believe that the ability to purchase entire portfolios
provides us a significant price advantage because of the certainty it provides
the seller. We prefer to negotiate directly with sellers in order to
garner detailed information on their analysis from the process of suggesting,
discussing, deleting and replacing securities in the prospective sale.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-3"><span style="color: blue;">3</span></a></sup> </div>
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<span style="font-size: 10.0pt;">We value our reputation.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-4"><span style="color: blue;">4</span></a></sup> <span style="font-size: 10.0pt;">We believe in our analysis and we often invest more in
a transaction than all of our clients combined.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-5"><span style="color: blue;">5</span></a></sup> </div>
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<span style="font-size: 10.0pt;">While all investment strategies
have risks, our strategy has some unusual risks. Clients should carefully
review the <b>Risks</b> section.</span> </div>
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<b><span style="font-size: 13.5pt;">Risks</span></b> </div>
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<b><span style="font-size: 10.0pt;">Sellers
Seeking Buyers</span></b><span style="font-size: 10.0pt;">. We seek
motivated sellers. This might cause us to purchase securities from
sellers who are <b>actively seeking buyers </b>.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-6"><span style="color: blue;">6</span></a></sup> </div>
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<b><span style="font-size: 10.0pt;">Selection.</span></b><span style="font-size: 10.0pt;"> We might select for purchase sublime securities
selected by sellers for sale. While we endeavor to select for purchase
only securities sold accidentally by sellers, or not sold by sellers at all,
there can be no assurance that we won't buy securities intentionally being
sold.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-7"><span style="color: blue;">7</span></a></sup>
</div>
<div class="Div">
<br /></div>
<div class="Div">
<b><span style="font-size: 10.0pt;">Adverse Selection</span></b><span style="font-size: 10.0pt;">. We might purchase securities from a seller
who <b>has done analysis</b>. Such a seller may even have a
particular view on how to weigh attributes of those securities.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-8"><span style="color: blue;">8</span></a></sup> <span style="font-size: 10.0pt;">We might purchase securities from sellers who wish to
sell because they <b>think the securities' prices will decline.
</b></span> </div>
<div class="Div">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Excessive
Interaction with Sellers/Stockholm Syndrome.</span></b> </div>
<div class="Div">
<span style="font-size: 10.0pt;">We might negotiate with sellers
about which parts of their portfolios we’d like to buy.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-9"><span style="color: blue;">9</span></a></sup> <span style="font-size: 10.0pt;">We might be influenced by facts and arguments about
the securities. We might be subjected to give and take during
negotiations with sellers (see GS Wells response footnote 3 above). We
might spend months negotiating such a purchase,</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-10"><span style="color: blue;">10</span></a></sup><span style="font-size: 10.0pt;"> triggering <b>Stockholm Syndrome</b>,
which could cause us to identify excessively with the seller. </span> </div>
<div class="Div">
<b><span style="font-size: 10.0pt;">References</span></b><span style="font-size: 10.0pt;">:</span> </div>
<div class="Div">
<i><span style="font-size: 7.5pt;">Voice and Choice: How too Much
Talking Distorts Security Selection, </span></i><span style="font-size: 7.5pt;">Dr. Richard E. Simpson, ABS. <b>Annals of Selection as
a Choice</b>, Vol. 1, No. 1.</span> </div>
<div class="Div">
<i><span style="font-size: 7.5pt;">Excessive Interaction with
Sellers Turns Selections into Assortments, </span></i><b><span style="font-size: 7.5pt;">Journal of Sublime Chocolate Studies</span></b><span style="font-size: 7.5pt;">, 2010.</span> </div>
<div class="Div">
<span style="font-size: 7.5pt;">Stockholm Syndrome, Securities
Selection Pressure Variant, <b>DSM-V</b> Pending.</span> </div>
<div class="Div">
<i><span style="font-size: 7.5pt;">Selection Pressure: Interaction
with Sellers and the Failure of Evolution</span></i><span style="font-size: 7.5pt;">. Prof. Simon Richmanson, CCD, 2010.</span> </div>
<div class="Div">
<br /></div>
<div class="Div">
<b><span style="font-size: 10.0pt;">Loss of Entire Portfolio
Concession</span></b><span style="font-size: 10.0pt;">. Under proposed SEC
Rule ABC-2010, we must avoid even the appearance of selecting jointly with a
seller. Rule ABC-2010 provides a safe harbor for Selection Agents that
reject at least 65% of the securities that sellers first wish to sell. If
this rule is adopted, we will lose the price concession that attends our
purchase of entire portfolios from sellers.</span> </div>
<div class="Div">
<br /></div>
<div class="Div">
<b><span style="font-size: 10.0pt;">Loss of Ability to Agree with
Sellers' Choices</span></b><span style="font-size: 10.0pt;">. If proposed
SEC Rule ABC-2010 is adopted, then on those occasions that the best
selection for purchase is the seller's original list offered for sale, we won't
be able to avail our clients of this opportunity. This can be costly when
the seller wants to sell the wrong securities.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-11"><span style="color: blue;">11</span></a></sup> </div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Failure
to Notice Price Changes</span></b><span style="font-size: 10.0pt;">. We may
fail to adjust the price at which we would purchase a security despite a market
price drop of 15% over the selection period.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-12"><span style="color: blue;">12</span></a></sup><span style="font-size: 10.0pt;"> [see
sea blue chart at end for prices]</span> </div>
<div class="MsoNormal">
<b><span style="font-size: 10.0pt;">Alertness in Noticing
Price Changes</span></b><span style="font-size: 10.0pt;">. We may react quickly
to price changes. This could draw scrutiny from the Subcommittee for
Permanent Investigations. </span></div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">False
Impressions. </span></b><span style="font-size: 10.0pt;">We may get false
impressions about significant conflicts or coincidences of interest by being
explicitly misled, by the failure of others to disabuse us of misapprehensions
that we evince, by misreading body language, or from the <b>reckless failure of
someone to answer a vague email</b> we might send, compounded by our <b>failure
to resend.</b><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-13"><span style="color: blue;">13</span></a></sup> These
false impressions can persist despite our being told otherwise repeatedly.<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-14"><span style="color: blue;">14</span></a></sup> </span>
</div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Specialized
Terminology</span></b><span style="font-size: 10.0pt;">. We might not
understand the terminology of our area of expertise (see <b>Transaction
Sponsor</b>, in <b>Glossary</b>, below).</span> </div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Strange
Circumstances/Delusions. </span></b><span style="font-size: 10.0pt;">We
might fail to use common sense and common knowledge. Apparently strange
circumstances may persist without notice. For example, we might have an
equity purchaser with whom we interact extensively over a four month deal
arrangement period. We might learn in the middle of the period from a
Bloomberg Top Story that the equity purchaser has formally predicted that the
assets on which the equity sliver lies will "implode" and that the
equity purchaser will continue to bet on falling security prices. </span>
</div>
<div class="MsoNormal" style="text-align: justify;">
<span style="background: black; color: #ff9900; font-family: Tahoma; font-size: 10.0pt;">Subprime Defaults to Soar,
Hurt Lenders, Funds Say - March 15, 2007 (Bloomberg) -- </span> </div>
<div class="MsoNormal" style="text-align: justify;">
<span style="background: black; color: #ff9900; font-family: Tahoma; font-size: 10.0pt;">"We believe we are in
the early stage of a correction in this market and that the market will
eventually implode,'' New York-based Paulson & Co., which manages $11
billion, said in a letter to investors last week. Paulson said bad loans held
by the riskiest borrowers will ``skyrocket''. Paulson's
8-month-old credit fund gained 67 percent, swelling assets to almost $2
billion. [Paulson]... said they continue to bet loan defaults will rise.
... "While the bonds have fallen significantly, we think they have
much further to fall.''</span><sup><span style="font-family: "georgia\, sans-serif";"><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-15"><span style="color: blue;">15</span></a></span></sup><span style="font-family: "georgia\, sans-serif";"> </span> </div>
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: 10.0pt;">We
might be directly told by the equity partner that in fact they're going short.<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-16"><span style="color: blue;">16</span></a></sup> We
might later not notice that in the final documents there is no equity.</span><sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-17"><span style="color: blue;">17</span></a></sup> </div>
<div class="MsoNormal" style="text-align: justify;">
</div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Failure
to: Startle/Heed/Question/be Slightly Curious</span></b> </div>
<div class="MsoNormal" style="text-align: justify;">
<span style="font-size: 10.0pt;">We
might fail to heed stark warnings about the markets in which we’re active
[Paulson, 2007]. This could be despite extreme price declines during deal
negotiations. We might fail to ask the equity purchaser about they're
thinking about the securities market or about their counterintuitive purchase. (See
sea blue chart below).</span> </div>
<div class="MsoNormal" style="text-align: justify;">
<br /></div>
<div class="MsoNormal" style="text-align: justify;">
<b><span style="font-size: 10.0pt;">Time
Confusion</span></b><span style="font-size: 10.0pt;">. We might confuse the
present with either the future or the past<i>. </i>For example, our
Commitments Committee might approve a transaction before the securities are
selected,<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-18"><span style="color: blue;">18</span></a></sup> or
it might find significance in old, expired, facts.<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-19"><span style="color: blue;">19</span></a></sup></span> </div>
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<i>Acknowledgement: I'd like to thank the SEC for helpful
complaints. All remaining errors are my own.</i> </div>
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<a href="http://1.bp.blogspot.com/-_ZK9yzodbv8/UeQy5WE9dYI/AAAAAAAAAAo/l8Y9z3Pv7j0/s1600/image001.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="430" src="http://1.bp.blogspot.com/-_ZK9yzodbv8/UeQy5WE9dYI/AAAAAAAAAAo/l8Y9z3Pv7j0/s640/image001.jpg" width="640" /></a></div>
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<span style="font-size: 10.0pt;">Source: Leak of Confidential
Goldman Sachs Document Submitted to the SEC. Downloaded from Scribd.</span>
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<b><span style="font-size: 13.5pt;">Glossary</span></b> </div>
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<div class="Div">
<b><span style="font-size: 10.0pt;">Transaction</span></b> <b><span style="font-size: 10.0pt;">Sponsor</span></b><span style="font-size: 10.0pt;">, n.:</span>
</div>
<div class="Div">
<span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">1
- In a synthetic CDO, the buyer of protection/shorting. "...in a
synthetic CDO...[t]he sponsor of the CDO acts as the buyer of protection".
<b><i>Fixed Income Markets and Their Derivatives, </i></b></span><span style="font-size: 10.0pt;">Suresh M. Sundaresan, Academic Press (Elsevier),
2009. </span> </div>
<div class="Div">
<span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">2
- In a CDO, the entity buying protection/transferring away credit
risk/shorting. "The sponsoring institution transfers the credit
risk", <i>Credit Portfolio Management</i>, Wiley Finance, 2003.
Also, see any internet search for documents created before
April 16, 2010.</span> </div>
<div class="Div">
<span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">3
- Not well defined.<sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1#FOOTNOTE-20"><span style="color: blue;">20</span></a></sup></span>
</div>
<div class="Div">
<span style="font-family: "georgia\, sans-serif"; font-size: 10.0pt;">4
- In a synthetic CDO, the equity holder, but not protection buyer. This
definition is speculative. Etym: from the implication of the SEC's
inference about the recklessly unresponded to and not resent email (see <b>False
Impressions</b>, under <b>Risks</b>). <i>Caution</i>: This special
definition may not apply to native English speakers. The SEC hasn't
opined on this.</span> </div>
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<b><span style="font-size: 10.0pt;">Select</span></b><span style="font-size: 10.0pt;">, <i>vt</i>.:</span> </div>
<div class="Div">
<span style="font-size: 10.0pt;">1 - To choose from among a group by
applying skill and effort, except if that choice is agreed to by others.
[preferred usage, obs.] Etym: SEC 2010</span> </div>
<div class="MsoNormal">
<span style="font-size: 10.0pt;">2 - To choose from among a
group by applying skill and effort. [required when securities
are selected for purchase given the necessity of having sellers]</span> </div>
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<b><span style="font-size: 10.0pt;">Buy Protection</span></b><span style="font-size: 10.0pt;">, v.:</span> </div>
<div class="Div">
<span style="font-size: 10.0pt;">go short. Use in a sentence:
Paulson partner described their purpose to ACA: "...we wanted to buy
protection on tranches of a synthetic RMBS portfolio." Pellegrini said.
(SEC deposition according to CNBC)</span> </div>
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<b><span style="color: #6aa84f; font-family: Arial, Helvetica, sans-serif;">The reader is free to print, post and distribute this.</span></b></div>
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footnotes </div>
<div class="MsoNormal">
<sup>1 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-1"></a><span style="font-size: 7.5pt;">http://www.aca.com/about/
ACA Financial Guaranty Corporation is a monoline bond insurance company ...
regulated by the Maryland Insurance Administration.</span><br />
<sup>2 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-2"></a><span style="font-family: "georgia\, sans-serif"; font-size: 7.5pt;">MIA BULLETIN NO. 00-16. Maryland Insurance
Administration adoption of NAIC Codification of Statutory Accounting
Principles.</span><br />
<sup>3 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-3"></a><span style="font-family: "georgia\, sans-serif"; font-size: 7.5pt;">GS Wells Response: The Seller initially suggested <b>123</b>
securities to ACA. ACA evaluated these, rejected <b>68</b>, accepted <b>55</b>
and proposed an additional <b>31</b>. ACA later proposed an additional <b>26</b>.
GS requested that <b>two</b> be rejected, and ACA suggested <b>three</b>
replacements. After a meeting between ACA and the Seller, ACA circulated a
spreadsheet of <b>100</b> securities, including the securities that the two
parties had agreed upon, as well as <b>several</b> additional securities. The
Seller requested removal of <b>eight</b> and GS requested removal of <b>two</b>
others. The Seller then circulated a list of <b>90</b>. ACA requested
removal of <b>3</b> and proposed <b>11</b> alternatives, <b>3</b> of which were
agreed upon by the Seller.The parties than further discussed the substitution
of a <b>handful</b> of securities and settled on the final portfolio.</span><br />
<sup>4 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-4"></a><span style="font-size: 7.5pt;">SEC/48
"for us to put our name on something, we have to be sure it enhances our
reputation.”</span><br />
<sup>5 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-5"></a><span style="font-size: 7.5pt;">SEC/58, 61,
GS Response. ACA invested $951 million, the other investor, $150 million,
and GS bought some.</span><br />
<sup>6 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-6"></a><span style="font-size: 7.5pt;">SEC/3 In sum,
GS&Co arranged a transaction at Paulson’s request</span><span style="font-family: "Arial\, sans-serif";"> /</span><span style="font-size: 7.5pt;">43 “Goldman is effectively working an order for
Paulson"</span><br />
<sup>7 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-7"></a><span style="font-size: 7.5pt;">SEC/2 "</span><span style="font-family: "georgia\, sans-serif"; font-size: 7.5pt;">Paulson, with
economic interests directly adverse to investors, played a significant role in
selection." [by negotiating what securities it wanted to sell].</span><br />
<sup>8 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-8"></a><span style="font-size: 7.5pt;">SEC/25 ...
Paulson performed an <b>analysis</b> of recent-vintage Triple B RMBS ...
Paulson's selection criteria favored RMBS that included a high percentage of
adjustable rate mortgages, relatively low FICO scores..[etc.] .</span><br />
<sup>9 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-9"></a><span style="font-size: 7.5pt;">SEC/30
On January 22, 2007, ACA sent an email to Tourre and others at GS&Co
with the subject line, “Paulson Portfolio 1-22-10.xls.[sic]” The text of the
email began, “Attached please find a worksheet with 86 sub-prime mortgage
positions that we would recommend taking exposure to synthetically. Of the 123
names that were originally submitted to us for review, we have included only
55.”</span><br />
<sup>10 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-10"></a><span style="font-size: 7.5pt;">SEC/26
On January 8, 2007, a meeting with Paulson and ACA.SEC/41. On or about
April 26, 2007, GS&Co finalized a 178-page offering memorandum for ABACUS
2007-AC1.Also, see sea blue chart at the end.</span><br />
<sup>11 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-11"></a><span style="font-size: 7.5pt;">Thu, Apr
22, 2010. CNBC</span><span style="font-family: "Arial\, sans-serif";">. </span><span style="font-size: 7.5pt;">Main Investor in Goldman Deal May Have Caused Losses.</span><br />
<span style="font-size: 7.5pt;">ACA actually threw out 68 of the 123 securities
suggested by Paulson. Those 68 securities had higher delinquency rates than the
remaining ones, according to documents reviewed by CNBC. However, those
documents show that ACA added 14 securities with lower credit ratings than the
overall portfolio.</span><br />
<span style="font-size: 7.5pt;">Documents also show that ACA added other
securities with a higher percentage of mortgages from California and
interest-only loans-two favorites of the shorts because they were perceived as
having a higher chance of failure.</span><br />
<span style="font-size: 7.5pt;">The apparent reason for adding these securities
was that they had lower delinquency percentages overall. But they also has the
very characteristics that Paulson and other shorts at the time believed would
lead to higher delinquencies in the future.</span><br />
<span style="font-size: 7.5pt;">CNBC asked one investor who was short mortgages
during this time how he would have responded to the securities suggested by
ACA. His responses: "I'd say, 'Thank you, sir. May I have another?' "</span><br />
<sup>12 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-12"></a><span style="font-size: 7.5pt;">The SEC Complaint
never discusses price as part of the security selection process. This recently
stable market became very volatile during security selection. Since there are
no bad securities, just bad prices, much of the quality of the selection
process rests on what prices were chosen. Perhaps they have reserved for
trial the decisive evidence that the buyer and seller agreed on price.
