Guest Post: Mystery Solved: ECB Can’t Afford The Greek Barber Shop

Tyler Durden's picture

Submitted by Alex Gloy of Lighthouse Capital Management

Mystery Solved: ECB Can’t Afford The Greek Barber Shop

Whenever you come across a mystery in finance there always is an explanation. Like the question why the ECB would so ferociously resist any “haircuts” on Greek debt. Despite all the evidence that current debt, now expected to peak at levels exceeding most calculators’ capacity, is unsustainable.

Why would the ECB, the largest single holder of Greek debt, not set an example by accepting the 21% haircut orchestrated by the banking lobby in July? (In order to still reach the 90% acceptance rate, the ECB was simply to be excluded from the calculation). Instead, the ECB promised Sodom and Gomorrah in case of a haircut (“Greek restructuring would be a disaster” – ECB’s Bini Smaghi, July 20th).

According to this chart, the ECB holds (nominal) EUR 55bn out of a total of roughly EUR 350bn of Greek debt:

Now they didn’t buy it at par (100%), but, let’s say, at 70% or EUR 38.5bn. A 50% haircut would reduce the value to 50%, at a cost of EUR 7.7bn. And this is only Greece (the ECB has other fine bonds on its books; EUR 165bn in total). Marked-to-market, losses would be much higher.

Problem is, the ECB has only EUR 5.3bn in equity. Here’s the balance sheet at the end of 2010:

Source: ECB 2010 annual report

(By the way, 5.3bn equity supporting 163bn in assets makes for 30x leverage).

By the end of 2010, the situation (due to unrealized losses on PIIGS bonds) was so dire the ECB had to ask national central banks (NCBs) to double its equity to 10.7bn effective 12/29/2010. However, not all NCBs could or would afford their share, and so the payment was stretched over three years (as seen in those “three easy low payments” commercials). Only 1.1bn was paid in a first installment, the remainder due at the end of 2011 and 2012 respectively.

To make matters worse, the non-Euro NCB’s (among them the Bank of England) are not liable for any losses the ECB incurs (since they are not entitled to share any profits, for example from seigniorage, either). That would explain why some NCB’s were not too keen on coughing up the big dough at once.

The ECB is basically bankrupt and would need to ask NCB’s (and those in turn their governments) again for more capital. This would create lots of cheer as governments are already struggling to protect their ratings from falling.

Governments could try to extract concessions from the ECB in return for recapitalizing, endangering the little independence and credibility that is left at this stage.

Hence the ostrich strategy: pretend the Greek bonds are worth what they were purchased for (and the ECB’s equity is still there). And this explains the ridiculous fight against allowing Greece a fresh start.

Maybe it’s time to pull a “Jordan” and claim that negative equity doesn’t really matter for a central bank (“Does the Swiss National Bank need equity” – Thomas Jordan, Vice Chairman of the Governing Board of the Swiss National Bank, speech in Basel 9/28/2011: http://www.snb.ch/en/mmr/speeches/id/ref_20110928_tjn/source/ref_20110928_tjn.en.pdf).

Somehow, accounting tricks are not explained in the ECB’s educational material for students:

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Azannoth's picture

the ECB promised "Sodom and Gomorrah" hey I am IN! in S&G they always have the best parties

baten's picture

Show me the MONEY!!!!!

eaglefalcon's picture

bring on the end already and show us the money (shot)

Zeroexperience2010's picture

There is a point this article doesn't take into account: the ECB uses MARK TO MARKET FOR GOLD. This means, as the EUR looses 'value' due to printing or other, the gold holdings will increase in value on the balance sheet.

Popo's picture

Once again, we see that the powers that be are only interested in protecting themselves.  All other policy discussions are a charade.  

Greek "austerity" is just another way of saying "better them than us".

The Greeks should give the ECB the finger and thank them for playing.

It should also be said that the entire investing world is desperate for a 'growth story'.  Want a growth story?  Be the first to exit unscathed from the Euro fiasco,  reset to "New Drachma" (or whatever) and create a pro-investment climate.

In 3 years the Greeks would be laughing at poor Europe.

All it takes is a set of balls.

Mentaliusanything's picture

Bad Popo Bad boy.

Balls and Greeks - EUuuuuuuuuuuuwwwwwwww

Gene Parmesan's picture

But does someone else step in where the ECB has stepped aside? The IMF? Is this just a way for the eurocrats to get the US in on paying the bar tab?

oogs66's picture

the ECB is same as EFSF except that the liabilities are joint and several, so when the capital calls come, it will all be Germany

buzzsaw99's picture

yeah the ecb & efsf seem to be heading the same way, leveraged toxic waste dump. i don't think the size of the ecb's bazooka is the problem here, but rather everyone knows the assets stink so they balk at the prospect of being stuck with the old maid. ultimately germany's credit rating is all the eurotards have so they would love for the usa to buy that crap. bunch of pussies imo.

