Tuesday, 13 December 2011

Smart interpretations of a Treaty and debt management

If you have followed the debate on the ECB as a lender of last resort you probably came across Article 123 of the Lisbon treaty. Article 123 prohibits the ECB from purchasing bonds directly from public bodies. Paragraph 1 says:

1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

However Paragraph 2 allows the ECB to purchase bonds from a public bank.

2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.

(Paragraph 2 was the basis of Soros proposal to transform the ESF into a bank in order to have access to the ECB liquidity. The proposal was rejected.).

Now the key question is who qualifies as a "publicly owned credit institution" described in paragraph 2? At first sight the German Finance Agency (Finanzagentur) qualifies (any one can confirm?). Finanzagentur auctions german debt, through the Buba, using a retention mechanism. The retention mechanism, that came in the highlights with the last November Bund auction, allows Germany to use "the sale of German Government securities in the secondary market that stem from the portions set aside in the auctions" to meet borrowing requirement. According to the Corriere della Sera, the Italian treasury already expressed interest in the retention mechanism as it permits a less risky debt management (if you check the graphs below, you will notice that the last bund auction, where 40% of the bonds have been retained has commanded an average yield of 1.98% when the coupon offered was 2%). Other euro governments might want to follow as well.

(click to enlarge)


  1. Hello,

    I have a slight off-topic question for the experts here. I recently ran into Kyle Bass' Dec 14th Hedge Fund letter to his clients wherein he posts a graph in the second page suggesting that Portuguese (PIIGS M1) (physical currency+chequing accts+saving accts) were showing a declining trend of 8 to 10% in 2011.

    I interpret this contraction to mean that the 'smart' money is leaving the country likely out of concern for all kinds of nighmarish scenarios possible in 2012 (bank runks, government insolvency, default, etc - use your imagination here).

    My questions are three fold:
    1) Is Mr. Bass' chart on page 2 accurate?
    2) If so, what's your interpretation of it? If not, can you refer me to where I can find inflow/outflows of Portuguese banks, or even just the M1 aggregate?
    3) What are you advising your families living in Portugal with significant savings in Euros to do with their money at this time?

    Much obliged,

    PS. I should note that Mr. Bass turned into a highly successful hedge fund as a result of his betting on the US housing collapse before it occured. You can also watch a recent (Nov 2011) 1 hour Youtube interview session with Mr. Bass here.

  2. http://www.ecb.int/ecb/legal/pdf/en_dec_2010_5__f_sign.pdf?72ecc796378cbecb07fbfbb93e3d7110

    Framework for ECB Bond purchases.

    Neither Finanzagentur nor any EZ government agency can sell Bonds to the ECB directly.
    Retention is a smart mechanism for price stabilization after debt placements, also used in private sector benchmark issuances.

  3. @ Buica

    I am sorry but I really do not see how your link is related to the post. Beyond the fact that it says bond purchases. Further, that retention is a smart mechanism, I obviously agree as I have used the epithet in the title of the post. Finally, can you explain on what balance sheet the retained debt is accounted?

  4. I agree with the underlying argument about retention. But the ECB is the lender of last resort for banks, not governments. Even if it's buying public debt every day within the framework of the link provided.
    Balance sheet? On the agency's I guess, but don't see the relevance...

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  6. Francesco, excellent point. Issue is really with retained portion of auction, as you point out. On whose balance sheet does it remain and for how long?

    Nonetheless, this feature does seem to offer the german government some significant advantages when selling debt.

  7. I own a restaurant in the Algarve, and have been reading this blog and other articles to try and guage the effect on the economy. I am not an economist but have some basic understanding on finincial issues. Can someone tell me if Portugal is in a worse state than Greece with reasons to justify the position. Also if one exit´s the euro will the other follow. Thank You.

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  9. Francesco, excellent point. Issue is really with retained portion of auction, as you point out. On whose balance sheet does it remain and for how long? non profit debt settlement