Saturday, February 9, 2013

What’s next on our agenda with the ECB?

Patrick Honohan’s recent appearance at the Oireachtas Finance Committee included the following exchange.

Deputy Kevin Humphreys:  “The ECB purchased significant amounts of distressed euro sovereign debt in the secondary bond market in 2010 and 2011 through the security market programme. I understand that approximately €200 billion worth of bonds are being held to maturity. It is estimated that between €15 billion and €20 billion of Irish bonds were bought, mostly at distressed prices well below par.

The Barclays Capital report of January 2012 stated that about €19 billion of Irish Government bonds were being held by the ECB. Is that the correct sum?

We heard a lot about how Franklin Templeton made huge returns by buying Irish bonds at low prices. It is difficult to estimate the profits the ECB will make on the capital proportion of these bonds bought through the SMP but it could be in the range of €3 billion to €5 billion. The problem is, and I asked about this in private session before and was given short shrift, we do not know what the ECB profits may be because the ECB will not tell us. The Governor sits on the board, however, so does he know and will he tell us?”

Patrick Honohan:  “I know how much Irish paper is held by the ECB in the security market programme. I could try to calculate the profits.”

Kevin Humphreys:  “Am I far off in my calculations?”

Patrick Honohan: “I would steer the Deputy away if I thought he was. I think that more information about the SMP holdings will be provided. The SMP has terminated as a programme and the reasons of market sensitivity that caused it not to be disclosed would fade away. At present, however, I am not at liberty to give out those numbers.”

Here is the set of Irish government bonds that was in issue around the time the Euro System of Central Banks (the constituent elements of the ECB) were making these purchases under the Securities Market Programme in the second half of  2011.

It is likely that the ECB purchases were focussed on the short end of the market.  The first two bonds on the list have been redeemed.  The next on the list is the bond maturing on the 18th of April coming.  A bond swap last July reduced the amount outstanding on this bond which now is just over €5 billion.  The ECB are likely to be significant holders of this bond and also of the remaining €8 billion of the January 2014 bond.

The November 2012 Eurogroup meeting included the following agreement:

A commitment by Member States to pass on to Greece's segregated account, an amount equivalent to the income on the SMP portfolio accruing to their national central bank as from budget year 2013.

Can we get this too?


  1. I think, given the Pringle judgement, that they'll not want to repeat this by passing back all the profits indirectly.

    But to ask the States whose borrowing costs do not exceed the price at which they lend to us would, I think be preferable. So leave Italy and Spain with their share (other PIIGS have stepped out of EFSF) but ask the non PIIGS to not profit from our pain.

    Subtle difference from Greece and less damaging for an OMT precedent.

    Accept that since theory of OMT/ SMP is redomination risk the ECB should be able to profit, and should be able to pass that profit to members pro-rata their share. But in the spirit of solidarity those States benefiting from redenomination risk should pass their share of profits back to those suffering from that risk.

  2. There is a very fundamental issue of principle involved here for the EZ. What was the purpose of the intervention? Was the ECB taking a gamble on behalf of the EZ or was it intervening to support a member State. Tat is the key issue.
    Most people will contend that the intervention was to support a member State and that to hold onto any resulting profits or 'windfall', runs totally contrary to the stated spirit of the intervention.
    There should be no equivocation on this issue. Ireland or any country should be allowed to buy back the bonds at ECB intervention price, less a very small handling fee, if their situation allows it.

    If the ECB makes profits on an intervention to support a particular State's bond, on what basis does it argue that such a profit is the collective profit of the EZ.
    If the ECB is allowed to retain the profit, well then it may as well start trading in the market to make a profit.

    1. The risk that the bond yields had moved in the opposite direction was taken by the purchasor, the ECB, on behalf of all Eurozone states.

    2. @Meself

      But the pain associated with ensuring that the bond yields did not go in the opposite direction, was a pain suffered by the citizens of Ireland, not a pain suffered those of the all the EZ, with the ECB acting as a pretty ruthless administrator of that pain, thereby enhancing its odds of a win on the gamble.

      Either way, that is not the point.
      The question is whether it is equitable that any European institution, holds onto windfall profits made on the bonds of a member country, based on a market intervention, a market intervention disallowed to that same member State.

  3. The Euro area bank resolution mechanism will be via the ESM which will be initially funded by non-ECB finance, real money, from Euro member states. Real money, that is, that the member states will wish to have returned to them. Or, at least, the member states might be happy enough to leave the initial funding on medium-term hold as long as the costs thereafter were being borne by the bank resolution mechanism itself. Consequently, the bank resolution mechanism will work best (and will pass the political hurdles) if, as far as possible, it can function over time on a break-even basis. All income streams will be welcomed, including transfers (conforming to rules) from the ECB. (Another good source might be capital gains from equity held in distressed banks.) On that basis, profits arising from the Securities Market Programme would be a neat revenue source for the bank resolution mechanism. Furthermore, if the EU honours Ireland's 'special case' status, the start-up date for resolution would be September 2008 and the Ibrc would be in the mix. A further neat step would be to allocate the profits arising from the Securities Market Programme, $3-5bn, to the Ibrc. I would prefer the allocation going there, a loss-making bank, than to the 'viable' banks which I consider will generate a gain in the medium-term.