Friday, January 24, 2014

The Bundesbank versus the ECB

A wide-ranging interview in The Irish Times today with current Bundesbank president, Jens Weidmann, offers the following:

Derek Scally: The euro zone door to debt write-downs, now open, was held closed by ex-ECB president Trichet for Ireland. Does this argument hold water here?

Jens Weidmann: A The Governing Council then was weighing bail-in versus financial stability risks, and its majority concluded that the latter were more relevant under the concrete circumstances. In that debate the Bundesbank has always considered it important to make investors bear the risks of their investment decisions and already then favoured contributions of investors in the event of solvency problems, especially for banks that are to be wound down. Our common goal is to be able in the future to wind down banks without endangering financial stability.

In 2010 Weidmann was head of Economic Policy in the German Chanellor’s Office of Angela Merkel so this view of the Bundesbank was relayed to him at some stage.

We know that at the time of the negotiations surrounding the EU/IMF programme that burden sharing with the €6 billion or so of senior unsecured (and unguaranteed) bonds that remained in Anglo Irish Bank and Irish Nationwide was  “raised” by then Minister for Finance, Brian Lenihan.

The view expressed by Weidmann today differs from that offered by another German official.  In November 2010, Jorg Asmussen  was a deputy finance minister in the German government but in early 2012 he was appointed to the ECB Executive Board and sat on the Governing Council.  He was in Dublin in April 2012 and delivered a speech which included this:

I know that the decisions concerning the repayment of bondholders in the former Anglo Irish Bank have been a source of controversy. Decisions taken by the Irish authorities such as these are not taken lightly. And the consequences of subsequent actions are weighed carefully. It is true that the ECB viewed it as the least damaging course to fully honour the outstanding senior debts of Anglo. However unpopular that may now seem, this assessment was made at a time of extraordinary stresses in financial markets and great uncertainty. Protecting the hard-won gains and credibility from the early successes in 2011 was also a key consideration, to ensure no negative effects spilled-over to other Irish banks or to banks in other European Countries.

When speaking both Weidmann and Asmussen are giving the views of their employer.  At the time of the decision in November 2010 they did not work for the Bundesbank or the ECB.  The views from with their employers at the time (the German government/civil service) would also be interesting.

If the Bundesbank had German interests at heart why would it favour imposing losses on creditors in failed Irish bank thereby exposing German banks to possible losses?  The answer is that German banks never really had a huge direct exposure to the ‘covered’ Irish banks and it was close to zero even before the end of 2007 (three years before the above mentioned discussions).  See this research letter from the Central Bank.

Funding Profile

There have been indirect exposure through the operations of German banks based in the UK but it can be clearly seen that by far the greatest source of the massive external funding used by the ‘covered’ banks was London.

Finally, in this question Weidmann hints that the Promissory Note swap might be a concession to compensate for the decision to force the repayment of the €6 billion of Anglo/INBS unsecured senior bonds in November 2010 (emphasis mine).

David Scally: Was a line crossed that has brought the ECB into a position of political dependency?

Jens Weidmann: As you know, I viewed this transaction with great scepticism. At the end of the day, the central bank (of Ireland) largely has the debt on its books and is refinancing it at the main refinancing rate. This transaction is a blurring of monetary and fiscal policy that, from my perspective, risks being perceived as monetary financing. If the impression arises that monetary policy is handling fiscal problems, this would bring central banks into a situation where monetary stability is dominated by fiscal policy. Some might consider the transaction as a kind of a compensation for the Irish support to its banking system, but in my view such transfers should not be the business of central banks.

A 66% haircut on the €6 billion of bonds would have generated around €4 billion of savings which is a possible figure that arises if one tries to estimate the interest savings from the Promissory Note swap.

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