By any judicious means necessary

Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate.

The most important sentence of Mario Draghi’s 26 July 2012 speech. The most important phrase is factors inherent to my counterparty.

Of course, much of the work of saving the euro that he talked about in that speech was done just by giving the speech. If the ECB announces that it will protect periphery sovereign debt against the wicked speculators, those speculators are going to need big hearts and deep wallets before they decide to test this thesis.

But now suppose a Southern European country, say Portugal, runs into various forms of political drama and instability, and yields start to grow. The ECB can act or not act, and it has to act if the bond prices are not caused by risk that Portugal won’t pay its debts. Equally, it can’t act, if the sell off is caused by factors inherent to my counterparty, such as the genuine possibility of default (including buybacks, bailins, bailouts with PSI, etc.)

So the ECB now has the job of doing things like looking at Portugese governments and deciding if they have a chance of being stable, finding out how much Portgual (headline unemployment rate: 28%) has lied about various economic indicators, figuring out how and to what extent her banks are being encouraged to misallocate money they don’t have to people who can’t afford to pay them back… They are not supposed to hand over Finnish and German surpluses merely based on the benefit of the doubt. And the longer they wait before doing this, the more of this hard-earned money will be seen to go to reward hedge funds who bought in at the bottom. But neither do they want their statement about why they are not buying any Portugese government debt (in the immortal words of Gerald Ratner, “because it’s crap”) to be the thing that happened the day before Greece 2.

See why this is a more dangerous road to go down than LTRO. A bank that has collateral to get money with is by definition illiquid and not insolvent, unless the collateral is crappy. And crappy collateral suddenly gets a lot less crappy, if you allow the bank holding it to pretend it isn’t crappy and treat it as currency. It’s a bit like playing Monopoly when you choose to ‘forgive’ debts for as long as everyone needs to pay, rather than have them go bankrupt and spoil the party. Sooner or later everyone passes Go and collects £200 enough times.

Governments tend not to have much collateral, other than things like hospitals, and buying up government debt to lower its yield doesn’t actually give the government in question any more money to pay its deputy mayors until the next bond auction comes along.

Unlike the IMF (and the Egyptian army), the ECB doesn’t have a lot of functionaries whose job is to decide at what point it would be in everyone’s best interest to cancel democracy. This might be one of the things that has to change in the new Europe.


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