Perhaps even that the seller went first.</span><br />
<sup>13 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-13"></a><span style="font-size: 7.5pt;">SEC/49
On January 16, 2007, the GS&Co sales representative forwarded that
email to Tourre. As of that date, Tourre knew, or was <b>reckless in not
knowing</b>, that ACA had been misled into believing Paulson intended to invest
in the equity of ABACUS 2007-AC1..</span><br />
<sup>14 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-14"></a><span style="font-size: 7.5pt;">SEC/29 On
January 10, 2007, Tourre sent an email to ACA.... The text of Tourre’s email
began, “we wanted to summarize ACA’s proposed role ... for the transaction that
would be sponsored by Paulson (the ‘Transaction Sponsor’).” 47.On January
10, 2007, Tourre emailed ACA a “Transaction Summary” that included a
description of Paulson as the “Transaction Sponsor” ....</span><br />
<sup>15 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-15"></a><span style="background: black; color: #ff9900; font-size: 10.0pt;">http://www.bloomberg.com/apps/news?pid=20601103&sid=agHGvijV55fM&refer=us</span><br />
<sup>16 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-16"></a><span style="font-size: 7.5pt;">CNBC, 21
Apr 2010: from SEC document, In one part of Paulson partner Pellegrini's
testimony, a government official asked him: "Did you tell (ACA) that you
were interested in taking a short position in Abacus?"<br />
"Yes, that was the purpose of the meeting," Pellegrini responded.<br />
"How did you explain that ...?" the government official said.<br />
"That we wanted to buy protection on tranches of a synthetic RMBS
portfolio." Pellegrini said.</span><br />
<sup>17 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-17"></a><span style="font-size: 7.5pt;">Greg Palm,
GC GS, Conf Call Transcript, April 20, 2010, "the term sheets and offering
circular did not reflect an equity tranch."</span><br />
<sup>18 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-18"></a><span style="font-size: 7.5pt;">SEC/51
On February 12, 2007, ACA’s Commitments Committee approved the firm’s participation
in ABACUS as portfolio selection agent. /35. On or about February 26,
2007, ... Paulson and ACA came to an agreement on a reference portfolio of 90
RMBS for ABACUS 2007-AC1.</span><br />
<sup>19 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-19"></a><span style="font-size: 7.5pt;">SEC/51
The ... approval memorandum described Paulson’s role...: “the hedge
fund equity investor <b>wanted</b> to invest in the 0- 9% tranche of a static
mezzanine ABS CDO....” </span><br />
<sup>20 </sup><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711&pli=1" name="FOOTNOTE-20"></a><span style="font-size: 7.5pt;">GS Wells
Notice Response: several Goldman Sachs employees testified, the term “sponsor”
is not uniformly defined in the context of a CDO transaction, and it need not
refer to an equity investor at all. (See Tourre Tr. Vol. 1, 13 (stating
that the term transaction sponsor is “not necessarily . . . a defined term” and
“a very loose concept”); Gerst Tr. 105 ( “I don‟t really think of [“sponsor”]
as . . . an official designated role in a transaction per se.”); Nartey Tr. 31
(“[W]e use [transaction sponsor] in different ways.”).)Indeed, the documents
and testimony show that that the term “sponsor” was sometimes used to refer to
an investor that initiated a reverse inquiry, a counterparty that initiated a
reverse inquiry, the entity that selected the portfolio, or Goldman Sachs
itself. (See Tourre Tr. Vol. 1, 24 (describing IKB as the “sponsor
investor” for the first ABACUS deal ); Tourre Tr. Vol. 1, 71 (stating that the
term “ACA Sponsorship” in the 2007-AC1 flipbook referred to the fact that ACA
selected the 2007-AC1 Reference Portfolio); GS MBS 0000010036 (ABACUS 2007-AC1
Flipbook dated February 26, 2007) (stating that ABACUS 2007-AC1 was being
“sponsored by ACA.”); Gerst Tr. 105 (stating that he thought of the investor
who “initiated the inquiry” as a transaction sponsor); Nartey Tr. 31 (stating
that clients, managers, and Goldman Sachs itself could be deemed a sponsor)).</span>
</div>
</div>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-52876181236366809692013-06-08T13:22:00.000-04:002013-06-09T09:48:45.127-04:00Bundesbank Letter to German Constitutional Court - English Translation<div style="text-align: justify;">
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<span style="font-family: Georgia, Times New Roman, serif;"><i>The following is an English translation of the <a href="http://www.handelsblatt.com/downloads/8124832/1/stellungnahme-bundesbank_handelsblatt-online.pdf" target="_blank">Bundesbank's letter</a> to the German Constitutional Court that was published by Handelsblatt. We welcome comments on translation issues and otherwise.</i></span></div>
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<b id="docs-internal-guid-47a3bc29-1fad-3551-4f89-f2ca27e889f2"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Bundesbank December 21, 2012</span></span></b></div>
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<b id="docs-internal-guid-47a3bc29-1fad-3551-4f89-f2ca27e889f2"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Statement to the Federal Constitutional Court of Germany regarding the lawsuits with file reference 2 BvR 1390/12, 2 BvR 1421/12, 2 BvR 1439/12, 2 BvR 1824/12, 2 BvR 6/12</span></span></b></div>
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<b id="docs-internal-guid-47a3bc29-1fad-3551-4f89-f2ca27e889f2"><span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">A.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Introduction</span></span></b></div>
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<b id="docs-internal-guid-47a3bc29-1fad-3551-4f89-f2ca27e889f2"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Within the Monetary Union of the European Union, the monetary policy framework is given by the Maastricht Treaty and the legal acts based thereon. The general principle is a stability-oriented monetary policy with the goal of price level stability which is implemented by independent central banks and to whom monetary government financing is prohibited. This reflects the experiences of those central banks which prior to the Monetary Union were independent, and able to ensure monetary stability with a focus on price level stability. The narrow and clearly defined mandate of the central bank system recognizes the particular constellation of the Monetary Union: a community of countries which have assigned responsibility for monetary policy over to the supranational level, but which continue to decide on fiscal and economic policy primarily at a national level, and which deliberately did not enter into a liability or transfer union. Within this scope, the protection of the common monetary policy, from, for example unsound government financing of some member states, is ensured by the exclusion of liability for other member states, the prohibition of monetary government financing as well as the independent role of markets in the evaluation of the solvency of member states of the Monetary Union, which derives from their individual fiscal responsibility. The latter is expressed by the respective risk premia governments incur when borrowing on capital markets.</span></span></b></div>
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<b id="docs-internal-guid-47a3bc29-1fad-3551-4f89-f2ca27e889f2"><span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">The financial and economic crisis since 2007 as well as the debt crisis in some member states of the common currency area since 2009 witnessed a considerable enlargement of the range of monetary policy instruments employed, and a strong expansion of the balance sheets of Eurosystem central banks. With these measures, the Eurosystem has made a substantial contribution to the containment of the crisis. The Bundesbank endorsed many</span><span style="font-size: 12px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> of the measures taken. However, the Bundesbank considers some decisions as very problematic, and has also publicly stated its criticism.</span></span></b></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Against the background of the arguments and views newly presented during the cases at the Federal Constitutional Court of Germany, the Bundesbank hereby completes its statement. This statement focuses on the purchase of government bonds by the Eurosystem, the TARGET2 balances, and the resulting risks of losses for the federal budget.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">B.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">The OMT program</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Following a brief description of the enacted OMT program, the monetary policy justification for this program is discussed with a particular regard to a disruption of the transmission mechanism. The subsequent section elaborates in more detail on the instrument of government bond purchases and its relation to monetary government finance.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">I.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">The current operating framework of the OMT program</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">On September 6, 2012, the Council of the European Central Bank ended the SMP. It had been initiated in May 2010 and the Eurosystem’s current stock of government bonds which were acquired in the context of the SMP amounts to an acquisition volume of approximately 210 bn €.[1] The OMT program was enacted at the same time as the SMP was ended. </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">As was the case for the SMP, the purpose of the OMT program is to ensure a properly functioning monetary policy transmission and the uniformity of monetary policy. In contrast to the SMP, the extent of OMT purchases is explicitly not limited, but tied to certain conditions. A complete macroeconomic EFSF/ESM adjustment program or a preventive EFSF/ESM program, both of which include the possibility of EFSF/ESM primary market purchases, are mentioned as a necessary, but not sufficient requirements. However, the ECB Governing Council reserves the option of setting further conditions beyond what was mentioned. As a basic principle, OMT purchases shall be stopped if a government breaches a program’s conditions.[2] No purchases are to take place during an ongoing program review.[3] Furthermore, purchases are only allowed to take place if the respective government has broad access to the capital markets.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Further details of OMT include the organizational and monitoring involvement of the IMF in the adjustment program, as well as the possibility of bond purchases from the current program countries (Greece, Portugal and Ireland) once they have regained access to the bond market. Moreover, and as in the case of the SMP, liquidity provided through OMT purchases shall be fully sterilized, regardless of how long the current full allotment of monetary policy refinancing operations lasts. In contrast to the SMP framework, OMT purchases shall be focused on the shorter end of the yield curve which is understood as bonds with remaining maturities from one to three years. As it is not desired that beneficiary member states shift possible issuances towards shorter maturities in response to purchases, the issuing behavior of these states shall be closely observed. The Eurosystem does not want to claim a preferential creditor status with respect to government bonds acquired through OMT purchases. The public shall be informed about the total amount and market value of the OMT portfolio on a weekly basis, and in addition there shall be a monthly disclosure of average times to maturity and a breakdown with respect to states. The start, continuation and suspension of government bond purchases are at the sole discretion of the ECB Governing Council and shall be decided in accordance with the monetary policy mandate.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">II.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Monetary policy justification of the OMT program regarding the transmission</span></span><br />
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The ECB justifies the necessity to guarantee monetary policy transmission via the OMT by the following argument:[4] the current situation is characterized by risk premia on government bond returns which are attributed in particular to the unjustified fear on the part of investors regarding the reversibility of the euro.[5] As markets for government bonds would be important for different parts of the transmission mechanism, these risk premia would undermine the functionality of monetary policy transmission. The effectiveness of monetary policy measures would hence be limited particularly in those countries of the euro zone where (unjustified) risk premia on government bonds exist. Due to tensions on the markets for government bonds the banks’ lending capacity is considerably limited, which would have negative consequences for the real economy. Thus, OMT purchases shall serve to better align the financing conditions of the real economy with the ECB’s policy rates. Hence, the following sections discuss the concept of monetary policy transmission as well as the necessity of a correction in case of disruption and the role of conditionality of OMT purchases.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The monetary transmission mechanism is a process through which monetary policy decisions influence the economy in general and the price level in particular.[6] Monetary policy decisions are transmitted through different channels which impact the various phases of the transmission process. In general, monetary policy decisions impact the prices with a time lag and have different impacts depending on the economic situation. In principle, it is not possible to give a precise estimate (point estimate) on the consequences of monetary policy measures due to uncertainties regarding the data used (for example, revisions, under-reporting), models (nonconsideration of important channels of transmission) and parameters (for example, regarding structural changes within an economy). It is only possible to provide probabilistic statements, typically using confidence intervals. The only thing one can say with certainty is that central banks are generally confronted with long, variable and not precisely predictable delays in monetary policy effects; a delay of one to two years until the full impact of monetary policy actions is a rough estimate. Moreover, it has to be considered that the economy is in a constant state of change. For monetary policy transmission in particular this means that one cannot assume it remains constant over time, but rather is altered by increasing globalization, structural reforms or behavioral changes, for instance. Whether and how these changes manifest can only be empirically assessed sometime after they occur, sufficient amount of data is required.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">At the beginning of the transmission or impact channel usually stands a change in the main instrument used by the central bank, i.e. the policy rates.[7] The central bank decides on interest rates applying to its monetary policy operations and, due to its monopoly on central bank money creation, thereby determines the refinancing costs of commercial banks.[8] By steering the refinancing costs the central bank exerts a considerable influence on money market rates. In turn, changes in money market rates have an effect on other interest rates to a different extent, such as the banks’ interest rates on short-term loans and deposits (“interest channel”). Studies within the Monetary Transmission Network of the Eurosystem show that it is the interest channel of monetary policy that primarily influences economies in the euro area.[9]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Interest rates for longer duration securities (such as on government bonds or private borrowing) are only indirectly influenced by changes in money market rates, as expectations of market participants play an important role in determining long-term rates. As such, long-term market rates are determined to a considerable extent by the expectations of market participants regarding the long-term development of growth and inflation, and thus by the long-term perspectives of an economy (or a currency area). Accordingly, expectations regarding future policy rates and thus monetary policy pursued are reflected in long-term market rates. As a result, changes in policy rates only influence long-term markets rates once they induce a change in market expectations regarding the long-term development of prices and the economy.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Via the outlined interest channel, changes in interest rates influence the saving, consumption and investment decisions of private households and firms in various ways. The resulting demand effects temporarily influence economic activity and, moreover price development. Due to their impact on financing conditions, monetary policy decisions also influence financial parameters such as asset prices (“asset price channel”) and exchange rates (“exchange rate channel”). Finally, changes in policy rates can also affect credit supply (“bank lending channel”)[10] as well as firms’ balance sheets (“balance sheet channel”).[11]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Some important aspects of the monetary transmission mechanism and its transmission channels are still not fully understood, even after a series of recent empirical studies. In particular, there is only limited knowledge as to how institutional changes and financial innovations since the beginning of the monetary union in 1999 changed the dynamic relations between different economic variables in the euro area (which in turn may have had an impact on monetary policy transmission). On balance, there is only incomplete knowledge as to how monetary policy transmission has developed over time – this always applies in particular to recent data, as the demand for data analytics is large and only a small amount of data is available to begin with. Since the outbreak of the financial crisis, this knowledge gap has expanded rather than diminished.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The following stylized facts can be summarized: first, there still exist indeterminate delays regarding the transmission of monetary policy to the price level. Second, as a rule monetary policy influences the overall economic development essentially via the interest channel. As already explained tightening monetary policy temporarily leads to a decrease in production which reaches its peak approximately one to two years after the respective interest rate increase. This finding is essentially based on studies using data from the time before the crisis. Price decreases tend to take place more slowly and prices react more sluggishly to monetary changes than production. Third, changes in interest rates influence the business cycle through firms’ cash flows and banks’ credit supply and thereby underline the importance of the bank lending channel of monetary policy.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">2.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Existence of a current disruption of the monetary transmission channel</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Just as the transmission of monetary policy to the real economy encompasses a series of different mechanisms and reactions of economic actors, so too, disruptions of the monetary policy transmission channel can arise in different places. A disruption of the transmission process can be described as an unexpected effect of a monetary policy impulse. Plainly speaking a disruption of monetary policy occurs if the impulses do not evoke their “normal” or “usually to be expected” effect regarding sign, timing or strength. Or, to describe it in a more technical manner: a disruption can exist if current estimates regarding the monetary policy transmission lie outside the range of those confidence intervals which one “usually” obtains from econometric estimations. An obvious reason for a disruption can be that one or several of the aforementioned transmission channels work either just partially or not at all. This may be the case if, for example, the formation of prices in certain markets no longer follow the traditional empirical pattern. For instance, the risk assessment of market participants may be detached from traditional factors in a crisis-like situation on financial markets.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">However, it is not possible to determine whether a current deviation represents a temporary disruption or a fundamental, long-term change of monetary policy transmission, since the economic context has changed such that the assumed consistency of effects is no longer given. If the change is fundamental then the use of the term “disruption” would not be justified. Moreover, an exact diagnosis is impeded by the fact that according to consensus opinion such a disruption can only be evaluated with certainty in hindsight. An empirical analysis of the monetary transmission mechanism in real time is therefore afflicted with considerable uncertainties.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">3.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Indications for a disruption of the monetary transmission mechanism</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Hence, a diagnosis in times of crisis depends on the evaluation of indications. Given the prevailing uncertainty and also the potential for serious long-term risks resulting from monetary policy measures taken, these indications should be subject to heightened scrutiny. </span></span></div>
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<span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Risk premia on government bonds as an indication of a disruption</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">As an indication of the presence of a disruption of monetary policy transmission, one could, study returns on government bonds of the members of the euro system which, in comparison to the pre-crisis time, developed differently. With the outbreak of the sovereign debt crisis, the yields on government bonds of the so-called periphery countries developed in a clearly different way than the yields on, for instance, German government bonds.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">However, recent developments in the market for government bonds cannot with certainty be used as an argument for a disruption of monetary transmission, as it is not possible to determine whether a “disruption” in the development of yields on government bonds can be attributed to fundamentally justified causes or whether possible exaggerations, irrationalities or other forms of inefficiencies are present. Such an argument would require proof of both an inaccurate market valuation of government bonds of individual member states as well as a transmission of this mispricing to financing conditions of the private sector. In order to determine that there is a mispricing, it is indeed possible to resort to observable data on fundamentals such as governmental or macroeconomic debt or deficit ratios. However, quite different results can arise depending on the the specifications of the model. Moreover for a forward-looking analysis of the sovereign debt crisis, already implemented reform and consolidation measures should be considered, which adds to the uncertainty and subjectivity. In addition, a crucial factor in the market’s valuation is the extent to which the further implementation of reforms, the compliance with conditionalities and ultimately the service of private and governmental debt are seen as safe. Thus, focusing on risk premia of selected government bonds is not sufficient. If it is not possible to quantify individual risk components with certainty and to attribute and interpret them unambiguously, that is, to analytically disentangle risk premia, then as a result any interpretation and resulting recommendation for actions can be justified through respective assumptions.</span></span></div>