Ghordius's picture

sorry, you might be right re EFSF, not on the ECB

a CB like the ECB does not need to be bailed out, ever - per definition

it pulls itself by the strings of it's shoes - it's called currency inflation

--------

and the game in town is still "who prints less then the others" - ECB winning at the moment, thanks to it's "evil twin" EFSF

and the EURUSD is still under the effect of gravity - toward 1.425 (my very humble estimate)

DaBernank's picture

In the longer term, if the ECB prints, then Germany is out, if the ECB doesn't print, most everyone else will leave. They will balance somewhere in between for some time until common currency becomes unworkable. My thesis is that nationalism will make this discussion irrelevant, I mean, things haven't even gotten bad yet and people are rioting.

HD's picture

If you're part of the 1% and the rules are not in your favor - just ignore them, manipulate them or in a pinch, just change them...

If you're part of the 99% - you should just get used to the pressure of the jackboot on your neck.

Ghordius's picture

society never had a conflict between the 99% and the 1%

society always had a conflict between the 80%, the 19.9% and the 0.1%

now banksters are the "new kid in the block" and make this old mess even messier

Crash N. Burn's picture

 This will make you feel better, banksters are pissed at Oblahma "support" of Occupy Wall Street.

http://worldwideponzicollapse.blogspot.com/2011/10/banks-pissed-at-democ...

HD's picture

What does Obama have to lose? Not like Wall Street was going to support him in 2012 anyway.  I bet if Obama had to do it all over again he would have nationalized Citi and BOA.

jeff montanye's picture

depends on who is the republican nominee.  if it's ron paul obama gets plenty wall street support.  

HD's picture

Agreed, good point.  But, and forgive me fellow ZHers but Paul has a snowball chance in hell. Paul has a nasty habit of telling the truth and that has never been a path to the white house.

Crash N. Burn's picture

From the video - Obama has already raised $3.9 million from the "financial services industry", Romney has raised $7.5 million.

HD's picture

Did they at least tip the Godfathers pizza guy?

moneymutt's picture

If he was polically smart he would have nationalized them because then he would not have had taxpayers fund people spending massive money on lobbying against him, contributing to negative campaigns against...if your companies are bankrupt, the upper management fired, and they armpit into receivership, the lobbying and campaign and PAC contributions stop. What did he have to lose, 40 percent of the country already thinks he is a pinko commie who has somehow taken over evrpery private business in the country, he lost the house to Repubs in 2010 anyways, and Republicans refuse to support any of his legislative proposals, even when they promoted some of these policies 6 months before.

Instead, he thinks he is doing right thing, propping up banks, because Summers told him he should do it.

Cantor said publicly that Wall Street had buyers remorse about giving campaign donations to Dems in 2008 and bragged how easy it was for Repubs to raise money from Wall Street now, ....so if what Obama and Dems did in 2009 and 2010 bothered Wall Street so much and they lost their WS big daddies anyways...why not get out a can of populist whoop arse and at least appeal to general voters. Instead Obama is stuck in Clinton era when it was good to bow to banks, sign the bill that deregulated banks that Dorgan corrected predictable would lead to risk and huge bailouts ten years....it worked for Clinton because he got the front end of good times based on risk, and got the WS money...but Obama is stupid to think that will work now....but he is captured by banksters like everyone else

moneymutt's picture

If he was polically smart he would have nationalized them because then he would not have had taxpayers fund people spending massive money on lobbying against him, contributing to negative campaigns against...if your companies are bankrupt, the upper management fired, and they armpit into receivership, the lobbying and campaign and PAC contributions stop. What did he have to lose, 40 percent of the country already thinks he is a pinko commie who has somehow taken over evrpery private business in the country, he lost the house to Repubs in 2010 anyways, and Republicans refuse to support any of his legislative proposals, even when they promoted some of these policies 6 months before.

Instead, he thinks he is doing right thing, propping up banks, because Summers told him he should do it.

