Their capacity to shock and awe markets
will not occur in one day, but over time.
Thinking about the European Central Bank buying bonds. What it is buying is bonds in the secondary market, from what I can see. No money being lent directly to, in this case, Spain and Italy. Instead, buying the bonds that are already out there, where people (or, more precisely, institutions, particularly financial institutions) hold so much and are concerned about repayment, that they won’t lend any more. In fact, they are so tied up with these bonds that they can’t raise any new cash to lend anyway. So the European Central Bank buys the bonds from them, giving them more cash to lend…to the same countries that were having difficulties paying in the first place.
At the same time, the European Central Bank is concerned that the European Union bailout fund is not doing what it was supposed to do–buy the bonds in the secondary market. The risk is assumed therefore by the European Central Bank, rather than by the richer member states of the European Union, contributing more to the bailout fund. Which is worse?
The fact remains that these countries cannot repay their existing debt and are being set up to simply borrow more, where the European Central Bank’s actions mean that Spain and Italy won’t have to borrow at the higher rates that would otherwise be reflected in increased debtor risk. Why? Because the risk of default on the earlier bonds is now assumed by the European Central Bank.
Something tells me that this is doing little but defer the inevitable, and dragging down more in the process. Maybe I am missing something, as usual, though here is the Wall Street Journal article, featuring the comments of people more knowledgeable.
ECB Buys Italy, Spain Bonds, Easing Fears
Wall Street Journal, August 8, 2011
By BRIAN BLACKSTONE and CHARLES FORELLE
FRANKFURT—The European Central Bank delivered on its promise to purchase Italian and Spanish bonds on a large scale, calming investors who had grown increasingly worried that euro-zone leaders might sit idly by while the debt crisis engulfed Spain and Italy.
Government bond yields of Spain and Italy plunged Monday, as did their yield spreads over safe German bonds. Italy’s 10-year bond yield fell to around 5.3% from just over 6%. Spain’s fell even further, to 5.15%.
The ECB bought those countries’ bonds for the first time since creating its debt-purchase program 15 months ago, said traders. The ECB didn’t say how much it bought or confirm what bonds it purchased, but estimates range from around €3.5 billion ($5 billion) to as high as €5 billion. In an interview with German broadcaster ZDF on Monday, ECB President Jean-Claude Trichet said the central bank’s actions “undoubtedly were significant,” and necessary to ensure that its interest-rate policies functioned smoothly.
Even €5 billion is a “drop in the ocean” compared with the size of Italy and Spain’s bond markets, said Ciaran O’Hagan, fixed-income strategist at Société Générale. “Their capacity to shock and awe markets will not occur in one day, but over time,” Mr. O’Hagan said.
The ECB’s purchases of Italian and Spanish bonds were no help to European equities, which tumbled along with the rest of the global markets Monday. Bourses in London, Paris and Frankfurt all traded lower; German and French indexes each shed more than 4%. Even the Italian and Spanish markets, each of which had initially seen a lift into positive territory from the ECB’s weekend announcement, were hit. Milan ended the day down 2.3%; Madrid was off 2.4%. The Athens stock exchange fell 6% to its lowest level in more than 14 years.
The ECB said late Sunday it would “actively implement” its bond program, which was reactivated late last week after a four-month hiatus. The ECB only bought Irish and Portuguese bonds last week.
There was some good news in Europe this morning as the ECB agreed to purchase Italian and Spanish bonds. Although it has not solved any long-term issues, it has temporarily moved the countries away from the brink of bankruptcy.
Officials were unwilling to commit to wider purchases at the time, wanting assurances from Italy and Spain that they would accelerate austerity and reform measures, and from other euro-zone governments that Europe’s crisis fund would be able buy bonds in the next few weeks. With those pledges in hand, ECB officials were ready to move into new territory: buying bonds of the euro bloc’s larger countries.
Italy and Spain, the region’s third- and fourth-largest economies, have a combined gross domestic product of nearly €2.7 trillion, almost 30% of the euro zone total. Royal Bank of Scotland economists estimate the ECB and Europe’s bailout fund will eventually have to own €850 billion of Spanish and Italian bonds to safeguard those countries.
“I can’t imagine they’re going to be willing to put up the amounts of the money the markets would want to prop up Italy and Spain, it would have to be hundreds of billions of euros,” said Raoul Ruparel, an analyst at Open Europe, a London-based think tank. Data on Monday brought an illustration of just how strained markets had become in the run-up to the ECB’s intervention. Italian commercial banks doubled the amount of money they borrowed from the ECB last month to €80 billion, reflecting the difficulty they had tapping interbank markets for short-term cash.
Among the issues rattling traders and mitigating the ECB’s moves was the emergence, again, of fractures among the leading euro-zone countries over how big to make their own bailout fund. The ECB has made clear it is a reluctant crisis fighter; the central bank has long viewed that the primary responsibility for dragging weak euro-zone countries out of their fiscal mire rests with the taxpayers of the strong countries—not with it. Sunday’s statement from Mr. Trichet said the bank’s governing council “considers fundamental that governments stand ready to activate” the bailout fund to buy bonds in the secondary market, in other words, to take over what the ECB is now doing. In a joint statement Sunday, France and Germany said they are ready to give the rescue fund that power—by the end of September.
But a crucial issue remains unresolved: How much the fund should be empowered to spend. No one knows for sure what quantity of secondary-market buying will be necessary to calm nerves and ensure that Italy and Spain are able to raise money from financial markets. Several analysts said Monday the sum was likely to be hundreds of billions a year—an amount beyond the fund’s current capacity. That is currently around €250 billion, though the governments have promised to raise it to €440 billion soon. France’s finance minister, François Baroin, said in a radio interview Monday that it could get even larger. “If we need to go further, we will go further,” he said.
Germany doesn’t share that view. The bailout fund “will remain what it is,” Christoph Steegmans, a spokesman for Chancellor Angela Merkel, said Monday. Since last spring, Ms. Merkel has pushed Germany further into the role of euro-zone rescuer than she had initially wanted, and her political support is weakening.
The debate over the size of the fund, and its purchases of bonds, is fundamental. Italy is too large for the current fund to rescue, but a significant enlargement of the fund will pressure the credit quality of Germany, France and the euro zone’s four other triple-A borrowers, who are backing it.
A tripling of the fund, as some analysts suggest, would mean a contingent liability of equal to 20% of the aggregate GDP of the six triple-A countries.
European policy makers hope the bond purchases will shore up investor confidence in Italy and Spain, safeguarding the countries’ ability to finance themselves on private markets without public assistance.
But the mere establishment of the euro-zone bailout fund, in May 2010, was supposed to calm the crisis engulfing Greece. Many EU leaders said it would never actually need to be used. Now, the debate is what to do if it runs out.
—Bernd Radowitz, William Horobin and Neelabh Chaturvedi contributed to this article.
Write to Brian Blackstone at firstname.lastname@example.org and Charles Forelle at email@example.com