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<span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">High financing costs for the real sector as an indication for a disruption</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Another indication of a disruption of the monetary transmission might be derived from the national differences regarding interest on borrowing to nonfinancial corporations and private households. It is undisputed that with the emergence of the sovereign debt crisis, the financing environment of credit institutions deteriorated as a result of harm done to national banking systems by the impaired credit-worthiness of individual states.[12]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">This applies all the more as noncompliance with reform obligations shall lead to a discontinuation of OMT purchases. In such a case, the solvency of a state would be in acute danger and risk premia can therefore be rational. It is obvious that such doubts regarding the sovereign solvency can impact the private sector, as the financial outlook and thus credit-worthiness for parts of the private sector would be extremely damaged by the potential for state insolvency. Higher financing costs for the private sector can thus mirror higher sovereign fiscal risks. This would not be a development that is to be dealt with by monetary policy, but is the direct consequence of the independent national fiscal policy.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In this respect different market rates within the euro area do not contradict a uniform monetary policy. In principle, different economic fundamentals should result in different equilibrium market rates for member states of the EMU.[13] Therefore, it is highly doubtful whether a uniform market rate within the currency union is a desirable economic situation: these doubts are justified as long as individual countries differ in their economic fundamentals. With this in mind, a possible disruption of the transmission mechanism should not be diagnosed by the absolute level of the market rate but rather by the change of the general interest rate level in response to changes in the policy rate, i.e. by the transmission of interest rates. The question is whether the financing conditions of the real economy are in accord with the Eurosystem’s policy rates,[14] such that price level stability can be guaranteed through the resulting impact on economic activity.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Just as differences in interest rates per se cannot serve as an indication for a disruption in the transmission mechanism, one cannot necessarily speak of a well-functioning transmission mechanism in case of a uniform level and reaction of the private sector’s financing costs. From the present point of view, it should be indisputable that the risk premia of periphery states’ government bonds were clearly too low compared to returns on German bonds prior to the outbreak of the sovereign debt crisis in 2010 – be it due to inaccurate risk assessment or be it that the exclusion of liability stipulated by EU contract was not considered to be credible. Due to different data on fundamentals (economic structure, business situation, expectations regarding the future business situation and political development as well as the realization of shocks etc.), a heterogeneous transmission (despite a uniform policy rate of monetary policy) could be expected and even economically in order. An (enforced or artificial) uniform interest rate or an (enforced) uniform transmission of interest rates could impede just these necessary adjustments.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Finally, it is also necessary to consider the relationship between the refinancing conditions of the financial sector and the supply of credit for the real economy more carefully. Even if the banks’ financing terms depend on the level of government bond returns, one does not only have to examine the relationship’s actual strength (and whether it is the same in each state). Beyond that, one has to examine the importance of a possible increase in risk premia for lending activities and thus for the aggregate demand for loans and the price development. The level of government bond returns on its own does not allow for conclusions in this respect. Moreover, the importance of government returns for monetary policy transmission might have to be relativized, as the banking sector is, at least in the short run, less dependent on refinancing through the money or capital market since the transition to full allotment. Eventually also the implication of high risk premia is less obvious as it first seems: do high risk premia which are not fundamentally justified put more pressure on bank balance sheets and thus monetary policy transmission as if they were fundamentally justified? Does monetary policy have to intervene in the first case, but not in the second?</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">4.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Necessity of monetary policy adjustment of a disruption</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Even if one would abstract from the problems associated with a practical assessment of a disruption of the monetary transmission mechanism and affirm such a disruption, the question is whether and why such a development has to be adjusted – and whether and why this has to be realized through monetary policy. In the end, economic developments in the various states are connected with potentially different risks as long as decisions on economic and financial policies remain on a national level. These differences also justify different risk premia for private credit relationships. In this respect, monetary policy (interest rate) being targeted at the euro area can be dominated by country specific developments without it being irrational or calling for correcitve monetary policy action. The uniformity of monetary policy within the Eurosystem thus rules out measures and decisions which are only aimed at the elimination of national disruptions.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">These considerations especially apply to the argument raised in the context of OMT that a currency reversibility of individual member states would lead to additional interest premia and that this would not be acceptable from the perspective of monetary policy. However, in light of the continued sovereignty of national states, the current composition of the currency union cannot be guaranteed – at least not by the central bank. Hypothetically, this would only be possible if it agrees on unconditional, unlimited financing for each state in order to prevent withdrawal. This does not belong to the field of responsibility of monetary policy, though. And even in the case of monetary policy assistance, the majority of a state’s population can urge to a state’s withdrawal from the currency union and the elected representatives can democratically decide on withdrawal, as they are not able or not willing to create the economic foundations to stay in the currency union. An opinion on the probabilities of such political developments and the related appropriateness of governmental and private debt instrument prices necessarily has to be highly subjective.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Just as the diagnosis of a disruption in monetary transmission, this subjectivity translates to a government bond purchasing program whose purchases which are in principle unlimited should be based on such considerations. And if it is not beyond any doubt that individual states remain in the currency union, the occurrence of reversibility premia per se is no justification for unlimited monetary policy interventions aimed at eliminating these premia. Decisions on how the euro area is composed or whether and how this composition is guaranteed fall to other actors, above all governments and parliaments. The respective risks have to be evaluated by them and, if necessary, be borne via assistance measures.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">5.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Conditionality of OMT purchases</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Furthermore, it is argued that conditionality and the compliance to it would be of particular importance for the program’s legitimacy. That is to say, if conditionality were adhered to and the assistance program realized, redenomination or insolvency premia would obviously not be justified: on the one hand, a sustainability analysis would have to come to a positive conclusion, and on the other hand, the expected successful program realization would make it seem irrational for the state to “derail”. The assumption that the program terms agreed upon within a comprehensive political compromise and a certain level of information are realistic and thus have to convince rational investors is vital for this line of argument. The case of Greece however illustrates that program terms do not have to be able to exclude insolvency. It remains open whether the program’s assumptions, being definitely too optimistic in retrospect, could have been avoided. In any case, against the background of the experiences made so far, it is extremely ambitious to argue that monetary policy would be able to assume compliance to conditionality in any case and, based on these grounds, guarantee that the respective state remains solvent permanently and risk premia decrease in a fundamentally justified manner.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">A state’s solvency and low refinancing costs would only then be definitely guaranteed if the option of an eventually unlimited and unconditional monetary financing of the state existed which, however, is incompatible with the Eurosystem’s mandate.[15] In addition, based on the announced conditionality the transaction of OMT purchases would have to be suspended if the program terms can no longer be met. It is obvious, however, that the Eurosystem would then be deemed in a dilemma and inevitably, the question arises of why just in this situation, where savings programs can no longer be met and tensions start rising, monetary policy will suspend its interventions and no longer describe monetary transmission as being disrupted.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">6.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Findings so far</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Even if monetary policy works differently within the euro area, it is doubtful whether these differences constitute a disruption that has to be eliminated by monetary policy. The finding of a substantial disruption of the monetary transmission process will always involve strong subjective elements. It is inarguable that secondary market purchases can enable a temporary reduction of risk premia. Whether these purchases serve a sustainable stability-oriented development of the currency union is doubtful: due to comprehensive risk transfer to the Eurosystem related to OMT purchases, the reversibility of these measures becomes increasingly difficult, while fiscal policy can feel less burdened regarding the discharge of its duties. The assessment of the appropriateness of a country specific risk premium, the transfer of risk in connection with assistance measures (on the primary or secondary market) and in relation to potential misjudgments regarding the future economic and political development in a country is indeed the prerogative of fiscal policy. Another reason for this is that it is fiscal policy which ultimately decides on program terms in the particular case, as well as on the organization and further development of European integration as a whole, and since fiscal policy is subject to the direct parliamentary control. If monetary policy is loaded with this function, it is in danger of being dominated by fiscal policy considerations potentially endangering the goal of stability. </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">III.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Government bond purchases by the Eurosystem</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">1.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Classification of government bond purchases</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Independent of a disruption of the transmission process and the question whether this disruption shall or can be eliminated through monetary policy, the question arises whether government bond purchases in terms of OMT are an instrument whose use is allowed for the Eurosystem.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In general, also nowadays open market purchases of government bonds by central banks are not unusual. However, current government bond purchases by, for instance, the Bank of England (“BoE”) or the Federal Reserve System (“Fed”) deviate in a fundamental manner from scheduled bond purchases by the Eurosystem in terms of OMT purchases. These bond purchases do not aim at securing the solvency of states, but rather at open market operations. These aim at influencing the risk-free interest rate rather than at the solvency risk premium of individual member states of a currency union. In this respect, the Fed, the BoE and the Bank of Japan (“BoJ”) purchase those bonds of the respective central government with a high credit-worthiness. In contrast, the Eurosystem intends to decrease high risk premia of individual poorly rated member states of a currency union by means of government bond purchases. Furthermore, it has to be taken into account that the aforementioned states are federal states or central governments where the central state level holds the central bank’s equity and bears gains or losses. In this respect, purchases do not provoke redistributions between tax payers of different independent member states.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The discussion about government bond purchases by the Eurosystem also has to take into consideration that, in contrast to the mandates of the central banks mentioned, the European primary law imposes certain obligations in this respect. The prohibition of government bond purchases on the primary market is a key element of the prohibition of monetary state finance. It represents a necessary element to guarantee the independence of ECB and national central banks of the Eurosystem.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The prohibition of primary market purchases leads to the understanding that the ECB and the Eurosystem can purchase government debt instruments on the secondary market within their monetary policy mandate. In this respect, it is assumed that in principle, the purchase of government bonds on the secondary market is captured by the rule in article 18 of the statute of the European System of Central Banks and the European Central Bank (ESCB statute) regarding monetary policy operations by the Eurosystem. However, these secondary markets are required to move within monetary policy assigned to the Eurosystem and are not used to circumvent the prohibition of primary market purchases. Against the background of a possible evasion of the prohibition of monetary state finance, the ECB is not allowed to purchase such government bonds on the secondary market which aim at financing federal budgets independently of capital markets.[16]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The concepts of “monetary policy” and “monetary policy measure” are however not sufficiently defined. In this way, all measures taken by a central bank could be perceived as monetary policy in general, including comprehensive government bond purchases (such as the Fed’s quantitative easing, for instance) or even a comprehensive monetary state finance aimed at guaranteeing a state’s solvency. However, that implies neither this type of monetary policy to be necessarily sensible and beneficial to price level stability or possible minor objectives, nor does it imply that such monetary policy measures would be backed by a central bank’s mandate. If a central bank was authorized to pursue every action that with some plausibility might be regarded as beneficial to monetary policy and price level stability and that can be realized by the central bank itself, then normative limitations of monetary policy would be ineffective ex ante and thus unnecessary. However, this would rigorously challenge the legitimacy of monetary policy independence. The reason is that legitimacy is based on the fact that monetary policy operates within a binding and externally given, clearly defined framework. This is respected not also, but especially during times of crises and external pressure. Also, this may very well have been the understanding that prevailed during the currency union’s foundation and that was communicated to the public.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">2.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Regarding the prohibition of monetary state finance</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">When done on a large scale, secondary market purchases also support the financing of government budgets. But then these purchases are accompanied by considerable stability risks. This reasoning is based on the economically explicable and historically supported experience that governments are in principle more short-term oriented and thus inclined to accumulate debt. In the absence of limitations, this disposition to indebtedness can lead to an undesired and continuous accumulation of debt which can eventually endanger government solvency.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Such a development also compromises monetary policy targeted at the objective of monetary stability: indeed, if public debt in domestic currency is getting out of hand, monetary policy is generally able to guarantee government solvency by eventually covering government financing needs by monetary government financing. The more monetary policy uses its instruments to ensure government solvency, the more its hands are tied to pursue its actual objective of price stability at the same time. Measures such as increasing policy rates make it more difficult and expensive to meet government financing needs. Thus, the more monetary government financing proceeds, the more it dominates the objective of price level stability.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">If a situation arises where public finance threatens to be getting out of hand, monetary policy faces strong pressure to guarantee government solvency without regard to the future risk of inflation. Naturally, in the case of government insolvency there are severe risks for financial stability and the broader economy (and the monetary transmission mechanism does not work as in normal times). At the same time, it is often politically very difficult to take fiscal policy measures aimed at guaranteeing solvency on an adequate scale. The central bank is then faced with increasing expectations as the only agent alleged to be capable of acting. In the most extreme case, monetary policy is left no choice but to abandon price level stability or to accept the dangers arising from government insolvency. In the former case, government insolvency can be avoided if government debt is denominated in domestic currency and can be financed by the central bank (this is not possible if the government debt is denominated in foreign currency). But even in situations long before government insolvency looms, it will be difficult for a stability-oriented central bank to guarantee price level stability in the case of unsound fiscal policy. If economic agents expect the situation to escalate with a certain probability, and therefore put additional pressure on monetary policy, then there can come a point in time when inflation expectations rise rapidly and by a large amount, which makes it much more difficult for the central bank to ensure price level stability.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">At the moment, no such development is seems to be present. Long-term expected inflation identified by means of surveys or financial market data remain anchored, although, according to surveys, the uncertainty regarding the future development of inflation has increased. Unanchoring [of inflation expectations] in the Eurozone (which is designed as a stability union) does not have to have occurred to prove monetary government financing. A government, which in case of emergency is able to rely on the central bank to finance its expenditure policy, is as a rule more inclined to debt financing. Awareness of this incentive problem was indeed present during the foundation of the monetary union and molded the organization of the economic and monetary union. Fiscal rules were adopted to prevent imbalances of government finances; to strengthen them the Stability and Growth Pact was created. Furthermore, exclusion of liability was decided upon, which would generally cause investors to assess risks more carefully also in the case of government bonds. This, in turn, would lead to risk premia for less sound government finances which would discipline fiscal policy. Moreover, a prohibition of monetary government financing was put in the EU Treaty in order to guarantee the objective of price level stability. This clarified ex ante that monetary financing of governments would not be an option, and that monetary policy would not come to the rescue even in case of strong political and economic pressure. The goal was to make it in the self-interest of fiscal policy to independently prevent the fiscal situation from deteriorating sharply. Shifting this responsibility to monetary policy was intended to be impossible.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In retrospect, these precautionary measures did not have the desired success. In the time before the crisis, fiscal rules were insufficiently adhered to and the SGP increasingly eroded, such that it ultimately was no longer able to fulfill its stabilizing function. Moreover, serious undesirable developments occurred in other areas of numerous economies, and in addition a strong increase in private sector debt in some economies. </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In the European Monetary Union, all member states were to be protected from disregarding the objective of price level stability within the currency union (as well being protected from redistribution of member states' solvency risks among national taxpayers). Even a single precedent which damages the basic framework and undermines the fundamental prohibition of monetary government financing is capable of considerably impairing the desired monetary predominance; the precedent could subsequently result in tempting other member states to rely on monetary government financing. In such a situation, the protection of price level stability as a monetary policy objective would stealthily retreat behind fiscal interests. The common monetary policy would be increasingly dominated by solvency ensuring measures and credibility would be endangered. Once monetary policy is on such a precipitous path, reversing course is very difficult and associated with large costs: this is so even if, subsequently, monetary policy were to adopt a strict stability policy thereby (unexpectedly) tolerating a member state’s insolvency, the credibility and legitimacy of monetary policy would be damaged since the prior misinterpretation would be manifested in large losses with the resulting burden for EMU taxpayers via central bank balance sheets.[17 Compare with D]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In order to prevent such a gradual, but difficult to reverse dynamic it would be particularly important to demonstrate early on that monetary policy does not allow itself to be encroached upon and that the central bank strictly interprets the prohibition on monetary government financing. However, in a fiscal crisis this is potentially at odds with the arguments put forward regarding the disruption of the monetary transmission mechanism and also with the necessity of containing a possible financial market crisis. Monetary policy then gives the impression that it can be used for fiscal policy purposes insofar as it tries to compensate for insufficient fiscal policy actions; here, the development in the case of Greece (see following section) is an alarming example. In this context, the presentation of unlimited government bond purchases as an option is as alarming a signal as the argument commonly heard in public debate that timely, appropriate actions by fiscal policy are, as a practical matter, impossible; thus, only monetary policy would be in a position to act. Here, the seeming lack of alternatives leads to the conclusion that monetary policy has to act irrespective of legal, economic and institutional constraints. In such a situation, actions taken by monetary policy can reinforce governments’ impression that shifting the pressure for action to monetary policy is, from a national perspective, a beneficial strategy as the associated political costs can be reduced or even completely shifted. Thus, the lack of alternatives for central bank action becomes a self-fulfilling prophecy.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The liquidity provision to Greece</span></span></div>
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<span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The Eurosystem’s liquidity provision to meet the financing need in Greece is especially problematic, and shows that monetary policy has assumed responsibilities of fiscal policy. The Greek need for liquidity was financed through the Eurosystem, without regard for the solvency of the country or its banks. While there was a tendency to transfer the risk accruing from the Eurosystem’s liquidity provision to the Bank of Greece, the latter is hardly in a position to independently assume potential losses on a large scale. In the case of a complete insolvency of Greece and its banking system, and in particular in the case of a withdrawal from the currency union – which, was not unthinkable amidst the political tensions present during the implementation of the adjustment program – the Eurosystem has exposed itself to substantial loss risks.</span></span></div>
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<span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">It seems particularly alarming that ultimately, financing of barely solvent banks without adequate collateral was permitted via ELA, where banks also used the obtained liquidity to finance the Greek government. The problems arising from the encroachment of monetary policy into fiscal policy became especially clear during the actions taken in connection with the looming insolvency of Greece in August 2012:</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">The implementation of the Greek assistance program fell considerably short of its targets, which was later confirmed by the adoption of a new program.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">European fiscal policy refused to pay out the promised assistance, when conditions were not met.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">But Greece had considerable financing needs (especially refinancing maturing debt).</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Plainly, Greece had decided not to meet its financing needs by means of fiscal policy (e.g. by freezing expenditures).</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Instead, Greece issued additional T-Bills. However, this was not possible due to continued, regular access to capital markets. Instead most of these T-Bills were undoubtedly purchased by Greek banks. However the Greek banks had no reserves left, as they had already been relying on liquidity assistance by the central bank (ELA). </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Greek banks were only able to acquire these T-Bills since the Eurosystem had, in an ad hoc manner, considerably extended the volume of T-Bills, which were accepted as collateral for liquidity operations. In this way, Greek banks were able to purchase additional Greek T-Bills, and immediately refinanced themselves at the Greek central bank.</span></span></div>