Cantor said publicly that Wall Street had buyers remorse about giving campaign donations to Dems in 2008 and bragged how easy it was for Repubs to raise money from Wall Street now, ....so if what Obama and Dems did in 2009 and 2010 bothered Wall Street so much and they lost their WS big daddies anyways...why not get out a can of populist whoop arse and at least appeal to general voters. Instead Obama is stuck in Clinton era when it was good to bow to banks, sign the bill that deregulated banks that Dorgan corrected predictable would lead to risk and huge bailouts ten years....it worked for Clinton because he got the front end of good times based on risk, and got the WS money...but Obama is stupid to think that will work now....but he is captured by banksters like everyone else

Lady Heather...UNCLE's picture

bankers aren't pissed really...it's all a front Obama is playing the part the banksters have told him to play

jeff montanye's picture

true.  his greatest skill is lying convincingly.  however that works best once per mark.

asdasmos's picture

Anyone else think this is all a headfake to draw the FED in to bail them out?

Draw the rumours out long enough to worry the FED officials...

Mentaliusanything's picture

In Austraaaaalia, Juliar said we won't Help Europe even if on bended knee she be asked.

Reason being Juliar spent it all up to and including anything not nailed Down after levering up

Now in Europe's time of need (for cash)I think its the Patrotic duty of All Americans to get back to 1942 and Help the children out. (a Fucken gan)

Opps my bad

Uz as broke as a $2.00 watch droped in wet water.

My Guess is New Zealand or the Emperor Penguins in Antarctica are the next rumour to be used for a bailout

Its the DEBT ......... Bitches 

I owe I owe it of to work I go

Ghordius's picture

sorry, can't resist: you seem to live in a very simple world

just a question: do you know why there are still US military bases in Europe?

Mentaliusanything's picture

Yes  - The US is the only relative in the World that once invited in, will never leave.

last count 162 countries in the World & 768 active bases

This pond is full of "lily pads" and its choking the light.

Even the Roman Empire had 37 and the English 36.

and on the Oceans American personell out number the humpback.

Geezz - a pimple on the ass of the World. - winning yes

 

 

Zero Debt's picture

This begs the question, if ECB is insolvent, then what is a Euro inherently worth?

HD's picture

What's it worth? Or where is it trading? Never the two shall meet.

Mentaliusanything's picture

Reminds me of a very lame Joke - funny enough whose time has come.

"If England is the Mother Land and Germany the Father Land - what is Greece ?

2 shillings and six pence a can at the servo"

Ghordius's picture

my two cents:

eventually the gold of the member's CBs

(which is quite a tonnage, by the way)

qussl3's picture

Which they actually have in their vaults.

Because when things have broken down to the point where implicit gold backing is needed for fiat to continue to circulate, the market would demand proof of control of said bling.

DaBernank's picture

No chance our sovereign gold gets put into a common fund, as in, physically removed from the country, but the sheep here in Austria might just yawn and have another kaffee.

Eugend66's picture

ECBs holdings are twofold: USD and Gold. None of the CBs in the EMU holds EUR, only certain percentages of foreign currencys and Gold.

Zero Debt's picture

A balance sheet has two columns: assets and liabilities. If the liabilities of a central bank exceeds assets, then whatever the bank has issued (bank notes, promises to pay in any form) cannot all be claimed at once. An analogy could be, nobody would buy a share OTC from a counterparty if the issuer of the share has defaulted.

Lebensphilosoph's picture

What is 'inherent worth', never mind that of a currency?

johny2's picture

They could print one septilion euro note. quadrillion, quintillion, sextillion would also do it, but with septillion they can pay off all debts and have good savings as well. But they who print money probably have different ideas.

juggalo1's picture

This brings us to the crux of the issue that I have never understood.  If the Euro central banks (or any central bank) is undercapitalized can't they just "create" money?  What if they issue 1 trillion new Euros and say they have 1 trillion new Euros in assets.  What authority that can declare a central bank insolvent (besides the market)?  Given that they can "create" infinite money, how can they ever run out of liquidity?  They always will have ink and bits to hand over to their counterparties.  What meaning can undercapitalization have in this context?

sumo's picture

Creating money at will worked wonders for the Weimar Republic, so yeah ...

How do you say "Ponzi on, Garth" in German?

GoldBricker's picture

True what you say, in theory. There's no formal default, only a default in fact.

The reality is in real stuff. At some point too few people are willing to trade any real stuff for money. (They will be all too willing to pay off their old debts denominated in that money.) Nobody will be willing to lend (except for very short terms at loan-shark rates). Stores are cleaned out as people rush to exchange their cash for anything tangible. At this point the formal economy comes to a halt.

At some point the CB can create all it wants, but there will be no use for it. By that time some form of alternate money (typically a foreign currency that still has some credibility, most often the dollar) will have taken over in informal commerce.

