Revamped ECB Lending Rules May Give Greece More Pain Than Gain
Trichet has promised to reveal details of the bank's new collateral framework, which includes a proposed "graded haircut schedule."
A haircut is the risk premium central banks apply to securities they accept as collateral against loans. A 10 percent haircut on an asset means the central bank would lend commercial banks 90 percent of its value. The ECB is proposing to apply bigger haircuts to assets with lower credit ratings.
Had the ECB stuck to its plan to revert to pre-crisis rules at the end of the year, Greek bonds would have become ineligible in refinancing operations in the event of Moody's Investors Service cutting its rating two notches to a level comparable with other agencies. Greece is rated A2 at Moody's, while Standard & Poor's and Fitch Ratings both have a BBB+ rating on the country's debt.
"Soon, due to its poor credit rating, Greek debt will be treated like poor collateral, so banks will no longer be able to borrow as much with Greek debt as collateral," Simon Johnson, Professor of Finance at the Massachusetts Institute of Technology and a former International Monetary Fund chief economist, wrote in the Huffington Post yesterday. "When these changes at the ECB come into effect in 2011, the days of Greece being able to borrow easily at low interest rates in the euro zone will close once and for all."
Greece is struggling to cut its budget deficit from 12.7 percent of gross domestic product, prompting investors to dump Greek assets amid speculation the country could default on its debts.
The spread between Greek 10-year bonds and the German equivalents rose to 407 basis points yesterday. The average gap over the past decade was 34 basis points. Concerns about the country's creditworthiness have affected the bonds of Spain and Portugal, whose budget deficits have also ballooned.
Some economists say the ECB will be wary of tightening lending rules for countries that are struggling to convince investors they can cut their budget shortfalls.
Eoin Treacy's view These
rules, if they are indeed implemented next year as expected, would cap any hopes
that Greece will be able to borrow at rates close to those of Germany for a
considerable period and perhaps ever in the absence of a major change in economic
governance. In addition to changes to collateral rules, the Greek government
has a large funding requirement which needs to be rolled forward in April and
May and Greek banks have asked for the balance of an aid package from the government
which runs into billions. This additional article
by Gabi Thesing and Frances Robinson for Bloomberg contains some additional
commentary quoting Jean Claude Trichet.
These are significant challenges and bond vigilantes are signaling anxiety about Greece's ability to avoid a default. Greek yields and spreads hit 10-year highs earlier today at 7.5% and more than 400 basis points over German Bunds respectively. So far, this deterioration remains limited to Greek bonds with other vulnerable Eurozone countries debt remaining relatively steady.
Germany's attitude to lending assistance to Greece will be pivotal. This interesting article by Quentin Peel for the Financial Times highlights German opposition to any bailouts and is worth a read. Greek politicians probably feel that have gone as far as they can in narrowing deficits this year and there appears to be certain amount of brinksmanship as who will blink first on supplying substantive aid to the country.