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<span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Thus monetary policy enabled a state’s financing through the provision of liquidity despite that the conditions of a fiscal assistance program were not adhered to and fiscal policy had stopped the disbursement of further assistance. These experiences also provide a basis for fearing that the handling of conditionality within the OMT program, even in dubious cases, will not to guard against vast purchases, and thus not against against redistribution of risk through the Eurosystem’s balance sheets.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The preceding considerations regarding monetary government financing certainly offer some room for interpretation regarding purchases of government bonds on the secondary market. From our point of view, these have to be critically evaluated due to the following reasons:</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">As already mentioned, government bond purchases by other central banks differ from those of the Eurosystem insofar as the Eurosystem targets bonds of poorly-rated sovereigns and thus the balance sheets risks are considerably higher. Moreover, the purchases of other central banks are of bonds of their own federal or central government where the central government owns the central bank’s equity and bears gains or losses, thus purchases do not imply redistribution between taxpayers of different autonomous member states.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">If the Eurosystem effectively imposes an upper limit on the interest rate (or interest rate spreads) of a member state’s bonds through purchases on the secondary market, this will also have an effect on the primary market and thus on new issues of government bonds. The reason is that financial market participants can be sure that they can sell a newly issued bond to the Eurosystem at a minimum price at any time. Thus, a member state’s financing access is partially detached from the market prices, since these are now predetermined by interventions of the Eurosystem.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">This becomes more problematic if the majority of a member state’s current borrowing is purchased by the Eurosystem without the guarantee of a considerable time lag from issuance. If there existed a substantial time lag, then the circumvention of financial market pricing would be mitigated insofar as buyers would still hold risks over a noticeable period of time and could not presume to quickly sell the bonds to the Eurosystem. Conversely, the shorter the time lag between issuances and the purchases, and the larger the Eurosystem’s purchase volumes are, the smaller the residual risk for the original buyers. At its extreme, these purchases reduce the role of buyers to simply handing-off the newly issued bonds to the Eurosystem with short delay. The access to capital markets of the respective member state would then largely be protected from market forces.[18]</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">This problem of circumventing financial markets also arises even more severely if it is state-owned banks or banks under government control or even the ESM / the EFSF performing the hand-off. This would be all the more problematic if in turn banks were dependent on financing from the central bank.[19]</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Furthermore, purchases can compromise central banks’ independence, which is necessary for accomplishing their main purpose – ensuring price level stability. For one thing, this occurs through the organization of scheduled purchases of government bonds on secondary markets, where a necessary requirement for such purchases is the conclusion of a complete macroeconomic EFSF/ESM adjustment program, or a preventive EFSF/ESM program which includes the possibility of EFSF/ESM primary market purchases. For another, unconditional continuance of the euro zone in its current composition, which is at least implied by the organization and justification of secondary market purchases, ultimately implies that member state can also be financed independently of markets in order to ensure that it can remain in the currency union. This provides the governments in question with a special capability to blackmail the Eurosystem which endangers the independence of monetary policy.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">·</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> <span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">To justify the recently dormant SMP created in 2010, it was then argued that it was limited in both scope and volume. These limitations shall not apply to the newly adopted OMT program for the purchase government bonds on the secondary market. So over time, and also given the aforementioned guarantee, the debt of a beneficiary member state could to a large extent enter the balance sheet of the Eurosystem. Thus a country could end up with the central bank being by far its largest creditor. This endangers the independence of monetary policy decision-making in the Eurosystem, since the insolvency of a member state would strongly damage the credibility of the Eurosystem.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">C.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">The TARGET2 problems</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">I.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Why are the TARGET2 balances of interest for the case?</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">There has been a large public debate about so-called TARGET2 balances, which occurred at Eurosystem national central banks since the outbreak of the financial crisis. The public debate has focused on the causes and risks associated with these balances. The guiding principle of this statement is to describe the TARGET2 program and to clarify potential risks. The underlying assumption of this statement is that the Bundesbank constitutes an integral part of the Eurosystem, which consists of the ECB and the national central banks of the member states whose currency is the euro. The Bundesbank assumes that this system will endure and that Germany will remain part of the currency union. This is the basis for the Bundesbank’s considerations regarding risk.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">II.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">What is TARGET2?</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Although the national central banks of the Eurosystem were not merged into one central bank upon entering the third stage of the European Monetary Union, their monetary policy competences were transferred to the Eurosystem. Hence, the Bundesbank’s competences in monetary policy were transferred to the Eurosystem with the introduction of the euro as electronic currency in 1999. Decisions on monetary policy are taken by the ECB Governing Council. Changes in the monetary policy framework for action can only be decided upon by the ECB Governing Council. However, the national central banks are still responsible for the implementation of monetary policy according to the principle of decentralization, see article 12.1 of the statute of the European System of Central Banks and the European Central Bank (in the following: ESCB statute). Given this institutional framework, it is necessary to ensure an efficient and reliable execution of monetary policy operations. To this end, a safe and fast payment system was essential in order to provide and absorb central bank money within the unitary currency area without restrictions. For this purpose, TARGET was implemented as a payment system where central bank liquidity could be transferred within the common currency area without restrictions. Banks are supplied with central bank money primarily through refinancing operations, but also through operations which are the responsibility of the national central banks including the accumulation of security holdings and other operations.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">TARGET was first launched as a network system on January 4, 1999. To this end, the national RTGS systems[20] were linked by an interlinking component. In 2007, the network system was replaced by a uniform technical infrastructure (TARGET2). The underlying decisions of the ECB Governing Council as well as the respective implementing guidelines of the ECB Governing Council are based on article 22 of the ESCB statute. These guidelines[21] were decreed by the ECB Governing Council pursuant to article 12.1 of the ESCB statute and are binding for all national central banks of the Eurosystem. Therefore, all central banks of the Eurosystem are legally required to participate in TARGET.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Each day, on average, about 350,000 payments amounting to roughly 2.5 trillion €[22] are processed via TARGET2. This approximately corresponds to the German gross national product. The Eurosystem has decided to allow the system, which was created for its own needs, to process transactions other than those related to monetary policy in accordance with its mandate, derived from article 22 of the ESCB statute, and to obtain a better utilization of the system [23][24]. These payments can be very different in nature. For instance, one can think of the payment for a delivery of goods, the purchase or sale of a security, the granting or repayment of a maturing loan, the financial investment at a bank, and much more. Here, TARGET2 does not exclusively serve for the execution of cross-border payments. For example, in 2011 about seventy percent of all payments executed were domestic and only about thirty percent were cross-border within the German component. Besides TARGET2, there exist other payment systems in Europe (e.g. EURO1) which often have large turnovers. At the end of a business day, the remaining balances from these private payment systems are also settled by TARGET2, since the latter settles payments safely in central bank money[25], thus the resulting amounts from these other systems are also incorporated into the TARGET2 system.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">III.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">What causes TARGET2 balances?</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The decentralized implementation of common monetary policy in the eurozone results in the fact that central bank money can be created in different countries and can flow across borders. If net central bank money flows to a member state’s financial institutions, a positive balance is generated at the respective national central bank, which currently the case at the Bundesbank, for example. If there are net central bank money flows to a member state’s financial institutions, a negative balance results, which is currently the case at the Bank of Greece, for instance. In the TARGET2 system, the counterpart of this negative balance is not another national central bank, but the ECB. The reason is that the legal relationships between the central banks are organized in such a way that a real settlement of accounts takes place where the ECB acts as a clearing center between national central banks. The individual relationships between national central banks and the payment balances generated between them are thus legally eliminated each night; hence, only their payment balances with the ECB matter. In any case, however, bilateral relationships between Germany and the periphery states are only able to explain a small fraction of generated balances. Instead, complex multilateral transactions are responsible for their formation. From a legal perspective, this process is ongoing where balances are updated daily. As long as the system exists, these balances are updated on a daily basis. In a legal sense, balances are claims by or against the ECB for which a regular settlement outside the circular flow of central bank money is not intended. As the continued existence of the system is presumed, its rules and standards do not include rights of termination which could be used to effectuate a repayment of these claims. In our judgment, the relationships between the ECB and the national central banks are not to be understood from a legal perspective as a standard credit agreement as evidenced by the fact that no credit terms are negotiated.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">As national central banks involved maintain checking accounts for financial institutions participating in TARGET2, liabilities of national central banks against national banking systems as well as claims against the ECB (TARGET balances) can thus be generated by cross-border liquidity flows, as observed in the case of the Bundesbank. This applies if financial institutions have credit at national central banks. Conversely, in the case of Greece for example, the national central bank can have liabilities against the ECB as well as claims to its national financial institutions, which may be due to refinancing, for instance.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">There is no liquidity provision through TARGET2 itself and no credit is granted. TARGET2 balances rather mirror the decentralized implementation of monetary policy decisions of the ECB Council as well as the money market environment, and thus does not allow for limitations on money flows. In normal times, the respective balances were always settled through capital flows between national banking systems, as capital requirements by one banking system are settled by means of interbank lending from creditor countries. Hence, between 1999 and the outbreak of the crisis in 2007 there existed no TARGET2 balances which might have indicated fundamental problems.[26]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">IV.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Did TARGET2 balances grow in absolute value with the outbreak of the financial crisis?</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">This situation fundamentally changed with the onset of the financial crisis. Since 2007, larger positive[27] and negative TARGET2 balances were generated within the Eurosystem as a consequence of the financial crisis. Mistrust among banks is responsible for the fact that from that time on, the money market did not function to equalize liquidity balances from surplus to deficit banking systems. At the same time, market based refinancing of banks became more difficult and more expensive. Some institutions were, and continue to be, isolated from the market and draw on liquidity assistances provided by central banks which are inexpensive for them. This applies in particular since the sovereign debt crisis created mistrust of entire national markets. </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Ultimately, the current development of TARGET2 balances can be traced back to disequilibria in balances of payments in several EMU states. Here, both current account deficits and capital exports of the private sector can play a role. These are mirrored in outflows of liquidity from these countries, which are ultimately financed by the Eurosystem. Spain and Italy as well as the program countries of Greece, Ireland and Portugal currently have the largest TARGET2 liabilities against the ECB. Apart from Germany (with 715 bn € on November 30, 2012), the Netherlands, Luxembourg and Finland currently have large TARGET2 claims against the ECB. TARGET2 balances increased considerably during 2011, especially during the second half of the year when the financial and sovereign debt crisis grew more acute. Following a further considerable expansion during the first half of 2012, when balances increased by more than 200 bn €, they have averaged slightly above 1000 bn € since June.[28] Within this time period, the Bundesbank’s TARGET2 claims oscillated around a value of approximately 740 bn €. However, the overall stabilization that was observed was accompanied by some considerable daily fluctuations. There were already several phases during the financial and sovereign debt crisis where temporarily, TARGET2 balances did not increase further or even decreased (e.g in the first half of 2009).[29]</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">V.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Consequences</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">1.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">In the Surplus Countries</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Banking systems that receive central bank money via TARGET2, in part because their domestic markets are perceived as safe havens during the sovereign debt crisis, have a lower need for refinancing at “their” central bank. Thus, institutions in Germany have continually decreased their refinancing volume at the Bundesbank and now have large net deposits at the Bundesbank. The German banks direct further inflows of central bank money to their deposit facility or invest them in liquidity absorbing operations of the Eurosystem; an enlargement of the Bundesbank’s balance sheet occurs. It is not necessary to sell assets such as currency reserves in order to compensate for inflowing central bank money. The reason is that the TARGET2 asset vs. the ECB balances against the inflow of central bank money in the balance sheet of the Bundesbank. This TARGET2 asset represents an important part of German foreign assets.[30]</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">2.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">In the deficit countries</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The above mentioned outflows of liquidity were reflected in financial institutions of deficit countries. However, and in contrast to the pre-crisis situation, they stopped borrowing from financial institutions in surplus states due the loss of trust. The latter were not willing to provide funds, at least not at a low interest rate. The banking sectors in the deficit countries thus financed themselves at their central banks which provided liquidity at prevailing central bank interest rates.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">a)</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Full allotment and the extended collateral framework of the Eurosystem</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In the course of the crisis, the demand for central bank financing strongly increased and the provision of liquidity by the Eurosystem was massively expanded. In this way, substantial liquidity was provided within the framework of full allotment. The collateral framework against which the Eurosystem is permitted to provide credit for financial institutions – article 18.1 of the ESCB statute only allows lending on the basis of appropriate collateral – was relaxed several times in order to be able to provide more liquidity and thus meet the deficit countries’ need. These crisis measures of the Eurosystem were meant to be short-term in nature in order to keep the finance system working under difficult conditions. Without this additional provision of liquidity, extremely short-term adjustment processes would have taken place. It turned out that not only a few financial institutions were concerned, but that increasing outflows of payments from the entire banking system were settled. On one hand, this allowed for a prolonged process of necessary adjustments in periphery countries. On the other hand, increased balance sheet risks were incurred due to lowered requirements for solvency of counterparties and collateral accepted. Here, the boundary between liquidity and solvency assistance was shifted and the tasks of monetary policy were greatly extended.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">b)</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">ELA</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">This situation was even more aggravated by the fact that besides this regular source of central bank money, financial institutions experiencing difficulties also drew on additional emergency liquidity (so-called Emergency Liquidity Assistance: ELA) provided by national central banks. This is a traditional instrument of national central banks, and, since it is not specifically mentioned in the ESCB statute, it can be used by national central banks in their own responsibility in accordance with article 14.4 of the ESCB statute. Similar to normal refinancing, this emergency liquidity has to be collateralized. However, in this case the common collateral requirements of the Eurosystem do not apply because these operations are taken at the responsibility of the national central bank in question. Hence, flexible credit can be granted on this basis. In order not to collide with state aid rules of the EU, this is only allowed for the coverage of a temporary liquidity need of illiquid but not insolvent financial institutions. The granting of emergency liquidity through national central banks does not completely lie beyond the ECB Governing Council’s control. According to article 14.4 of the ESCB statute, the ECB council can decide by a two-thirds majority that the granting of ELA is not in line with the objectives and duties of the ESCB. If the Governing Council so decides, the national central bank could no longer grant ELA. In fact, substantial ELA assistance is currently granted for long periods of time, for example the Greek banking sector heavily draws on ELA provided by the Greek central bank.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">3.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Ways to reverse this development</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Within the Eurosystem, an increase in balances can be limited by reducing the strong usage of central bank refinancing by individual financial institutions. This was repeatedly emphasized by the Bundesbank. To this end, based on a majority vote of the ECB Council, the collateral framework of the Eurosystem would need to return to more strictly enforced standards. At the same time, the respective financial institutions either need to be recapitalized or if necessary be liquidated if they cannot survive without the special refinancing by the central bank. Ultimately, it is only fiscal policy which should decide on taking over risks via the provision of credit to banks which are in danger of insolvency. The ongoing lateral movement of TARGET2 balances since the middle of 2012 does not imply that problems are less severe. However, this shows that, in particular, the additional external financing need of periphery countries is not (or no longer) primarily covered by national central banks. At the same time, countries receiving funds from assistance programs have not shown noticeable increases in (negative) TARGET2 balances for a long time.[31]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Measures to directly limit or collateralize TARGET2 balances are currently not planned. They could only be introduced as a change to the TARGET-Guideline on the basis of a majority within the ECB Governing Council. Under no circumstances should such measures contribute to a segmentation of the money market or to a limitation of free capital flows.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The creation of balances can also arise at the US Federal Reserve’s payments system Fedwire. These are registered in the so-called Interdistrict Settlement Account (ISA). Usually, ISA balances are only partially settled. The Fed carries out these settlements by redistributing security holdings within the so-called System Open Market Account (SOMA) in April of each year based on average changes in balances during the past year; hence, security holdings increase for a surplus Fed whose ISA claims decrease accordingly.[32] Such a settlement cannot readily be applied to the TARGET2 system, as the Eurosystem – unlike the Fed – does not generally implement monetary policy by purchasing securities (“Outright Transactions”), but rather by granting credit against collateral in a decentralized manner through national central banks. National central banks are not able to transfer these securities among each other, as they are bound by the respective credit relationship. Moreover, in the US these purchases are almost always targeted at federal government securities or at least at marketable securities of high quality. For the federal government of the United States, the redistribution of interest bearing securities within SOMA is effectively irrelevant. This is because gains of all districts are distributed to the US Treasury (approximately 98% of distributed gains in 2011) after a dividend of 6% on capital deposited is distributed to all member banks.[33]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">VI.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">What information do TARGET2 balances convey?</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">TARGET2 balances are a good instrument for the assessment of the situation of the banking sector in different countries. They mirror disequilibria in the balance of payments (resulting from trade and capital flows) which are settled by relatively inexpensive central bank financing. If a country’s banks receive net central bank money, then a positive balance is created at the respective national central bank as in the case of the Bundesbank. However, if there is a net outflow of central bank money from a banking sector, then a negative balance is created as in the case of the Bank of Greece.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">VII.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Risks from TARGET2 balances</span></span></div>
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<span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">1.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Continued existence of the Eurosystem</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">As long as the Eurosystem exists in its current form there are no direct risks from TARGET2 balances, but only from the measures taken to provide liquidity described above. If trust in the banking sector of the euro area and in individual banks is reestablished, and if banks with currently large liquidity problems are either improved or have exited the market, tensions at financial markets should decrease. Recapitalizing solvent banks and liquidating financially unviable ones is an essential requirement in this respect. In addition, those countries which have lost the trust of capital markets need to remove their structural deficits and strengthen their competitiveness in order to improve their public finances and current account situation and to become attractive for private capital again. As soon as this is the case, equalizing capital flows will result between national markets of the Eurosystem which will potentially cause the balances to return to normal.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">2.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Risks that result from a member state’s withdrawal from the currency union</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">The withdrawal of a member state of the currency union is a hypothetical case discussed in public debate. In such a case, part of the negative TARGET2 balances can manifest as a balance sheet risk. A withdrawal is not envisioned in the Treaty on the Functioning of the European Union (TFEU). However, such an occurrence would lead to the withdrawal of the respective central bank from its current status in the TARGET2 system, even though this is not discussed within the rules of TARGET2. In such a case, the ECB’s Target2 claims against the national central bank of the departing state become due. The potential for offsetting these claims against paid-in capital and transferred currency reserves is rather negligible in light of the given dimensions. If the withdrawing central bank is not able to fulfill its obligations, an arrangement would have to be found for the remaining difference. In this respect, these obligations of the national central bank against the ECB are in principle the counterpart to claims against its national financial institutions, which are collateralized. However, the ECB as a creditor of TARGET2 balances does not have direct access to this collateral. Within the decentralized organization of monetary policy, collateral is provided to the national central bank. Moreover, a realization of the collateral [,i.e., a default event,] is not necessarily given in such a scenario, as the national financial institution does not have to default against its central bank. Moreover the collateral’s value measured in euro might be relatively limited.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Regarding the level of possible losses, it is ultimately decisive to what extent the withdrawing central bank (or government) is willing or able to fulfill its obligations. As an accounting matter, the remaining claim only needs to be written down by the ECB if it is deemed permanently unrecoverable. A write-down, or a provision taken because of a foreseeable write-down would cause a loss on the ECB’s balance sheet. The risk thus primarily lies with the ECB. Regardless of the timing of the respective payment flows, losses generated within the Eurosystem will eventually have to be borne by the taxpayers of the remaining member states from an economic perspective.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">From a risk perspective, the level of TARGET2 claims of the Bundesbank is only relevant in a scenario that assumes the withdrawal of Germany from, or the collapse of the currency union. Here, the claims’ recoverability would depend on the willingness to bring about a negotiated solution on the European level. As already mentioned earlier, the Bundesbank assumes the Eurosystem will survive and that Germany will remain part of the currency union. This is the basis for its risk considerations.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">D.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Risks for the federal budget</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">I.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">General risks of monetary policy</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">A requirement for the participation in refinancing operations of the Eurosystem is the counterparty’s solvency on the one hand and the provision of sufficient collateral on the other. Within traditional central bank operations, this results in a double safety mechanism, as losses can only occur if both the counterparty defaults and the liquidation of collateral provided is insufficient to cover the claim. In case of adequate provision of collateral according to article 18.1 of the ESCB statute, losses should normally not occur. Hence, refinancing usually generates gains for the Eurosystem. Based on the principle of decentralization and generally uniform collateral, refinancing can take place everywhere within the Eurosystem. If national central banks were able to fully retain these gains, a race regarding these refinancing operations might emerge within the Eurosystem. In order to avoid this, gains generated by refinancing operations are divided among national central banks using the capital key according to article 32 of the ESCB statute.[34]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Conversely, and as a complement to this distribution of gains, losses generated by refinancing operations are ordinarily borne by national central banks according to their capital share in the ECB, as settled by the decision of the ECB Governing Council. The underlying reason is that national central banks have no influence on the choice of collateral, as these are jointly defined for the entire Eurosystem by the ECB Governing Council. Furthermore, there are refinancing operations unrelated to monetary policy, which are excluded from risk sharing. An example is the short-term provision of liquidity assistance (ELA) by a national central bank that chooses the collateral.