On the ECB’s latest contradiction (and how it helps Greece) 

15/01/2015 by

Screen Shot 2015-01-15 at 2.08.26 AMThere is little doubt that the OMT program has been Mr Mario Draghi’s (the European Central Bank’s dexterous-yet-severely-constrained President) greatest success story. In the summer of 2012 the euro was on the brink. Mr Draghi’s announcement of an intention to buy unlimited quantities of sovereign debt (Italian in particular) to stem the contagion in the bond markets sufficed: the run on the Periphery’s bonds ended even though Mr Draghi did not buy a single bond.

While this in no way ended the euro crisis, forcing it instead to migrate to the foundations of the real economy (and causing the current deflationary bout), the ECB’s battered prestige was lifted and trust in its capacity to hold the Eurozone together improved. Alas, from the word ‘go’ German opponents of OMT (including the… Bundesbank), and of the general idea of ECB sovereign bond purchases, took the matter to the German Constitutional Court which, after much deliberation, deferred to the European Courts for a final verdict on the matter. Could the ECB legally indulge in sovereign bond purchases, as the OMT program insisted it could? That was the question.

Advocate General Pedro Cruz Villalón, of the Court of Justice of the European Union, yesterday delivered his verdict: OMT did not violate European law and could be energised at the discretion of the ECB’s board. Mr Draghi must be a pleased man. Not only has his OMT not been denied a legal foundation but, in addition, his hand has been strengthened in his current battle to convince the Bundesbank and Berlin that the ECB must buy hundreds of billions of Eurozone nations’ sovereign bonds as part of a belated Quantitative Easing exercise that Mr Draghi hopes will defeat deflation. This makes sense: If bond buying is OK in the context of the OMT it surely is OK too in the context of Quantitative Easing.

But why am I arguing that this decision is pertinent to Greece? Greece issues no bonds and cannot benefit, as long as it remains hopelessly insolvent, from QE that concentrates on government bonds. Be that as it may, there is a substantial potential benefit in Mr Cruz Villalón’s decision for the next Greek government. This decision unshackles Mr Draghi from any ban on government bond purchases. However, for this new ‘freedom’ to turn into a meaningful form of QE, there must be no constraint that the ECB only buys triple-A rated bonds and there must be no assumption that the ECB can never take any losses from the bonds it buys (in case they are restructured in the future). Just like when the Fed was purchasing oodles of private debt with no iron cast guarantee of zero-losses, similarly the ECB, in order to utilise its new freedom to conduct macroeconomically meaningful QE, must accept that it may have to take some losses from its bond purchasing program.

And here is the rub. If the ECB accepts this, as the Bank of Italy insists it should, then the ECB’s stubborn insistence (against SYRIZA’s demands) that ECB-held Greek bonds (circa the failed SMP bond purchasing program of 2010/1) cannot be restructured collapses unceremoniously.

In short, the European Court’s endorsement of OMT’s legality is a major boost in the bargaining power of a prospective SYRIZA government. For otherwise the ECB’s plans for meaningful QE, against the forces of deflation, are doomed.



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