Europe's Bank Faces Pressures

01.02.2012 10:32

WSJ: FRANKFURT—The European Central Bank, Greece's biggest creditor, is finding it hard to stay on the sidelines as Greece negotiates a debt-restructuring deal with its private-sector bondholders.

The ECB isn't part of the talks, even though it holds around €50 billion ($66 billion) in Greek government bonds, about one-seventh of Greece's outstanding debt. Those holdings raise questions about the central bank's appropriate role in keeping Greece afloat that will linger even if a deal with other investors is completed this week.

Comments by a top European policy maker on Tuesday underscore the pressure the ECB faces.
"We must as far as possible bring to an end the negotiations with private creditors by the end of the week," Luxembourg Prime Minister Jean-Claude Juncker said in a radio interview. "Thereafter we can consider whether others need to be ready to provide further assistance," he added, echoing comments made last week by International Monetary Fund head Christine Lagarde. Outside the private sector, Greece's main lenders are other European governments, the ECB and the IMF.

The ECB started purchasing Greek bonds in 2010 at distressed prices when Athens first appeared headed toward a messy default. Those bonds are on the ECB's books at near the price it paid for them, meaning the ECB stands to make billions of euros in profit if it redeems them at full value when they mature.

That has led to suggestions that the ECB help repair Greece's solvency by putting its Greek bonds on the table as part of an overall funding deal. Negotiations between private-debt holders and the Greek government are centered on a write-down, or haircut, of as much as €100 billion. Greek Prime Minister Lucas Papademos says he expects a bondholder deal to be reached this week, although deadlines have come and gone before.

The ECB also bought Portuguese and Irish government bonds in 2010 and early 2011 before expanding the program in August to include Spanish and Italian debt. It has purchased a total of €220 billion in government bonds, which are held on the books of the Frankfurt-based ECB and the 17 national central banks that make up the euro.

ECB officials refuse to take part in any voluntary restructuring. Doing so, officials say, would violate the ECB's charter, which forbids it from financing governments. The central bank legally justifies purchases as a way to ensure that its interest-rate and bank-lending programs transmit smoothly through financial markets and into the economy. Agreeing to take a loss would be hard to justify on those grounds.

Officials at the central bank concede there is no easy answer. One option is a coercive default that includes all of Greece's creditors, public and private. That would shield the bank from the charge that it is going easy on Athens because the ECB would be forced to comply. But it would also strengthen the hand of bond-buying opponents within the ECB, who believe buying bonds was always a bad idea and should be scrapped altogether.
A Greek default could lead to an even-worse investor flight from Portugal and other indebted euro members, which the ECB might struggle to contain. If euro-zone central banks can't absorb losses with other income, then governments would need to recapitalize them.

Another option under consideration is for the ECB to sell Greek bonds to Europe's bailout fund for what it paid for them. That could shave about €10 billion or more off Greece's debts.

"The best option would be for the ECB to say it wants its nominal investment back, and that is the price [at which] they should sell" to the bailout fund, said Daniel Gros, director of the Centre for European Policy Studies, a Brussels think tank.

Mr. Gros's suggestion has drawbacks, too. Taxpayer funds would have to be used to buy the bonds, which would incur resistance in some European capitals. Ireland and Portugal, which are also struggling under harsh austerity measures as conditions of their own bailouts, might want to see their debt written down as well, analysts say. That would eat up even more bailout resources.

"I don't see why the ECB should [forgo] a profit on Greek bonds but then make a profit on Portuguese bonds," said Christian Schulz, economist at Berenberg Bank. "The ECB doesn't want to be seen as helping Greece because other countries could demand the same treatment."

A successful private-sector deal would buy time for the ECB to rethink its bond-buying program more broadly. The bailout fund, like the ECB, can purchase government bonds in secondary markets. It hasn't started do so, but if it does that could make the ECB's program unnecessary.

The ECB doesn't need to take formal action to alleviate Greece's bond burden. National central banks hand their profits over to their respective governments, although they keep some for capital buffers. The Bundesbank distributed €2.2 billion to Berlin in 2010. It was twice that the previous year. Governments could simply decide that profits they receive from Greek bonds be earmarked for Athens.

"The ECB could say is it's up to the shareholders on what to do with the profits," said Mr. Schulz.

Write to Brian Blackstone