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In the context of the crisis, the ECB considerably lowered requirements imposed on collateral for monetary policy refinancing operations. This allowed for a comprehensive provision of liquidity in tandem with full allotment[35] and for the long-term provision of liquidity to credit institutions. This leads to risks resulting from operations intended to create central bank money, as higher default risks for this collateral are accepted due to the described expansion of approved collateral. Despite larger haircuts it is thus possibly no longer guaranteed that losses can be fully absorbed.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">The decisions made by the ECB Governing Council regarding the distribution of losses remain in force. Hence, </span><span style="background-color: white; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">financial risks res</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">ulting from the expanded monetary policy refinancing operations are in principle borne by national central banks according to their capital share, independent of which national central bank suffered the losses. </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">In addition, monetary policy includes the accumulation of security portfolios. These are held at the national central banks of the Eurosystem in proportion to the ratio of the so-called banknotes allocation key[36]. This implies that the ECB itself holds 8% and that the remaining amounts are distributed to national central banks of the Eurosystem according to their capital key at the ECB. If such securities default, for example Greek government bonds, the resulting risks are thus also distributed according to the capital key. This results in increased risk provisions on the part of the Bundesbank, leading to a lower distribution of profits to the federal government.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">II.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Losses in the Eurosystem from a balance sheet perspective</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">If based on the profit and loss statement, a loss is determined at a national central bank of the Eurosystem, it is handled as follows:</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">1.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Loss at the ECB</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">If a loss directly occurs at the ECB, it has to be settled using the general reserve fund and the loss provision of the ECB according to article 33.2 of the ESCB statute. If these means are not sufficient to cover the loss, the national central banks, in their position as shareholders, can decide by capital majority (according to article 10.3 of the ESCB Statute) within the ECB Governing Council that monetary income that is to be distributed to them will remain at the ECB for the purpose of settling remaining losses of the ECB. A coverage of losses by national central banks beyond that is not envisioned within the ESCB Statute. Loss sharing would decrease profits of national central banks.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">National central banks are not obliged to settle existing losses. However, national central banks are obliged to deposit an amount according to their subscribed share in ECB capital if the ECB’s nominal capital is raised; but the amount deposited for the purpose of capital increases cannot directly be used for loss compensation. In this respect, losses can only be reduced indirectly by using gains to build up additional provisions.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">For the case that possible losses of the ECB are not settled with this procedure, the ECB has to disclose loss carry forwards in its annual financial statement until, based on relevant decisions of the ECB Governing Council, the loss is compensated by future gains of the ECB or by future monetary income of national central banks of the Eurosystem.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">2.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">Loss of a national central bank of the Eurosystem</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">If losses result from monetary policy operations at a national central bank of the Eurosystem, the ECB Governing Council can decide to compensate the national central bank for these losses. According to article 32.4 of the ESCB statute, this compensation can be settled with earnings accruing from the monetary income of national central banks.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">If a national central bank suffers a loss due to the Eurosystem’s internal loss distribution mechanism or due to other reasons, it can resort to its current income as well as to its own provisions and in the event that there is a loss on the profit and loss statement to its reserves. The total value of risk provisions of the Bundesbank amounted to 7.709 bn € on December 31, 2011. The increase in reserves of the Bundesbank in the current year corresponds to the legal upper limit of 2.5 bn € as defined by § 27 no. 1 of the Bundesbank Act.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">For the case where the losses of a national central bank of the Eurosystem are not completely settled, the national central bank has to disclose a loss carry forward in its annual financial statement until the loss is covered by future gains.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">There is no obligation for the owners of national central banks – as in Germany, for most member states of the Eurosystem these are the respective states – to directly compensate losses of the central banks. However, a margin call might be required if a large loss carry forward continues over several years. According to the ECB’s convergence reports, a duty to compensate is assumed if, based on the level and sustainability of losses, doubts regarding the national central bank’s ability to carry out its tasks arise. (However, the same also has to be assumed for a large loss carry forward of the ECB). In its convergence report, the ECB elaborates on the issue as follows:</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">“For all the reasons mentioned above, financial independence also implies that an NCB should always be sufficiently capitalised. In particular, any situation should be avoided whereby for a prolonged period of time an NCB’s net equity is below the level of its statutory capital or is even negative, including where losses beyond the level of capital and the reserves are carried over. Any such situation may negatively impact on the NCB’s ability to perform its ESCB-related tasks but also its national tasks. Moreover, such a situation may affect the credibility of the Eurosystem’s monetary policy. Therefore, the event of an NCB’s net equity becoming less than its statutory capital or even negative would require that the respective Member State provides the NCB with an appropriate amount of capital at least up to the level of the statutory capital within a reasonable period of time so as to comply with the principle of fi nancial independence.”[37]</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;"> </span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Thus, if risk provisions of the Bundesbank are absorbed by losses resulting from the aforementioned monetary policy operations, this can lead to losses for the Bundesbank which need to be disclosed. In such a case, the federation as capital proprietor would face the question whether to recapitalize the Bundesbank’s losses in order to allow for a solvent balance sheet. Depending on the volume of the respective losses, this can imply considerable obligations for the federal budget though the recapitalization may be considered unavoidable for the preservation of a stability union. The German Bundestag would then have to appropriate the necessary funds. </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">III.</span><span style="font-size: 9px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">The effect of Eurosystem losses on the federal budget from an economic perspective</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">A central bank generally has the possibility to create money and could always relieve the national budget by providing liquidity independent of its own gains or losses. However, the Eurosystem is not allowed to engage in government financing. Moreover, the Monetary Union is designed as a stability union, and thus monetary policy is not governed by a government’s financial need, but rather by stability requirements.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Ultimately, the national budgets of member states are financially connected with the Eurosystem. Gains of national central banks are sent to the respective member state, while in the case of losses, national treasuries have to go without this income in the respective year and may face several years without this income and the possibility of having to recapitalize their national central bank at some point. In this way, losses enter the federal budget through the Bundesbank. Regarding the timing of payments between the national central bank and national treasuries, delays are possible if, for instance, gains are retained, loss carry forwards are effectuated or (at first) a loss only enters the balance sheet of the ECB. Given stability-oriented monetary policy, it does not matter for the federal budget from an economic perspective at what point in time possible losses resulting from government bond purchases, for instance, become effective. A prompt recapitalization by the federal government would be necessary if the central bank’s credibility in maintaining its primary objective of price stability was undermined by large losses. Ultimately losses generated by Eurosystem government bond purchases would put the same pressure on the long-term sustainability of government finances as losses sustained by the EFSF or the ESM; and accordingly limit the financial flexibility of the federal government. In this respect, the impact of Eurosystem government bond purchases do not fundamentally differ from secondary market purchases by the EFSF or the ESM. However, the latter require the approval of parliaments and are subject to possible judicial supervision.</span></span></div>
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<span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"><span style="font-family: Georgia, Times New Roman, serif;">Occasionally, it is argued that losses for the federal budget would be even larger if the Eurosystem were not to intervene with secondary market purchases to stabilize the situation and thus prevent a further escalation of the crisis. Thus it naturally follows, in keeping with the spirit of the guiding principles of EMU, that the volume and organization of assistance programs are to be decided within the framework of the EFSF and the ESM. The decision would then lie with national governments and parliaments preventing the dividing line between fiscal and monetary policy from blurring further and ensuring monetary policy’s capacity to achieve its primary objective of price level stability. In this way, decisions on individual assistance measures taken for the benefit of individual countries can be consistent with the current discussion on the basic orientation and further development of the currency union. Decisions on the assumption of large liabilities, appropriate control mechanisms or even rights to intervene in national budget sovereignty, as in the case of a fiscal union, for instance, should in general be considered in tandem. Here, the order of events is in danger of being confused due to the potential of large bond purchases by the Eurosystem, which is not eliminated by the announcement of principally unlimited purchases. In this way, the Eurosystem would actually buy government bonds and thereby collectivize risks without counterbalancing with enhanced rights to intervene which might be viewed as potentially desirable. This increases the danger that the disequilibrium between liability and control will be increased. </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[1]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> As acquisition prices deviated – typically downwards – from the nominal value of bonds purchased, the specified acquisition volume, that is the amount of liquidity being provided through the purchases, deviated from the nominal value of bonds purchased.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[2]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> However, it cannot be ruled out that in such a case the Eurosystem takes other measures with regard to the member state in order to counteract a potential exit from the common currency – even if conditionality is not adhered to.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[3]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Opening statement by ECB President Draghi at the press conference on October 4, 2012: “OMTs would not take place while a given programme is under review and would resume after the review period once programme compliance has been assured.”</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[4]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See, for instance, the editorial to the ECB’s monthly report of September 2012.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[5]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Some argue that the stability of the euro will be viewed in a negative light if a euro exit is seen as more likely in even just a single member state. At the press conference following the ECB Council meeting at the beginning of August, ECB President Draghi emphasized the irreversibility of the euro in each member state and explicitly pointed out that drachma and lira would not come back. Self-reinforcing dynamics which are attributed to “irrational interpretations of the market” shall be countered by government bond purchases. It is argued that there are multiple equilibria with harmful consequences which monetary policy could avoid via OMT.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[6]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> ECB (2011), Die Geldpolitik der EZB, p. 62. (</span><span style="font-size: 15px; vertical-align: baseline; white-space: pre-wrap;">The monetary policy of the ECB</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">)</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[7]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> When describing the monetary transmission mechanism, it is usually an implicit assumption that the prices of goods are not perfectly flexible, although this assumption represents an essential premise as to how changes in nominal interest rates can trigger effects in the real economy. For the following explanations, it is not necessary to describe the individual transmission channels. For more detail, see Worms, A. (2004), Monetary policy transmission and the financial system in Germany, in: J.-P. Krahnen & R. Schmidt (ed.), The German Financial System, Oxford University Press or J. Bolvin, M. Kiley and F. Mishkin (2011), How has the monetary transmission mechanism changed over time?, in: B. Friedman & M. Woodford (ed.), Handbook of Monetary Economics, North-Holland.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[8]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Commercial banks demand central bank money to cover their need for cash, to settle interbank loans and to fulfill their obligations with respect to minimum reserve requirements.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[9]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See, for instance, B. Hofmann and A. Worms (2008), Financial Structure and Monetary Transmission in the EMU, in: X. Freixas, P. Hartmann & C. Mayer (ed.), Handbook of European Financial Markets and Institutions, Oxford.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[10]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Besides the traditional bank credit channel which relies on the extent of the credit supply – higher policy rates reduces or raise the cost of capital at banks’ disposal for lending – the recent literature also discusses the so-called “risk taking channel”. This channel unfolds its effects if the banks’ incentive to take risks during lending is influenced by monetary policy decisions.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[11]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> The balance sheet channel applies to the fact that an increase in policy rates puts pressure on assets of firms’ balance sheets, for example as certain claims become relatively less valuable. However, a lower net value puts pressure on the firm’s credit-worthiness as a borrower and thus cushions lending.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[12]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> First, possible secondary reserves of the banking sector in terms of liquid securities (especially government bonds) decreased, through a rise in risk premia of the securities concerned. Hence, the refinancing of loans through secondary reserves was impeded. Second, higher risk premia reduced the value as a security. Third, the downgrading of a state typically led to a worse rating of the banks in the state concerned. Fourth, implicit or explicit governmental promises of guarantee towards banks diminished with increasing risk premia (Panetta et al., 2011. p. 1).</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[13]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> In this respect, it can be shown, for instance within the framework of a neoclassical growth model (to be more precise: using the Euler equation), that there exists a tight relationship between the long-term equilibrium growth path of an economy and the level of the (natural) real interest rate in this economy.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[14]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See ECB monthly report, September 2012, p. 10.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[15]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See European Court of Justice decision, 199/2012, of November 27, 2012, point 135 f.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[16]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See the decision of the Federal Constitutional Court, 2 BvR 1390/12, of September 12, 2012, paragraph no. 278.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[17]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See D.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[18]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See </span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Hermann</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">, Europäische Zeitschrift für Wirtschaftsrecht 2012, pp. 805, 811.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[19]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> While the refinancing of public banks by the Eurosystem is in line with the EU treaty such an approach can no longer be considered as justified if public banks or banks under government control are used to undermine the prohibition of primary market purchases. If in fact hardly any private investor is at risk of possible losses occurring during the intermittent period (but in fact the government is the proprietor), it stands to reason that this is a means to circumvent the prohibition of monetary government financing (just as in the case of ESM). </span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[20]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Real-time Gross Settlement-Systems</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[21]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Guideline ECB/2007/2 and guideline ECB/2011/NP17.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[22]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Figures according to the ECB announcement:</span><a href="http://www.ecb.int/paym/t2/html/index.en.html" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://www.ecb.int/paym/t2/html/index.en.html</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[23]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> TARGET2 has 976 direct participants, 3465 indirect participants and 13083 correspondents,</span><a href="http://www.ecb.int/paym/t2/html/index.en.html" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://www.ecb.int/paym/t2/html/index.en.html</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[24]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> The share of TARGET2 in large-value payments in euro amounts to 91% in absolute value and to 59% in volume,</span><a href="http://www.ecb.int/paym/t2/html/index.en.html" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://www.ecb.int/paym/t2/html/index.en.html</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[25]</span><a href="http://www.ecb.int/paym/t2/html/index.en.html" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://www.ecb.int/paym/t2/html/index.en.html</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[26]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> See the development of other claims of the Bundesbank to the Eurosystem including TARGET balances – available at:</span><a href="http://bundesbank.de/Redaktion/DE/Downloads/Statistiken/Aussenwirtschaft/Auslandspositionen_Bundesbank/S201ATB39697A.pdf?__blob=publicationFile" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://bundesbank.de/Redaktion/DE/Downloads/Statistiken/Aussenwirtschaft/Auslandspositionen_Bundesbank/S201ATB39697A.pdf?__blob=publicationFile</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> – which fluctuated from -31 to +71 bn between 1999 and 2007, but which were often within a range of a few bn.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[27]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> For the Bundesbank, see for instance</span><a href="http://bundesbank.de/Redaktion/DE/Downloads/Statistiken/Aussenwirtschaft/Auslandspositionen_Bundesbank/S201ATB39697A.pdf?__blob=publicationFile" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://bundesbank.de/Redaktion/DE/Downloads/Statistiken/Aussenwirtschaft/Auslandspositionen_Bundesbank/S201ATB39697A.pdf?__blob=publicationFile</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[28]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Sum of all TARGET2 claims or, as applies, sum of all TARGET2 liabilities.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[29]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Taken from the monthly report of the Bundesbank, November 2012, p. 52.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[30]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="font-size: 15px; font-style: italic; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">Schlesinger</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">, ifo-Schnelldienst 16/2011, p. 9, 10.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[31]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Bundesbank, monthly report, November 2012, p. 52.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[32]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> Krämer, Wirtschaftswoche, February 18, 2012, p. 38 and Board of Governors of the Federal Reserve System (2012), Financial Accounting Manual for Federal Reserve Banks, 40.40 SOMA Participation, Revision Set 52, July 2012.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[33]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> In 2011, 1.6 bn $ flowed to the district banks and 76.9 bn $ flowed to the central government. (</span><a href="http://www.federalreserve.gov/newsevents/press/other/2012011a.htm" style="text-decoration: none;"><span style="color: black; font-size: 15px; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">http://www.federalreserve.gov/newsevents/press/other/2012011a.htm</span></a><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">)</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[34]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> This is also a reason why TARGET2 balances pay interest on the basis of the refinancing rate, thus the same interest rate which also accrues directly for refinancing. In this way, returns are transferred to the national central bank to whom the created central bank money flowed according to capital shares in the ECB</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[35]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> ECB press release of October 15, 2008.</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[36]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> The decision of the European Central Bank of December 13, 2010 regarding the issuance of euro banknotes, ABI, of February 9, 2011, L35/26, defines in its Appendix I the banknote allocation key as of January 1, 2011, which is assumed for the distribution of the total value of the issued banknotes among the participants of the Eurosystem (according to article 4 paragraph 1).</span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="font-size: 13px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;">[37]</span><span style="font-size: 15px; font-weight: normal; vertical-align: baseline; white-space: pre-wrap;"> ECB Convergence Report, May 2012, p. 28/29.</span></span></div>
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<span property="dct:title" xmlns:dct="http://purl.org/dc/terms/">Translation of Bundesbank Letter to German Constitutional Court</span> by <a href="http://www.blogger.com/www.antehoc.com" property="cc:attributionName" rel="cc:attributionURL" xmlns:cc="http://creativecommons.org/ns#">antehoc</a> is licensed under a <a href="http://creativecommons.org/licenses/by/3.0/deed.en_US" rel="license">Creative Commons Attribution 3.0 Unported License</a>.</div>
Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-51388678823063526072013-06-06T16:12:00.000-04:002013-06-29T18:42:19.824-04:00Why is the Legal Documentation for OMT Important?<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">In today's ECB Press Conference, the FT's Michael Steen asked whether the legal documents for OMT were available. </span></div>
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<span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">Draghi's <a href="http://www.ecb.int/press/pressconf/2013/html/is130606.en.html" target="_blank">answer</a></span><span style="background-color: white; color: #222222; font-family: Georgia, 'Times New Roman', serif;">:</span></div>
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<span style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 12px; line-height: 16.796875px;">The second point, about the legal documentation on the OMTs, is that it is ready and is about to come out. Not today, no, but frankly, you ask me this question every time and I cannot really see the issue. What is the issue about that? Anyway, if it becomes an issue it is ready to come out. If it has to be an issue it is ready to come out. We never thought that it would be an issue.</span><br />
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<span style="font-family: Georgia, 'Times New Roman', serif;">You can also see Draghi's response </span><a href="http://www.ecb.int/press/tvservices/webcast/html/webcast_130606.en.html" style="font-family: Georgia, 'Times New Roman', serif;" target="_blank">here</a><span style="font-family: Georgia, 'Times New Roman', serif;"> at around 29:45. </span><br />
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<span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">In connection with the Greek bonds that the ECB bought, the ECB claimed an inability to accept pari passu status as a result of the prohibition on monetary financing. However, the ECB claimed to be able to be pari passu in OMT. So the documentation is important. </span><span style="font-family: Georgia, Times New Roman, serif;"> In its original <a href="http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html" target="_blank">press release</a> on OMT the ECB commented:</span></div>
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<h2 style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: 1.15em; margin-bottom: 0.6em; margin-top: 1.1em;">
Creditor treatment</h2>
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The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.</div>