If the inflation is 'orderly', on the low side of hyper (say, 100% per year), you'll have phenomena like people being paid daily so they can buy stuff before it goes up more.

This has happened in several smaller countries since WW2. We don't appear to be close to that yet. It is an open question how long such a process could go on in the US; not only must the population be willing to accept the declining dollars, but foreigners must as well.

In Europe, the cohesion is much weaker, so defections by more prudent members will signal that the end-game is underway. My wisdom is insufficient to even guess how this might play out with the dollar.

 

 

juggalo1's picture

I was curious (still am) because I keep hearing statements like Fed/ECB will go bankrupt, Fed/ECB will need recapitalization, Fed/ECB will have to be bailed out by taxpayers.  While I understand there are real economic costs to printing more money, I still don't understand how the FED/ECB could be forced to seek recapitalization or bankruptcy protection.  It seems to me that it would be much more likely that the Central bank would just create the money as opposed to seeking votes to transfer money from governments to a Central bank.  Since the costs would be borne by the currency users, which would not only be the voters / constituents / taxpayers, it seems that would be favored by the electorate as well.  We saw the dynamic play out in the US where we rejected TARP, then accepted it, then the FED decided to not ask and gave them 10(+) times as much under the table.

Ayr Rand's picture

When the ECB prints Euros, those Euros are accounted as a liability. Which is backed by real assets, including gold. This is the same way the Federal Reserve does their accounting. So they acknowledge that gold is an asset, and euros / dollars are liabilities. 

 

The problem is that the central banks also count debt (US Treasurys, Italian bonds) as assets. That's the root of the problem. As long as the debt of an insolvent country can be counted as an asset, the central banks are perpetuating a farce. 

campag's picture

Why does this imformation take so long to get into the Press?

mean while keep bidding up the stocks a new Marshal Plan on the way pdq

dcb's picture

Not sure what the surpise is here. Although I'd like to see this get out to the european public in all major headlines .This was exactly the plan all along. (As I stated on this web site). By buying these bonds two things happen. Either the eitlees make the banks not take a fairl haircut because it would bankrupt the ecb, or the ecb is removing the junk from the bank balance sheets to the countries are forced to recapitialize it instead of the banks. this folls the tax payers into thinking their tax dollars aren't really going into the banks, when it just happened through the ecb. If anyone wonders why I think all of these folks should be in jail or subject to mob justice?

youngman's picture

I think they are more worried about the CDS´s than the actual haircuts...the CDS´s will take down the world....Western world at least...that is why the kicking of the can....think 30 AIG´s at once....then Paulsons three pager turns into a Britianica Enclyopedia

Cone of Uncertainty's picture

ECB

Everyone Claim Bankruptcy

oogs66's picture

can't they see that the ecb, if it doesn't print money, is just germany and france in drag?  it is all so incredibly circular!   how come no politician will listen?

falak pema's picture

I don't see this argument as being the key; central bank equity on their BS is not an issue. I think the real argument is the one in the new article "Barclay's dealbreaker" spiel. That is the canary in the ECB coal mine. The fear of automatic contagion if haircuts go to 60% in Greece...

lookma's picture

Sweet, another person whose lack of understanding of the Euro and the ECB doesn't stop him from running his mouth.

Risk Management in Central Banking Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECB,
International Risk Management Conference 2011,
Free University of Amsterdam, 15 June 2011

.........

The solvency profile of central banks also differs significantly from that of private financial institutions. The latter need to weight their risks against the financial buffers provided by their explicit capital position. In the case of the Eurosystem, its explicit capital position is determined by consolidated capital and reserves amounting to more than €80 billion, but also by revaluation accounts amounting to more than €300 billion. Although such explicit financial buffers remain a valid and necessary benchmark to assess the leverage and the risk-taking capacity of central banks, their financial strength cannot be fully captured by using capital adequacy metrics such as those applicable to private banks for regulatory purposes, as it has been done in a rather simplistic way by some commentators.

http://www.ecb.int/press/key/date/2011/html/sp110615.en.html

Neat footnote:

[4]From 5 September 2008 to 3 June 2011, Capital and reserves have increased by 13.2% (from €71.7 to €81.2 billion) and revaluation accounts have increased by 100% (from €152.3 to €305.9 billion). Total Eurosystem assets have increased by 31.8% (from €1441 billion to €1899 billion) over the same period.

Guess what gets bigger if the Euro weakens? Maybe the revalaution account, as all that gold (you know, the FIRST ASSET listed  on quarterly Consolidated Financial Statement) goes up s the euro goes down.

Its almost like the planned it that way...oh wait