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<span style="font-family: Georgia, Times New Roman, serif;">The ECB has yet to "clarify in the legal act concerning [OMT]" in what way it will accept pari passu treatment with private creditors. </span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span>
<span style="font-family: Georgia, Times New Roman, serif;">Since it may require analysis and feedback, a release earlier than possibly during a crisis is sensible. What is the benefit of the ECB's opacity on this straightforward matter?</span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span>
<span style="font-family: Georgia, Times New Roman, serif;">[Update 2013.6.9: Perhaps the ECB doesn't want to provide clarity before the BVerfG decision. <a href="http://www.faz.net/aktuell/wirtschaft/europas-schuldenkrise/vor-der-verfassungsgerichts-verhandlung-europaeische-zentralbank-begrenzt-anleihekaeufe-12214532.html">FAZ reports</a> that the ECB has communicated to the court that the program is limited. The ECB is also trying to create rules that keep OMT from appearing to circumvent the prohibition on monetary financing that could be triggered by buying right after a primary bond issuance.]</span><br />
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-86947029933934883812013-06-04T14:25:00.001-04:002013-06-04T14:25:38.254-04:00Three-Year LTRO - Claiming Undue Credit <div class="MsoNormal">
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<span style="font-family: Georgia, Times New Roman, serif;"><a href="http://www.bloomberg.com/video/draghi-speech-about-euro-crisis-economy-markets-tRWufGisRZmtQwIoZoXhCw.html" target="_blank"><br class="Apple-interchange-newline" />Speaking in London Thursday</a> (at 8:53), ECB President Draghi made the following claims about the impact of the three-year LTROs (deviations from the ECB published text are in<span style="color: red;"> red <a href="http://www.ecb.int/press/key/date/2013/html/sp130523_2.en.html" target="_blank">(published text</a></span>): </span></div>
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<span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">"In late 2011 and early 2012 we launched two 3-year long term refinancing operations </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"><span style="color: red;">which we called</span> </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">LTROs. </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"><span style="color: red;">These operations</span></span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"> [Our LTROs] gave banks sufficient reassurance that access to liquidity will not be a problem over a relevant planning horizon. </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"><span style="color: red;">We injected about </span></span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"><span style="color: red;">€1tr, gross injection of liquidity with two operations which took place, one in January [sic] and the second in February of 2012. 60% of this has been repaid already.</span> </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">Without these operations, banks would have defaulted on their maturing obligations or would have discontinued and withdrawn existing credit lines to companies. <span style="color: red;">One should remember that in the first quarter of 2012 </span></span><span style="color: red;"><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">€</span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">230bn of bank bonds were maturing and more than </span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;">€300bn of soveign bonds were maturing. That's why banks in fact stopped giving credit starting</span></span><span style="font-family: Georgia, 'Times New Roman', serif; line-height: 1.4em;"><span style="color: red;"> in July of 2011, and that's where a good deal of the current credit crunch comes from. The LTROs therefore helped to avoid a major credit crunch.</span>"</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">This is consistent with previous claims Draghi made about how the LTROs prevented a credit crunch due to refinancing difficulties in the first quarter of 2012:</span></div>
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<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;"><span style="text-indent: -0.25in;">"</span><span style="text-indent: -0.25in;">[E]specially the LTROs, basically avoided major disasters which were looming ahead of the funding crunch that characterised the first quarter of this year. As I have told you many times, there were bank bonds worth about €230/€260 billion falling due." </span><b style="text-indent: -0.25in;"><a href="http://www.ecb.int/press/pressconf/2011/html/is111208.en.html" style="text-indent: -0.25in;">December 2012</a></b></span></li>
<li style="text-align: justify;"><span style="text-indent: -0.25in;"><span style="font-family: Georgia, Times New Roman, serif;">“Let us not forget that in the first quarter of this year, more than €200 billion of bank bonds fall due. So this decision certainly prevented a potentially major funding constraint for our banking system, with all the negative consequences this might have had on the credit side.” <b><a href="http://www.ecb.int/press/pressconf/2012/html/is120112.en.html">January 2012</a></b></span></span></li>
<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;"><span style="text-indent: -0.25in;">“[W]ith the first LTRO, we avoided a major credit crunch. I have already said that </span><b style="text-indent: -0.25in;"> </b><span style="text-indent: -0.25in;">€230 billion worth of bank bonds were coming due in the first quarter</span><b style="text-indent: -0.25in;">…</b><span style="text-indent: -0.25in;"> [t]he LTRO addresses the quantitative shortages and liquidity constraints of certain parts of the euro area financial and banking system.<b>” <a href="http://www.ecb.int/press/pressconf/2012/html/is120209.en.html">February 2012</a></b></span></span></li>
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<span style="font-family: Georgia, Times New Roman, serif;">But Draghi's claim, that the market dysfunction seen in November 2011 was due, in part, to an inability by banks to predictably access term financing, cannot be true for the following reasons:</span></div>
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<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;">On October 6 the <a href="http://www.ecb.europa.eu/press/pr/date/2011/html/pr111006_4.en.html" target="_blank">ECB had announced</a> a one-year LTRO for October 26 and thirteen-month LTRO for December 21. </span></li>
<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;">The ECB was already offering unlimited liquidity through its standard instrument, the MRO, since October, 2008, and had promised to continue this ‘fixed-rate, full-allotment’ policy ‘</span><a href="http://www.ecb.int/press/pressconf/2011/html/is111006.en.html" style="font-family: Georgia, 'Times New Roman', serif;">as long as necessary, and at least until the end of the sixth maintenance period of 2012 on 10 July 2012</a><span style="font-family: Georgia, 'Times New Roman', serif;">’.</span></li>
<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;">In addition to the unlimited MRO, the ECB has a standing discount window facility, the MLF. It has always been unlimited and available on a daily basis. The rate has been fixed since May, 2009 at 50-75 basis points over the MRO rate.</span></li>
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<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">The difference in <i>term</i> between the three-year LTRO and and these instruments is meaningless in the context of preventing an imminent disorderly deleveraging in the first quarter. </span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;">In addition, the three-year is not really a "long term" repo:</span></div>
<ul>
<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;">The haircuts on the LTROs are the exact same as the standard one-week policy instrument, the MRO. Both haircuts and eligible collateral can change at any time.</span></li>
<li style="text-align: justify;"><span style="font-family: Georgia, Times New Roman, serif;">Since the LTRO rate floats with the ECB’s policy rate, there is no economic difference for a bank between the LTRO and the weekly MRO. The three-year LTRO costs the same as rolling the MRO for three years<a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711#_ftn1" name="_ftnref1" title=""><span class="MsoFootnoteReference"><span style="color: black; font-family: Georgia; font-size: 11.0pt; mso-bidi-font-family: "Times New Roman";"><span class="MsoFootnoteReference">[1]</span></span></span></a>. </span></li>
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<span style="font-family: Georgia, Times New Roman, serif;"><a href="http://www.blogger.com/blogger.g?blogID=4360130099110594711#_ftnref1" name="_ftn1" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span style="font-family: Cambria; font-size: 11.0pt; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: "MS 明朝"; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-fareast; mso-hansi-theme-font: minor-latin;">[1]</span></span></span></a> If the ECB returns to its pre-October, 2008 mode of variable-rate tenders, and a period of stress comparable to the fall of 2008 occurs without a concomitant return to the fixed-rate, full-allotment policy, the LTRO may offer a microscopic benefit to its users.</span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
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<u><span style="font-family: Georgia, Times New Roman, serif;">An Alternate Explanation</span></u></div>
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<span style="font-family: Georgia, Times New Roman, serif;">The European crisis in late 2011 centered around Italy where short-term spreads were rising rapidly. Concern over the increasingly erratic behavior of the long-serving Italian Prime Minister, Silvio Berlusconi, combined with fears about Italy's high level of public debt to create a panic. The circus of Berlusconi's leadership is well captured by this smirk, shared by then French President Sarkozy and the German Chancellor Angela Merkel at an <a href="http://www.guardian.co.uk/business/2011/oct/24/merkel-sarkozy-italy-berlusconi"><span style="color: blue; mso-bidi-font-family: "Times New Roman";">EU crisis summit in late October 2011.</span></a><o:p></o:p></span></div>
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<a href="http://2.bp.blogspot.com/-InAxWH-yrtA/UP1rCHzYtCI/AAAAAAAAAZc/cQ4JOMbJvB0/s1600/smirk.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: Georgia, Times New Roman, serif;"><img border="0" height="205" src="http://2.bp.blogspot.com/-InAxWH-yrtA/UP1rCHzYtCI/AAAAAAAAAZc/cQ4JOMbJvB0/s320/smirk.png" width="320" /></span></a></div>
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<span style="font-family: Georgia, Times New Roman, serif;">Mr. Berlusconi's replacement by the technocratic Mario Monti was a significant change. For one, the risk of the Berlusconi doing something dramatic, like pulling Italy out of the Euro or defaulting on Italy's debt, was immediately reduced. In contrast, Mr. Monti first step was to appoint a cabinet of technocrats and to propose an agenda of structural reforms. A simple event study suggests that the drop in Italy's rate of borrowing was far more likely caused by Mr. Monti's arrival than the LTRO:<o:p></o:p></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;">*The spread closed 95 basis points on December 5. </span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;">While the above chart certainly proves nothing, the question remains: is it more likely that Italian spreads fell in late 2011 because of a central banking instrument that offered financial institutions no new benefit or a radical change of government in Italy?</span><br />
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com5tag:blogger.com,1999:blog-4360130099110594711.post-6196008516571869702013-04-29T23:13:00.002-04:002013-04-30T09:37:14.685-04:00ECB Revenue in the Case of a Low Risk Balance Sheet<div style="text-align: justify;">
<span style="font-family: Georgia;">In order to assess the ECB's ability to replenish capital in the event of a large loss, we estimate the ECB's low risk revenue going forward. This measure excludes interest income from the purchase of sovereigns, but also the potential losses from those purchases. The result is expressed in terms of a function of the MRO rate (the policy rate). </span></div>
<br />
<span style="font-family: Georgia, Times New Roman, serif;">The low risk income consists of:</span><br />
<div style="text-align: justify;">
<ul>
<li><span style="font-family: Georgia, 'Times New Roman', serif;">The MRO rate applied to 8% of the Eurosystem's outstanding banknotes (</span><b style="font-family: Georgia, 'Times New Roman', serif;">€</b><b style="font-family: Georgia, 'Times New Roman', serif;">73 billion*</b><span style="font-family: Georgia, 'Times New Roman', serif;"> at the end of 2012).</span></li>
<li><span style="font-family: Georgia, 'Times New Roman', serif;">Interest income on its all-in equity of </span><b style="font-family: Georgia, 'Times New Roman', serif;">€39bn;</b><span style="font-family: Georgia, 'Times New Roman', serif;"> this includes capital and reserves, provisions and the revaluation account, at the MRO rate.</span></li>
<li><span style="font-family: Georgia, 'Times New Roman', serif;">Interest on foreign exchange reserves minus remuneration of the NCBs at .85% of the MRO rate for those reserves. This totals about zero. (The ECB lost around </span><b style="font-family: Georgia, 'Times New Roman', serif;">€</b><span style="font-family: Georgia, 'Times New Roman', serif;">100 million on this in 2012.)</span></li>
</ul>
</div>
<div style="text-align: justify;">
<span font-family:="" georgia="" style="font-family: Georgia, Times New Roman, serif;">The low risk revenue of the ECB is €113 billion x MRO rate.</span></div>
<span style="font-family: Georgia;">This is about €.85 billion at the current MRO rate.</span><br />
<span style="font-family: Georgia;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: Georgia;"><b><br /></b></span>
<span style="font-family: Georgia;"><b>TARGET2 Income</b></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia;">There is net income of zero to the ECB on its offsetting TARGET2 assets and liabilities to NCBs, except in the case of a TARGET2 loss to the ECB (e.g., from a country departure and repudiation). (The ECB does report an imbalance in its TARGET2 assets and liabilities that is derived from fx swap transactions, but these transactions are matched and should earn the ECB no income; see note 6.2 in the annual accounts, link below.)</span></div>
<div style="text-align: justify;">
<br />
<span style="font-family: Georgia, Times New Roman, serif;">*<a href="http://www.ecb.europa.eu/pub/pdf/annrep/ar2012annualaccounts_en.pdf" target="_blank">ECB 2012 Annual Accounts</a></span><br />
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-74793439694380926172013-04-17T20:03:00.003-04:002013-05-02T09:49:49.330-04:00TARGET2 Loss Sharing - Applicable Treaty Provisions<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">A TARGET2 loss to the ECB might occur with the departure of a Eurosystem member accompanied by an expectation of less than full recovery of the TARGET2 liability. </span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">A loss recognized by the ECB would first be offset against the ECB's capital, reserves, provisions and perhaps the revaluation account. Recognition of a large loss, such as might have resulted from a departure of the Bank of Greece from the Eurosystem, could leave the ECB with negative equity. </span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">ECB losses can be shared by the NCBs under Article 33.2 of the <a href="http://www.ecb.int/ecb/legal/pdf/c_08320100330en_ecb_statute.pdf">statute</a>, pursuant to a Governing Council vote, i<span style="text-align: start;">n an amount up to the</span><span style="text-align: start;"> </span><a href="http://www.antehoc.com/2013/03/eurosystem-loss-sharing-in-monetary.html" style="text-align: start;" target="_blank">Eurosystem's monetary income for the year</a> of the loss. (It isn't clear whether the ECB can recognize parts of the loss each year in order to expand NCB loss sharing beyond the "relevant year" specified in the treaty.)</span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">If the ECB has negative equity after an Article 33.2 vote to share losses, an addition to ECB capital might be considered. Under Article 28.1 of the statute, a capital increase requires votes by the ECB's Governing Council and the 27 finance ministers of the EU, sitting as Ecofin. The ECB vote requires a qualified majority: two thirds, capital key-weighted and half of the shareholders (Article 10.3). Assent of Ecofin also requires a qualified majority. Under simplifying assumptions, until March 31, 2017, a qualified majority for a proposal by the European Commission would require at least half of the countries, with 75% of weighted votes and 62% of population. In contrast, a recommendation from the ECB would require two thirds rather than half of the countries (<a href="http://register.consilium.europa.eu/pdf/en/08/st06/st06655-re07.en08.pdf">TEU, Provisions Concerning the Qualified Majority, Article 3</a>). Starting April 1, 2017, the Ecofin vote will require 55% of the countries with 65% of the population if proposed by the European Commission, and 72% if proposed by the ECB <a href="http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF">(TFEU, Article 238)</a>.</span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br />In the event of a Eurosystem dissolution, since no obligation to share TARGET2 losses among NCBs precedes the dissolution, there is no claim to make after dissolution. Rather, TARGET2 is just a claim against the ECB. As a result, in the event of a dissolution, TARGET2 claims are shared among NCBs only to the extent those losses could be offset against paid-in ECB capital.</span><br />
<div class="MsoListParagraphCxSpMiddle">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
</div>
<span style="font-family: Georgia, Times New Roman, serif; text-align: justify;"><b>Article 32.4</b></span><br />
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">It has been argued <a href="http://www.oenb.at/en/img/mop_2012_q1_in_focus6_tcm16-246792.pdf" target="_blank">by the Austrian Central Bank</a>, Buiter/Rahbari and perhaps others that since TARGET2 liabilities resulted from monetary policy operations, they should be shared under Article 32.4. This wouldn't be true for:</span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">- ELA amounts, which can be large for a departing NCB.</span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">- In the case of an exit, where the NCB's losses result from redenomination of its TARGET2 liability rather than from losses on collateral resulting from loans to failed banks. A country might be exiting in part to preserve the viability of its banks in which case there wouldn't be 32.4 eligible losses.</span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">- In addition, using 32.4, which pertains to member NCBs, to compensate for losses at a non-member NCB would be open to legal challenge.</span><br />
<br /></div>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-71958317120430839702013-03-21T18:40:00.001-04:002013-12-05T12:16:06.534-05:00Loss Sharing in the Eurosystem - Excluding Target2 Losses<div class="MsoNormal">
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><b><br /></b>
<b>Monetary Policy Operations Loss Sharing Among NCBs</b></span><br />
<br /></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">
<span style="background-color: white; color: #222222;">Monetary policy operation losses are not automatically shared among Eurosystem NCBs. They are shared only pursuant to an ECB Governing Council vote, which need not be pro-forma.</span></span></div>
</div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
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<div style="text-align: justify;">
<span style="color: #222222; font-family: Georgia, Times New Roman, serif;"><b><a href="http://www.ecb.int/ecb/legal/pdf/en_statute_2.pdf" target="_blank">Article 32.4 of the ESCB Statute</a></b>:*<o:p></o:p></span></div>
</div>
<div class="MsoNormal">
<blockquote class="tr_bq">
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">...</span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">The Governing Council may decide that national central banks shall be indemnified against costs incurred in connection with the issue of banknotes or in exceptional circumstances for specific losses arising from monetary policy operations undertaken for the ESCB. Indemnification shall be in a form deemed appropriate in the judgment of the Governing Council; these amounts may be offset against the national central banks' monetary income.</span></div>
</blockquote>
<span style="font-family: Georgia, Times New Roman, serif;"><span style="text-align: justify;">Despite the plain language that a vote is required, </span><span style="text-align: justify;">Eurosystem official publications claim that this loss sharing is automatic: </span><span style="text-align: justify;"> </span></span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><span style="text-align: justify;"></span></span><br />
<a name='more'></a><span style="font-family: Georgia, Times New Roman, serif;"><span style="text-align: justify;"><br /></span></span>
<span style="font-family: Georgia, Times New Roman, serif;"><span style="text-align: justify;"><br /></span></span>
<span style="font-family: Georgia, Times New Roman, serif; text-align: justify;"><a href="http://www.dnb.nl/en/binaries/AR2011_tcm47-270450.pdf" target="_blank">Dutch National Bank 2011 Annual Report</a>:</span><br />
<blockquote class="tr_bq">
<span style="text-align: justify;">The risks, and thus the potential losses, stemming from OMO and SMP are shared within the Eurosystem.</span></blockquote>
<span style="font-family: Georgia, Times New Roman, serif;"><a href="http://www.ecb.int/pub/pdf/annrep/ar2011en.pdf" style="text-align: justify;" target="_blank">ECB Annual Report 2011</a><span style="text-align: justify;">:<i> </i></span></span><br />
<blockquote class="tr_bq">
<span style="font-family: Georgia, Times New Roman, serif; text-align: justify;">The residual risk that may emerge despite risk mitigation measures is, as a rule, shared among </span><span style="font-family: Georgia, Times New Roman, serif; text-align: justify;">the euro area NCBs in accordance with their respective shares in the ECB’s capital...</span></blockquote>
<span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">As do commentators:</span><br />
<br />
<br />
<div style="text-align: justify;">
<span style="color: #222222; font-family: Arial;"><a href="http://willembuiter.com/roublezone.pdf" target="_blank">Willem Buiter</a></span><span style="color: #222222; font-family: Arial;">: </span></div>
<span style="font-family: Georgia, Times New Roman, serif;"></span><br />
<br />
<blockquote class="tr_bq">
<div style="text-align: justify;">
<span style="color: #222222; font-family: Georgia, 'Times New Roman', serif;">Losses and profits made by the ECB and the NCBs in the implementation of the common MCL policy are shared among the NCBs in proportion to their share in the ECB capital.</span></div>
</blockquote>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial;"><a href="http://ftalphaville.ft.com/blog/2011/05/09/563016/)" target="_blank">JP Morgan</a></span><span style="color: #222222; font-family: Arial;">:</span></span></div>
<blockquote class="tr_bq">
<div style="text-align: justify;">
<span style="color: #222222; font-family: Georgia, 'Times New Roman', serif;">The losses incurred by the Eurosystem are to be shared by all national central banks in proportion to their shares in the ECB's capital.</span></div>
</blockquote>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial;"><a href="http://www.ucd.ie/t4cms/WP12_06.pdf" target="_blank">Karl Whelan</a></span><span style="color: #222222; font-family: Arial;">:</span></span></div>
<blockquote class="tr_bq">
<span style="color: #222222; font-family: Georgia, 'Times New Roman', serif; text-align: justify;">The official legal statute governing the Eurosystem is quite vague about the implications for an NCB of losses incurred in monetary operations… In practice, the Governing Council of the ECB used the defaults by Lehmans</span><span style="color: #222222; font-family: Georgia, 'Times New Roman', serif; text-align: justify;"> </span><span style="color: #222222; font-family: Georgia, 'Times New Roman', serif; text-align: justify;">and other banks in 2008 to clarify in a statement in March 2009 that losses should be shared in full by the Eurosystem NCBs in proportion to their ECB capital key shares.</span></blockquote>
</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif; text-align: justify;">Rather than contemplate a pro-forma vote, the statute prescribes a high hurdle to loss sharing</span><span style="font-family: Georgia, Times New Roman, serif; text-align: justify;"> by saying that the Governing Council may indemnify in "exceptional circumstances for specific losses". While it might be argued that the treaty means "in the exceptional circumstances of specific losses", that is not what it says. </span><span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">The French, German and Spanish versions of the treaty are consistent with the view we articulate. </span><span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;"> In addition, we have not noticed other language in this treaty that is gratuitously descriptive.</span><br />
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;"><br /></span></div>
</div>
<div class="MsoListParagraphCxSpFirst">
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">There is one known loss sharing vote by the Governing Council. In explaining the event, rather than describing a pro-forma vote, they appear to be providing a required justification. They comment </span><span style="font-family: Georgia, 'Times New Roman', serif;">elaborately on the Bundesbank's compliance with rules and procedures regarding the losing transactions:</span></div>
<br />
<br />
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;">From the </span><a href="http://www.ecb.int/press/pr/date/2009/html/pr090305_2.en.html" style="font-family: Georgia, 'Times New Roman', serif;" target="_blank">2009</a><span style="font-family: Georgia, 'Times New Roman', serif;"> </span><a href="http://www.ecb.int/press/pr/date/2009/html/pr090305_2.en.html" style="font-family: Georgia, 'Times New Roman', serif;" target="_blank">E</a><a href="http://www.ecb.int/press/pr/date/2009/html/pr090305_2.en.html" style="font-family: Georgia, 'Times New Roman', serif;" target="_blank">CB press release</a><span style="font-family: Georgia, 'Times New Roman', serif;"> [emphasis added]:</span></div>
<br />
<br />
<blockquote class="tr_bq">
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">The Governing Council<b> has confirmed </b>that the monetary policy operations in question were carried out by these NCBs<b> in full compliance</b> with the Eurosystem’s rules and procedures, and that these NCBs had <b>taken all the necessary precautions</b>, <b>in full consultation</b> with the ECB and the other NCBs, to maximise the recovery of funds from the collateral held. </span> </div>
</blockquote>
<blockquote class="tr_bq">
<div style="text-align: justify;">
<span style="font-family: Georgia, Times New Roman, serif;">The counterparties in question submitted eligible collateral<b> in compliance</b> with the Eurosystem’s rules and procedures.</span></div>
<span style="font-family: Georgia, Times New Roman, serif;">
</span></blockquote>
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">As we aren't aware of any general concern regarding Bundesbank procedural compliance, we think the Governing Council is meeting some requirement. </span><span style="font-family: Georgia, Times New Roman, serif;">Some commentators see a clarification in the press release that losses will be shared in the future (see Whelan, above). But as only</span><span style="font-family: Georgia, Times New Roman, serif;"> a one-time indemnification is described by the ECB, this view is surprising.</span><br />
<br />
<br />
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: Georgia, 'Times New Roman', serif;">The Bundesbank recognizes that a vote is required but describes loss sharing as customary. </span><a href="http://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Annual_Report/2011_annual_report.pdf?__blob=publicationFile" style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;" target="_blank">Bundesbank 2011 Annual Report</a><span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">:</span></div>
<br />
<br />
<blockquote class="tr_bq">
<span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">These losses are customarily borne jointly, dependent on a decision of the ECB Governing Council, by the partner central banks in line with their capital share in the ECB.</span></blockquote>
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<span style="font-family: Georgia, Times New Roman, serif;">As we are aware of only one loss sharing incident, it isn't clear how fully rooted the custom is.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><b>ECB Loss Sharing with the NCB Members of the Eurosystem</b></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><a href="http://www.ecb.int/ecb/legal/pdf/en_statute_from_c_11520080509en02010328.pdf" target="_blank">Article 33.2</a> </span></div>
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<span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">In the event of a loss incurred by the ECB, the shortfall may be offset against the general reserve fund of the ECB and, if necessary, following a decision by the Governing Council, against the monetary income of the relevant financial year in proportion and up to the amounts allocated to the national central banks in accordance with Article 32.5.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">ECB losses are shared only pursuant to a Governing Council vote and only to the extent of the relevant year's monetary income. Sources of ECB losses include foreign exchange reserves changes, SMP and TARGET2. Last year the Eurosystem’s monetary income was roughly €27 billion and the <a href="http://www.ecb.europa.eu/press/pr/date/2013/html/pr130221.en.html" target="_blank">ECB's capital and reserves was €38.8 bn</a>. The ECB's TARGET2 exposure to Greece is €87 bn (as of January 2013) and to Spain is €297 bn (as of February).</span><br />
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<span style="font-family: Georgia, Times New Roman, serif;">*Unlike Article 33.2, Article 34.2 can be amended by the European Parliament and the Council (TFEU 129).</span></div>
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Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-4360130099110594711.post-38793881548150571872013-03-04T21:33:00.002-05:002013-05-02T10:42:46.257-04:00Updated as of Q3 2012** French/German bank exposure to Spain and Italy<br />
With data through the third quarter of 2012 the trend remains the same - French and German banks continue reducing exposure to Spain and Italy. As a reminder - Data is from the <a href="http://www.bis.org/statistics/consstats.htm" target="_blank">BIS consolidated banking statistics</a> table 9D which shows exposure on an ultimate risk basis. The value is reported in dollars but it includes claims in all currencies.<br />
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<a href="http://3.bp.blogspot.com/-3WUB1EciC38/UTVJITYiKAI/AAAAAAAAAZ8/buMFBQhfWZk/s1600/German+exposure.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="352" src="http://3.bp.blogspot.com/-3WUB1EciC38/UTVJITYiKAI/AAAAAAAAAZ8/buMFBQhfWZk/s640/German+exposure.png" width="640" /></a></div>
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A slightly longer time series and an update on BIS data through the first quarter of 2012. Two takeaways:</div>
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1) exit made by German banks from both Italy and Spain began earlier than French banks </div>
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2) French banks are (still) very exposed to Italy </div>
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Data clarification: ultimate risk basis; also data includes entire exposure to subject countries, sovereign debt, bank debt & private debt </div>
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<a href="http://4.bp.blogspot.com/-Llqx_PW9aaM/UAmOpUvrTKI/AAAAAAAAAQA/wXN0r0tr8a8/s1600/German+b.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"></a><a href="http://4.bp.blogspot.com/-K3CZ6diDHG0/UAmOqglwz5I/AAAAAAAAAQI/_HL-yFVXAgs/s1600/french+b.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" height="352" src="http://4.bp.blogspot.com/-K3CZ6diDHG0/UAmOqglwz5I/AAAAAAAAAQI/_HL-yFVXAgs/s640/french+b.png" width="640" /></a><img border="0" height="385" src="http://4.bp.blogspot.com/-Llqx_PW9aaM/UAmOpUvrTKI/AAAAAAAAAQA/wXN0r0tr8a8/s640/German+b.png" style="cursor: move;" width="640" /></div>
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<a href="http://www.bis.org/statistics/consstats.htm" target="_blank">Data is from the BIS</a> - exposure data shows consolidated holdings (reported in $) of French and German banking sectors to Italian and Spain debt (both public and private). As one example of the reduction in foreign exposure, French banks reduced their exposure to Italian borrowers by $175 billion between year end 2009 and year end 2011 which represented a 34.5% reduction. Another interesting detail is just how large the French banking sectors' exposure was and remains to Italy in comparison to Spain. French banks held $332 billion in claims against Italian borrowers at the end of 2011 vs. claims of only $114 billion against Spanish borrowers. At the same time, German banks held claims of $146 billion against Spanish borrowers and $134 billion against Italian borrowers. </div>
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com2tag:blogger.com,1999:blog-4360130099110594711.post-79068505284942502602013-02-21T15:18:00.000-05:002013-02-21T15:37:16.404-05:00Eurosystem Seniority in OMT?At the announcement of the ECB's "Outright Monetary Trasanctions" (OMT) in September an accompanying <a href="http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html" target="_blank">press release</a> stated that any purchases by the eurosystem would not be senior to private creditors:<br />
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<i>The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.</i></div>
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As of yet, there has been no clarification. </div>
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-35595079361948874322012-11-30T18:38:00.001-05:002013-04-02T10:53:41.585-04:00Subsidized Haircuts in Eurosystem RefinancingIn his <a href="http://www.ecb.int/press/key/date/2012/html/sp121126_1.en.html" target="_blank">November 26 speech</a> to the Hyman P. Minsky Conference in Berlin, ECB Executive Board Member Peter Praet said that the Eurosystem's collateral framework lets the private market decide which assets to post as collateral. In contrast with the Fed's asset purchases, he argues, Eurosystem refinancing operations do not favor certain assets over others. <br />
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<i style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 11.818181991577148px; text-align: justify;">Asset purchases directly create scarcity in the instrument being purchased. This exerts an upward pressure on prices, and, through portfolio rebalancing effects, may also affect the prices of other assets. However, direct asset purchases involve a difficult choice for the central bank: it must take a decision on which assets to buy, necessarily interfering with relative asset prices and income distribution.</i><br />
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<i>Collateralised lending involves such decision only at the level of the definition of the collateral and its eligibility conditions. This can also influence the prices of collateral, but the role of selecting which assets to buy or sell is essentially “outsourced” to the banking system, that is, to many private agents. Hence, collateralised lending leaves the price discovery process and the allocation of savings to market mechanisms.</i></div>
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Praet's description minimizes the Eurosystem's role in favoring certain assets over others. The Eurosystem expresses a variety of preferences in the selection process for collateral. Many of these preferences, expressed by the size of haircuts, may be similar to the private market. But as the Euro area has seen increased volatility in its sovereign debt markets a haircut gap with the private market have emerged. <br />
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As an example, Spanish 2 year debt is haircut 3.5% at LCH and only 1.5% at Eurosystem operations. Spanish 8 year debt is haircut 10.25% at LCH and only 4% by the Eurosystem. If the LCH is any proxy for the rest of the private market it is not difficult to understand why Spanish banks have done more of their refinancing at the Bank of Spain as volatility (and thus private market haircuts) in Spanish sovereign debt began to rise late last year. The subsidy, in comparison with the private market, is evidence that the Eurosystem does not "essentially 'outsource'" decisions on asset purchases. <br />
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<u>Haircuts in eurosystem refinancing operations</u></div>
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<u><a href="http://www.lchclearnet.com/risk_management/sa/collateral_management.asp" target="_blank">LCH Haircuts</a> as of 11/30/2012</u></div>
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<br />Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-79680668012108101352012-11-21T16:07:00.000-05:002013-12-11T12:25:24.681-05:00Link - debt default as solution to euro crisisA <a href="http://www.irishtimes.com/newspaper/opinion/2012/1114/1224326574017.html" target="_blank">good analysis</a> from last Wednesday's Irish Times by Ashoka Mody of PrincetonUnknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-24535671398261916582012-10-24T19:12:00.001-04:002012-10-25T09:53:19.520-04:00European Officials as the Source of Convertibility Risk<div style="text-align: justify;">
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<span style="font-family: Georgia, Times New Roman, serif;">ECB President Mario Draghi identified convertibility risk <a href="http://www.ecb.int/press/key/date/2012/html/sp120726.en.html">as the source of increasing yields in Spain</a> and noted the ECB's mandate and determination to address it since there should be no convertibility risk in the euro. Under the <a href="http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:115:0013:0045:EN:PDF">relevant</a> <a href="http://eur-lex.europa.eu/en/treaties/dat/11992M/htm/11992M.html#0087000011">treaties</a>, membership in the EMU ranges from "irrevocable" to "irreversible". Nevertheless, the risk of a euro exit by Spain concerned depositors and investors in Spain. What explains this?</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">In early May, there was a spate of remarks by European officials that could have affected perceptions of the irrevocability of the euro:</span></div>
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<li><span style="font-family: Georgia, Times New Roman, serif;">On May 8, in the wake of the first round of Greek elections, ECB Governing Council member Jorg Asmussen <span style="color: blue;"><a href="http://www.reuters.com/article/2012/05/08/us-ecb-asmussen-idUSBRE8470V820120508">threatened</a></span>: "Greece needs to be aware that there are no alternatives to the agreed bailout program, if it wants to stay in the euro zone."</span></li>
<li><span style="font-family: Georgia, Times New Roman, serif;">On May 10, similar comments followed from European Council President Van Rompuy and European Commission President Barroso (<a href="http://www.reuters.com/article/2012/05/10/us-eu-greece-strategy-idUSBRE8490W820120510">EU Turns the Screw on Athens...</a>). </span></li>
<li><span style="font-family: Georgia, Times New Roman, serif;">On May 11, in response to a question of whether Greece could be forced from the EMU, Barroso <a href="http://uk.reuters.com/article/2012/05/11/uk-greece-barroso-idUKBRE84A0B120120511">amplified</a>: "Look, if a member of a club, I don't want to talk about a particular country, but if a member of a club does not respect the rules, it's better that it leaves the club...."</span></li>
<li><span style="font-family: Georgia, Times New Roman, serif;">At the May 14 Eurogroup meeting, Eurogroup head Jean-Claude Juncker <a href="http://www.spiegel.de/international/europe/europe-raises-threat-level-against-athens-a-834188.html" style="color: blue;">warned</a> his colleague Greek Finance Minister Filippos Sachinidis: "If we now held a secret vote about Greece staying in the euro zone…there would be an overwhelming majority against it."</span></li>
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<span style="font-family: Georgia, 'Times New Roman', serif;">That these comments came from European officials was surprising, as they are creatures of the collection of treaties that make the euro irrevocable.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, 'Times New Roman', serif;">A measure of the interest of Spaniards in this topic is</span><span style="font-family: Georgia, 'Times New Roman', serif;"> the frequency of searches from Spain in Google for "exit from the euro" without mentioning Greece and "open an account in Switzerland". (We recognize that the share of population that does these searches is small.) This graph overlays these measures on a chart of the 2-year yield spread between Spain and Germany:</span></div>
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<span style="background-color: white; font-family: Georgia;">People had discussed Greece's departure before Asmussen’s speech, but the idea that the ECB and EU officials could cause it was new. Depositors and investors in Spain, already concerned by bank solvency, may have thought that this casual treatment of euro membership could apply to Spain as well.</span><br />
<span style="background-color: white; color: #404040; font-family: Georgia; font-size: 16px;"><br /></span><span style="color: blue; font-family: Georgia, 'Times New Roman', serif;"><a href="http://online.wsj.com/article/SB10001424052702303448404577408133530671516.html">Draghi attempted to repair the damage</a> </span><span style="font-family: Georgia, 'Times New Roman', serif;"> on May 16:</span></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;">"While the ECB will continue to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet, I want to state that our <b>strong preference</b> is that Greece will continue to stay in the euro area."</span></i></div>
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<span style="font-family: Georgia, Times New Roman, serif;">This failed to stop the rise in Spanish yields. ECB changed <b>"strong preference</b>" to "<b>immutable preference</b>" <a href="http://www.djnewsplus.com/rssarticle/SB133735140453032758.html">two days later</a>, with little effect. It's difficult to counter </span><span style="font-family: Georgia, 'Times New Roman', serif;">effectively </span><span style="font-family: Georgia, 'Times New Roman', serif;">what appeared to be the broad-based view of EU officials.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">A further round of <a href="http://www.ft.com/intl/cms/s/0/45994658-d4e8-11e1-b476-00144feabdc0.html#axzz24stvmArs">stress</a> in Spain began during the week of July 16, when news that the Troika would be inflexible in its upcoming visit to Greece reignited concern over Greece's ejection. This began with a leak of a draft Troika report describing the "awful" situation in Greece. Reports of the Troika's inflexibility grew during the week. This culminated</span><span style="font-family: Georgia, 'Times New Roman', serif;"> </span><span style="font-family: Georgia, 'Times New Roman', serif;">over the weekend of July 21 when</span><span style="font-family: Georgia, 'Times New Roman', serif;"> </span><a href="http://euobserver.com/economic/117036" style="font-family: Georgia, 'Times New Roman', serif;">three senior German government ministers</a><span style="font-family: Georgia, 'Times New Roman', serif;"> said there would be no flexibility and suggested that Greece should leave the euro.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">On July 26, Mario Draghi indicated that the ECB would "do what it takes", which became the OMT program to buy bonds of countries with convertibility risk premia. Draghi's dramatic move was intended to respond to a crisis perhaps triggered by his own contemporaries.</span></div>
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<span style="color: #4c1130;"><span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;">Preview of Forthcoming Post: </span></span><br />
<span style="color: #4c1130;"><span style="font-family: Georgia, Times New Roman, serif;">Convertibility risk isn't the only cost of a Greek departure. Presumably unconsidered by the officials who spoke of Greece's departure was the effect on the ECB's balance sheet. Given the ECB's exposure to Greece through Target2 of about €120bn, a loss of that would have left the ECB with negative equity of about €-100bn, not counting any SMP losses. (The ECB's exposure to Greece is not collateralized.) Since the provisions of the treaty ( <a href="http://www.ecb.int/ecb/legal/pdf/c_08320100330en_ecb_statute.pdf">PSESCBECB</a> Articles 10.3, 28.1, 32.4, 33.2, and <a href="http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2000:115:0001:0001:EN:PDF">Council Regulation 1009/2000</a>) require a weighted 2/3 vote to go beyond modest recapitalization or loss sharing in the event of a large ECB loss, the ECB could be stuck with negative capital. This would be awkward at best. </span></span><br />
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Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-4360130099110594711.post-77629761450748790572012-10-23T15:24:00.000-04:002014-02-18T13:13:12.317-05:00Convertibility Risk - Cherry Picking* Interest Rate Spreads<div dir="ltr" style="text-align: left;" trbidi="on">
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<span style="font-family: Georgia, Times New Roman, serif; text-align: start;">ECB President Mario Draghi explained that the OMT program to buy sovereign bonds was within the ECB's mandate because unfounded fears of a euro exit had caused excessively high yields in Spain and Italy. <a href="http://www.ecb.int/press/key/date/2012/html/sp120925.en.html" style="color: #1155cc;" target="_blank">Speech to the Bundesverband der Deutschen Industrie, September 25, Berlin</a>:</span></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;">"In recent months, we have seen highly divergent borrowing costs for the real economy in different parts of the euro area. In our analysis, these differences were larger than justified by individual credit risk. They reflected, to a considerable extent, unfounded fears about the future of the euro area.</span></i></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;"><b>For example, a loan to a family in Germany for a house purchase with a five- to-ten-year maturity had an interest rate of 3%</b><b>; the rate for a comparable borrower in Spain was 7.5%.</b> <b>At the same time, the average firm in Germany paid around 3% for a new loan over five years, while the average firm in Italy paid above 5.5%.</b></span></i></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;">In these circumstances, monetary policy cannot work properly. This is because a key channel through which the ECB ensures price stability is through the cost of credit, in particular bank credit. Bank credit accounts for about 70% of external financing of euro area firms, and that ratio is even higher for smaller enterprises.</span></i></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;">But if we are unable to influence borrowing costs in some parts of the euro area, this channel is disrupted. Firms and households have less access to financing, economic growth stalls and these regions are faced with a risk of deflation. In other words, our ability to ensure price stability for the whole euro area is compromised.</span></i></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;">The ECB’s Governing Council therefore faced a choice: to accept this situation and allow the singleness of its monetary policy to be undermined; or to take actions within its mandate to restore the normal transmission of monetary policy across all parts of the euro area. We decided in favour of the latter."</span></i></div>
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<b>Mortgage Rates in Spain</b></span><br />
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<i><b><span style="color: #cc0000;">"For example, a loan to a family in Germany for a house purchase with a five- to-ten-year maturity had an interest rate of 3%</span></b><span style="color: #cc0000;"><b>; the rate for a comparable borrower in Spain was 7.5%."</b> </span></i></span><br />
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<span style="font-family: Georgia, Times New Roman, serif;">The ECB picks the red line to demonstrate the presence of convertibility risk:</span></div>
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<a href="http://4.bp.blogspot.com/-RE7BMN2Gz04/UHg8hBWMfKI/AAAAAAAAAJc/5XSNcc2Y8tU/s1600/spanish+-+german+mortgages.jpg" style="color: #1155cc; margin-left: 1em; margin-right: 1em;" target="_blank"><span style="font-family: Georgia, Times New Roman, serif;"><img border="0" src="http://4.bp.blogspot.com/-RE7BMN2Gz04/UHg8hBWMfKI/AAAAAAAAAJc/5XSNcc2Y8tU/s640/spanish+-+german+mortgages.jpg" height="382" width="640" /></span></a></div>
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<span style="font-family: Georgia, Times New Roman, serif;">(<span style="font-size: x-small;">Source: <a href="http://sdw.ecb.europa.eu/browseSelection.do?DATASET=0&sfl2=4&sfl3=4&sfl4=3&sfl5=4&BS_COUNT_SECTOR=2250&node=9484266" style="color: #1155cc;" target="_blank">ECB Statistical Warehouse</a>. Spain: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2C.F.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Up to 1 year</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2C.I.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 1 and up to 5 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2C.O.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 5 and up to 10 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2C.P.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 10 years</a>; Germany: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2C.F.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Up to 1 year</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2C.I.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 1 and up to 5 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2C.O.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 5 and up to 10 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2C.P.R.A.2250.EUR.N" style="color: #1155cc;" target="_blank">Over 10 years</a></span>)</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">The ECB chose a persistent outlier to make this point.</span><span style="font-family: Georgia, Times New Roman, serif;"> Both longer and shorter maturities had much lower rate differences than did their category.</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">Strikingly, the chosen maturity category has <i>de minimis </i>volume in Spain:</span><br />
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<a href="webkit-fake-url://656E46AE-8008-4091-8F5E-1A4EBAF4C2D7/image.tiff" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"></a><a href="http://3.bp.blogspot.com/--CgRYtfJUVo/UVrq_mm_kzI/AAAAAAAAAAc/W9LG90QxveQ/s1600/new+mortgage+volume,+spain+FIXED.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/--CgRYtfJUVo/UVrq_mm_kzI/AAAAAAAAAAc/W9LG90QxveQ/s1600/new+mortgage+volume,+spain+FIXED.jpg" height="390" width="640" /></a></div>
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<span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">(</span><span style="font-family: Georgia, 'Times New Roman', serif; font-size: x-small; text-align: justify;">Source: <a href="http://www.bde.es/webbde/es/estadis/infoest/a1918e.pdf" style="color: #1155cc;" target="_blank">Banco de Espana</a></span><span style="font-family: Georgia, 'Times New Roman', serif; text-align: justify;">)</span></div>
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<span style="font-family: Georgia, 'Times New Roman', serif;">The fact that most new Spanish mortgages appear to have maturities of up to one year should not surprise us. As the European Mortgage Federation <a href="http://www.ahe.es/bocms/images/bfilecontent/2008/01/28/2317.pdf?version=3">observes</a>, the vast majority of outstanding mortgages have rates that float to Euribor. The Banco de Espana <a href="http://www.bde.es/webbde/es/estadis/infoest/a1918e.pdf">notes</a>, "a 15-year loan at an annually revisable rate is classified under the term 'Up to one year'." </span><br />
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<span style="font-family: Georgia, 'Times New Roman', serif;">While the difference between five-to-ten year Spanish and German mortgage rates in July was 4.5%, it was between 0% and 1% for the categories with reasonable volume in Spain. We can fit both convertibility risk and "individual credit risk" into a 4.5% spread, but less easily into a 1% spread.</span><br />
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<b><span style="font-family: Georgia, Times New Roman, serif;">Corporate Loan Rates in Italy</span></b></div>
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<i style="font-weight: bold; text-align: justify;"><span style="color: #741b47; font-family: Georgia, Times New Roman, serif;">"The average firm in Germany paid around 3% for a new loan over five years, while the average firm in Italy paid above 5.5%"</span></i><br />
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<span style="color: #222222; font-family: Georgia, 'Times New Roman', serif; text-align: justify;">To demonstrate the existence of a convertibility risk premium, the ECB again picks the widest spread. </span></div>
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<a href="http://4.bp.blogspot.com/-UcwGIBafuYE/UHhOCj1tqgI/AAAAAAAAALU/a8inzvuZ95o/s1600/Italian+NFC+Spreads+Over+Germany,+by+Duration+.jpg" style="color: #1155cc; margin-left: 1em; margin-right: 1em;" target="_blank"><span style="font-family: Georgia, Times New Roman, serif;"><img border="0" src="http://4.bp.blogspot.com/-UcwGIBafuYE/UHhOCj1tqgI/AAAAAAAAALU/a8inzvuZ95o/s640/Italian+NFC+Spreads+Over+Germany,+by+Duration+.jpg" height="390" width="640" /></span></a></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="text-align: justify;"><span style="text-align: start;">(<span style="font-size: x-small;">Source: <a href="http://sdw.ecb.europa.eu/browseSelection.do?DATASET=0&sfl2=4&sfl3=4&sfl4=3&sfl5=4&BS_COUNT_SECTOR=2240&node=9484266" style="color: #1155cc;" target="_blank">ECB Statistical Warehouse</a>. Italy: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.IT.B.A2A.F.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Up to 1 year,</a> <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.IT.B.A2A.I.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Over 1 and up to 5 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.IT.B.A2A.J.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Over 5 years</a>; Germany: </span></span></span><span style="font-size: x-small;"><a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.F.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Up to 1 year</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.I.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Over 1 and up to 5 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.J.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Over 5 years</a></span>)</span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">Though the chosen series has meaningful volume, the over five-year spread, 2.5%, is twice as large as the up to one-year spread. </span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span><span style="font-family: Georgia, Times New Roman, serif;">The ECB has pointed to Spanish mortgages and Italian corporate loans as cases of a convertibility premium. Such a premium should manifest in all Spanish rates, including corporate loans. </span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">We present the spreads of corporate loans in Spain over Germany, which the ECB did not discuss. Notice that there are no outlying series. </span></div>
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<a href="http://3.bp.blogspot.com/-WRnZMhCZeoA/UIW3ZZSef1I/AAAAAAAAAMo/lh0OBL_F8uM/s1600/spanish+nfc+spreads+over+germany+by+duration.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-WRnZMhCZeoA/UIW3ZZSef1I/AAAAAAAAAMo/lh0OBL_F8uM/s1600/spanish+nfc+spreads+over+germany+by+duration.jpg" height="378" width="640" /></a></div>
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<span style="font-family: Georgia, 'Times New Roman', serif;">(</span><span style="font-size: x-small;"><span style="font-family: Georgia, 'Times New Roman', serif;">Source: <a href="http://sdw.ecb.europa.eu/browseSelection.do?DATASET=0&sfl2=4&REF_AREA=&sfl3=4&MATURITY_ORIG=A&sfl4=3&sfl5=4&node=9484266" style="color: #1155cc;" target="_blank">ECB Statistical Warehouse</a>. Spain: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2A.F.R.A.2240.EUR.N">Up to 1 year</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2A.I.R.A.2240.EUR.N">Over 1 and up to 5 years</a>, <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2A.J.R.A.2240.EUR.N">Over 5 years</a>; Germany: </span><a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.I.R.A.2240.EUR.N" style="font-family: Georgia, 'Times New Roman', serif;">Up to 1 year</a><span style="font-family: Georgia, 'Times New Roman', serif;">, </span><a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.I.R.A.2240.EUR.N" style="font-family: Georgia, 'Times New Roman', serif;">Over 1 and up to 5 years</a><span style="font-family: Georgia, 'Times New Roman', serif;">, </span><a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.J.R.A.2240.EUR.N" style="font-family: Georgia, 'Times New Roman', serif;">Over 5 years</a></span>)</div>
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<span style="font-family: Georgia, Times New Roman, serif;">Now let us compare the spreads of both countries to Germany:</span></div>
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<a href="http://2.bp.blogspot.com/-J1-rMwmtuXs/UIW6FZ92IfI/AAAAAAAAANE/XSu6o5JEYKw/s1600/spain+italy+nfc+spreads+to+germany.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://2.bp.blogspot.com/-J1-rMwmtuXs/UIW6FZ92IfI/AAAAAAAAANE/XSu6o5JEYKw/s1600/spain+italy+nfc+spreads+to+germany.jpg" height="382" width="640" /></a></div>
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<span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">(</span><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif; font-size: x-small;">Source: <a href="http://sdw.ecb.europa.eu/browseSelection.do?DATASET=0&sfl2=4&REF_AREA=&sfl3=4&MATURITY_ORIG=A&sfl4=3&sfl5=4&node=9484266" style="color: #1155cc;" target="_blank">ECB Statistical Warehouse</a>. Spain: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.ES.B.A2A.A.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Total maturity, total amount</a>; Italy: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.IT.B.A2A.A.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Total maturity, total amount</a>; Germany: <a href="http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=124.MIR.M.DE.B.A2A.A.R.A.2240.EUR.N" style="color: #1155cc;" target="_blank">Total maturity, total amount</a></span><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">)</span></div>
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<span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">The ECB's choice of the 2.5% spread in Italian over five-year loans looks even more like cherry picking when one sees that the weighted average rate spread of new loans is around 1%, and has been all year. </span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">The data starting in the fall of 2008 show that Spanish and Italian borrowing costs declined vis-a-vis Germany through 2009, and did not start rising from negative levels until spring, 2010. The period of negative spreads in 2009-10 might make one question the ECB's numbers, or recall how German <i>landesbanken</i> </span><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">had an </span><a href="http://www.ft.com/intl/cms/s/0/1c70ef16-76d0-11de-b23c-00144feabdc0.html#axzz2A2PDxfpC" style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">unsolved problem of toxic assets and a shortage of equity capital</a><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">, while Spanish authorities were the </span><a href="http://blogs.ft.com/martin-wolf-exchange/2012/06/25/what-was-spain-supposed-to-have-done/#axzz2A3OUS6Fd" style="background-color: white; font-family: Georgia, 'Times New Roman', serif;">paragon</a><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;"> of thoughtful banking regulation. </span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">Note the recent spread levels: Italian banks have loaned euros to corporations at 100 basis points over Germany rates since December, 2011. And while Spanish corporations saw their rates rise as high as 125 basis points over German corporations in May, the first quarter was lower, and rates did not persist at that high point. Indeed,</span><span style="background-color: white; font-family: Georgia, 'Times New Roman', serif;"> the same problem from the mortgage example applies here: a 100 basis point spread is simply not wide enough to capture both convertibility risk and "individual credit risk". </span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><b>Thus these comments should not be taken as skepticism of a convertibility premium in these rates**. However, we do not think the data presented justify such a finding. </b></span><br />
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<span style="font-family: Georgia, Times New Roman, serif;">* Probably unintentional. Cf. <a href="http://en.wikipedia.org/wiki/Confirmation_bias">confirmation bias</a>.</span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span>
<span style="background-color: white; color: #222222; font-family: Georgia, 'Times New Roman', serif;">**There are aspects of the data that we do not understand. For example, initially floating-rate mortgages of all maturities are categorized as 'up to 1 year' mortgages. We do not yet know the maturities or structures of such loans, and how they can be compared across countries. This is also true for corporates. </span></div>
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gasherbrumhttp://www.blogger.com/profile/00314964555371566832noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-88529147835768872482012-10-12T10:38:00.000-04:002013-04-02T10:46:20.348-04:00Spanish Deposits<a href="http://www.bde.es/webbde/es/estadis/infoest/e0903e.pdf" target="_blank">A chart from the Bank of Spain</a> showing average rates paid on new deposits by banks in Spain through August 2012 (term and overnight). Do these rates evince a banking system desperately trying to hold onto fleeing deposits?<br />
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Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-63820147683520594152012-09-13T16:26:00.000-04:002013-03-19T17:34:01.911-04:00Loss Sharing in the Eurosystem<!--[if gte mso 9]><xml>
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<span style="font-family: Georgia, Times New Roman, serif;"><u><span style="background: white; color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">Loss Sharing between NCB’s</span></u><span style="background: white; color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">: </span><span style="font-size: 10pt;"><o:p></o:p></span></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="background: white;">
<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><b><a href="http://www.ecb.int/ecb/legal/pdf/en_statute_2.pdf" target="_blank">Article 32.4 of the ESCB Statute</a></b>:<o:p></o:p></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="background: white; margin-left: .5in;">
<span style="font-family: Georgia, Times New Roman, serif;"><i><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">The amount of each
national central bank's monetary income shall be reduced by an amount equivalent
to any interest paid by that central bank on its deposit liabilities to credit
institutions in accordance with Article 19.</span></i><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><o:p></o:p></span></span></div>
<div class="MsoNormal" style="background: white; margin-left: .5in;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="background: white; margin-left: .5in;">
<i><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">The Governing Council may
decide that national central banks shall be indemnified against costs incurred
in connection with the issue of banknotes or in exceptional circumstances
for specific losses arising from monetary policy operations undertaken for
the ESCB. Indemnification shall be in a form deemed appropriate in the
judgment of the Governing Council; these amounts may be offset against the
national central banks' monetary income.<o:p></o:p></span></i></div>
<div class="MsoNormal" style="background: white; margin-left: .5in; tab-stops: 152.75pt;">
<i><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"> <o:p></o:p></span></i></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal">
<span style="font-family: Georgia, Times New Roman, serif;"><b><span style="background: white; color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">What experts say</span></b><span style="background: white; color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">:</span><span style="font-size: 10pt;"><o:p></o:p></span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoListParagraph" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><a href="http://www.ucd.ie/t4cms/WP12_06.pdf" target="_blank">Karl Whelan</a></span></u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">:</span></span></div>
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<i><span style="font-family: Georgia, Times New Roman, serif;"><span style="background-color: white; color: #222222;">“The official legal statute governing the
Eurosystem is quite vague about the implications for an NCB of losses incurred
in monetary operations… In practice, the Governing Council of the ECB used the
defaults by Lehmans </span><span style="background-color: white; color: #222222;">sic </span><span style="background-color: white; color: #222222;">and other
banks in 2008 to clarify in a statement in March 2009 that losses should be
shared in full by the Eurosystem NCBs in proportion to their ECB capital key
shares.” </span></span></i></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoListParagraph" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><a href="http://willembuiter.com/roublezone.pdf" target="_blank">Willem Buiter</a></span></u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">:</span></span></div>
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<span style="background-color: white; color: #222222; font-family: Georgia, Times New Roman, serif;"><i>“Losses
and profits made by the ECB and the NCBs in the implementation of the
common MCL policy are shared among the NCBs in proportion to their share
in the ECB capital.” </i></span></div>
<div class="MsoNormal" style="background: white; margin-left: .5in;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoListParagraph" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><a href="http://ftalphaville.ft.com/blog/2011/05/09/563016/)" target="_blank">JP Morgan</a></span></u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">:</span></span></div>
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<span style="background-color: white; color: #222222; font-family: Georgia, Times New Roman, serif;"><i>“The losses incurred by the Eurosystem are to be shared by all national central banks in proportion to their shares in the ECB's capital.” </i></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<span style="font-family: Georgia, Times New Roman, serif;"><br />
</span><br />
<div class="MsoNormal">
<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">
<!--[if !supportLineBreakNewLine]--><br />
<!--[endif]--></span><span style="font-size: 10pt;"><o:p></o:p></span></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><b><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">Our interpretation</span></b><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">:<o:p></o:p></span></span><br />
<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><br /></span></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">Based on </span><a href="http://www.ecb.int/ecb/legal/pdf/c_08320100330en_ecb_statute.pdf"><span style="font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">the Protocol on the Statute of the
European System of Central Banks and of the European Central Bank</span></a><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"> (the legal framework for
the Eurosystem), losses borne by
an NCB are <i>not </i>automatically
shared; losses may only be shared pursuant to a capital-key weighted majority
decision by the Governing Council.<o:p></o:p></span></span></div>
<div class="MsoNormal" style="background: white;">
<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">Evidence</span></u><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><o:p></o:p></span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><br /></span></div>
<div class="MsoNormal" style="background: white;">
<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">1) <b>Plain Reading: </b>Paragraph 2
of Article 32.4 states that the “Governing Council <b><u>may</u><u> decide</u></b> that national central
banks shall be indemnified… in exceptional circumstances for specific losses” (emphasis
added). <o:p></o:p></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><br /></span>
<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">We are not quite sure
whether the use of “exceptional” in Article 32.4 is intended to refer to a
decision on loss sharing (meaning loss sharing only happens in <i>exceptional</i> circumstances) or whether it
is descriptive (meaning losses themselves could only occur in <i>exceptional</i> circumstances). Under either
interpretation the sharing happens only <b>pursuant
to a Governing Council vote</b>. In the event of a large loss such mandatory
vote could easily be anything but <i>pro forma</i>.
<o:p></o:p></span></span></div>
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<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">Article 10.3 of the
Protocol provides that for any decisions taken under Article 32, <i>inter alia</i>, “the votes in the Governing
Council shall be weighted according to the national central banks’ shares in
the subscribed capital of the ECB.”<o:p></o:p></span></div>
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<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><o:p><br /></o:p></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">2) <b>The One Public Decision to Share
Potential Losses: </b>Due to counterparty defaults in 2008, the Bundesbank,
the Dutch National Bank and the Luxembourg Central Bank seized collateral of defaulting counterparties and
faced potential losses on its disposal. The Governing Council voted that
potential losses arising from these operations should be shared (it is </span><a href="http://www.ft.com/intl/cms/s/0/30d1a26e-42b8-11e1-93ea-00144feab49a.html"><span style="font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">unclear</span></a><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"> whether or not losses
ever materialized.) </span><span style="font-size: 10pt;"><o:p></o:p></span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;">Karl Whelan claims that
this decision “clarifie[d]… that losses should be shared in full by the Eurosystem
NCBs in proportion to their ECB capital key shares.” But that understanding
is hard to square with the <a href="http://www.ecb.int/press/pr/date/2009/html/pr090305_2.en.html" target="_blank">ECB’s press release</a> on the matter. The ECB made a
specific decision in March 2009, and nothing in it supports Whelan’s argument
that they took that opportunity to clarify Article 32.4. In fact the whole
exercise suggests loss sharing is not automatic, but only enacted pursuant to a
vote (as Article 32.4 requires) after making sure, for instance, that all rules
were followed. The press release
discusses specific potential counterparties and losses; it does not contemplate
any future events or decisions. <span style="font-size: x-small;"><o:p></o:p></span></span></div>
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<u><span style="font-family: Georgia, Times New Roman, serif;">ECB Press Release:</span></u></div>
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<b><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 11.5pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">5 March 2009 - Eurosystem
Monetary Policy Operations in 2008<o:p></o:p></span></b></div>
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<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i>The year 2008 has been exceptional, also in
terms of Eurosystem’s monetary policy operations. The intensification of the
market turmoil and the changes to Eurosystem refinancing operations led to an
increased level of activity by the Eurosystem to support the financial sector
and, through it, the entire economy.<o:p></o:p></i></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i><br /></i></span>
<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i>The Eurosystem income from monetary policy
operations is expected to amount to some € 28.7 billion in 2008, higher than in
2007 (€ 23.2 billion). The income from Eurosystem monetary policy operations is
redistributed among national central banks (NCBs) in proportion to their shares
in the ECB’s capital. However, net results of individual NCBs follow different
patterns, due to the historical structure of their balance sheets, some
specific national responsibilities and national accounting practices. The
aggregate net result of the Eurosystem NCBs, including the distribution of the
net result of the European Central Bank (ECB) that they receive, is estimated
to amount to approximately € 16.8 billion for 2008. The year before, the
aggregate net result was € 15.2 billion. The result of the ECB itself for 2008
amounted to EUR 1.3 billion in 2008, compared with zero in 2007 (see today’s
ECB press release on the ECB annual accounts for 2008).<o:p></o:p></i></span></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i><br /></i></span>
<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i>At the same time, the specific circumstances
of 2008 also implied higher financial risks in Eurosystem credit operations. In
autumn 2008, five counterparties defaulted on refinancing operations undertaken
by the Eurosystem, namely Lehman Brothers Bankhaus AG, three subsidiaries of
Icelandic banks, and Indover NL. The total nominal value of the Eurosystem’s
claims on these credit institutions amounted to some €10.3 billion at end-2008.
The monetary policy operations in question were executed on behalf of the
Eurosystem by three NCBs, namely the Deutsche Bundesbank, the Banque centrale
du Luxembourg and de Nederlandsche Bank. The Governing Council has confirmed
that the monetary policy operations in question were carried out by these NCBs
in full compliance with the Eurosystem’s rules and procedures, and that these
NCBs had taken all the necessary precautions, in full consultation with the ECB
and the other NCBs, to maximise the recovery of funds from the collateral held.<o:p></o:p></i></span></span></div>
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<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i>The counterparties in question submitted
eligible collateral in compliance with the Eurosystem’s rules and procedures.
This collateral, which mainly consisted of asset-backed securities (ABSs), is
of limited liquidity under the present exceptional market conditions and some
of the ABSs need to be restructured in order to allow for efficient recovery.
Under current market conditions, it is difficult to assess when the eventual
resolution will be achieved by the Eurosystem.<o:p></o:p></i></span></div>
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<span style="color: #222222; font-family: Georgia, Times New Roman, serif; font-size: 9.0pt; mso-bidi-font-family: "Times New Roman";"><i>The Governing Council decided that any
shortfall, if it were to materialise, should eventually be shared in full by
the Eurosystem NCBs in accordance with Article 32.4 of the Statute of the ESCB,
in proportion to the prevailing ECB capital key shares of these NCBs in 2008.
The Governing Council also decided, as a matter of prudence, that the NCBs
should establish their respective shares of an appropriate total provision in
their annual accounts for 2008 as a buffer against risks arising from the
monetary policy operations which were conducted with the counterparties
mentioned above. The size of the total provision will amount to € 5.7 billion,
and it is already accounted for in the net result figures stated above. The
level of the provision will be reviewed annually pending the eventual disposal
of the collateral and in line with the prospect of recovery.<o:p></o:p></i></span></div>
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<span style="font-family: Georgia, Times New Roman, serif;"><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">3) No ECB </span><span style="font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";"><a href="http://www.ecb.int/ecb/legal/html/index.en.html">decisions</a> have codified that losses are to be shared in the future</span><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">. Some decisions have referred to the sharing of monetary income and have periodically
updated the calculation of monetary income. In </span><a href="http://www.ecb.int/ecb/legal/pdf/l_33920091222en00550057.pdf"><span style="color: #1155cc; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">December 2009</span></a><span style="color: #222222; font-family: Arial; font-size: 10.0pt; mso-bidi-font-family: "Times New Roman"; mso-fareast-font-family: "Times New Roman";">, the ECB decided that
NCB’s should not suffer a hit to their monetary income when interest bearing
loans to counterparties are transformed into non-interest bearing claims
against the defaulted estate. <o:p></o:p></span></span></div>
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<!--EndFragment-->Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-79720879389041450562012-08-01T14:25:00.001-04:002012-08-01T14:40:03.303-04:00Fixing "Unsustainable" Rates in Spain/Italy: Subsidize Rates Instead of Buy Bonds #2Since our post from yesterday we have been made aware of two similar proposals:<br />
<br />
<a href="http://ftp.zew.de/pub/zew-docs/policybrief/pb01-12.pdf">http://ftp.zew.de/pub/zew-docs/policybrief/pb01-12.pdf</a><br />
<br />
<div class="p1">
<span class="s1"><a href="http://www.voxeu.org/article/euro-coupons-mutualise-interest-payments-not-principal">http://www.voxeu.org/article/euro-coupons-mutualise-interest-payments-not-principal</a></span></div>
<br />
<br />Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com0tag:blogger.com,1999:blog-4360130099110594711.post-43188219832971386322012-07-29T23:38:00.003-04:002012-07-30T23:12:24.729-04:00Fixing "Unsustainable" Rates in Spain/Italy: Subsidize Rates Instead of Buy Bonds<span style="background-color: white; color: #222222; font-family: arial, sans-serif; font-size: 13px;">This approach has vastly lower risk, better conditionality, and conserves resources for a real emergency.</span><br />
<br />
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
If Spain/Italy yields are "unsustainable" because they are 3% too high, then just pay the 3% from EFSF/ESM/EU as a subsidy and let them finance in the market. </div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
To avoid risk of having to pay very high subsidies, the EFSF/ESM/EU can backstop bond auctions at, for example, 9%. </div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
<br /></div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 13px;">
<b><span style="font-size: medium;">Benefits</span></b>:</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- <b>Vastly reduces risk</b>: Instead of holding large credit positions, the cost of this subsidy for €300bn of debt would be €9bn/year, but <i>only for as long as the market misunderstands</i> that Spain/Italy are better credits. The cost of subsidizing €2 trillion of debt is the same as the cost of EU agriculture subsidies. </div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- <b>Reduces pressure on Target2</b> creditors since they don't have to assume this additional risk.</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- <b>Conditionality works much better</b> since Europe dispenses the benefit over time instead of up front. </div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- Highlights how small are amounts that are claimed to cause unsustainability.</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- <b>Eliminates subordination risk.</b></div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- <b>Retains market information</b>, which is the first step to appreciating that information. </div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
---- Perspectives would have changed had it been shown that Spain could have financed the €100bn for bank capital in the market. The suggested approach allows this to be attempted without risk of disaster.</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
---- The market is often wrong, but should not be dismissed. When the market appears wrong, it's a good exercise to try to figure out why it might not be. Analysis of Greece would have benefited from this; same for Spain. Destroying this information makes it impossible to consider it.</div>
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<b><span style="font-size: medium;">Variations</span>:</b></div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- Subsidy could be repaid as subordinated debt or ordinary debt.</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- Subsidy could be repaid as GDP-linked debt</div>
<div style="color: #222222; font-family: arial, sans-serif; font-size: 12px;">
- If the auction is bought at 9% pursuant to the backstop, the subsidy is zero. </div>Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-4360130099110594711.post-83559385514581070952012-07-25T09:42:00.000-04:002012-07-25T10:08:10.934-04:00"Spain to struggle to fund 2012 debt crunch"<div class="separator" style="clear: both; text-align: center;">
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<a href="http://www.reuters.com/article/2012/07/25/us-spain-treasury-idUSBRE86O08I20120725" style="text-align: -webkit-auto;" target="_blank">The headline of a Reuters story.</a><span style="text-align: -webkit-auto;"> Hard to square with the following chart (which includes 2012 data through May).</span></div>
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<a href="http://4.bp.blogspot.com/-wER77vdwXzE/UA_3YsGwRWI/AAAAAAAAASU/vXHowMrO_OM/s1600/Spain%2Bdebt%2Bavg.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="424" src="http://4.bp.blogspot.com/-wER77vdwXzE/UA_3YsGwRWI/AAAAAAAAASU/vXHowMrO_OM/s640/Spain%2Bdebt%2Bavg.png" width="640" /></a></div>
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Source: Spanish Treasury</div>Unknownhttp://www.blogger.com/profile/03898545354202501806noreply@blogger.com1