Obviously neither the author nor CNBC understands the fundamental difference between the issuer of the euro and the users of euro.

In fact, the ECB as per the treaty has no capital requirement, nor does it have any particular use for capital.

However, a general belief has been expressed by various higher ups to the effect that negative ECB capital would somehow be inflationary, and therefore the current imperative for the ECB to have sufficient capital, whatever that means.

So the presumption is any losses the ECB realizes will be ‘matched’ by capital calls to the member nations. Hence the reluctance by the ECB to give Greece, for example, any discounts on the Greek bonds in the ECB’s porfolio.

European Central Bank Leveraged Like Lehman: Author

By Patrick Allen

May 10 (CNBC) — The European Central Bank is indebted to the hilt and is beginning to look like one of the banks it has done so much to save, according to author Satyajit Das.

Having subsidized the European banking industry with its 1 trillion euro ($1.29 trillion) long-term refinancing operation (LTRO), funds that were distributed at well below market prices, the central bank is leveraged to levels Bear Stearns and Lehman Brothers might have felt comfortable with in early 2007.

“If the European Financial Stability Fund was a collateralized debt obligation, the ECB increasingly resembles a highly leveraged bank. The ECB balance sheet is now around euro 3 trillion, an increase of about 30 percent just since Mario Draghi took office in November 2012,” said Das in notes sent to CNBC before an interview on “Squawk Box Europe” on Thursday.

10 Responses

  1. Warren,

    This is as far as I understand also why there is all the talk about the seignorage. (Soros c.s.)

    If the ecb capitalizes its seignorage rights they could sell it off (and even finance this with a loan) and this would boost their capital with the $2 to 3 trln that they say it is worth according to the independent calculations of Citi (W. Buiter) and Goldman Sachs (Huw Pill).

    Please note that if they would do such transaction that would also eliminate the objection of negative capital they could have against your proposal for a distribution from the ecb to the member states that would effectively bring the deficits from the level of currency users to the level of the currency issuer.

    I referred to this subject in your post on April 24th on this site, but we did not finish the discussion there.

    For Buiter’s (Citi) definition and calculation of Seignorage see this document (dec 2011), page 7:
    As far as I see it he basically has a narrow definition of seignorage:
1. the change in base money.
    In a broader sense he adds:
2. interest earned by investing the resources obtained through the past issuance of base money in interest-bearing assets (also called: central bank interest saved) 
3+4) Inflation tax (anticipated and unanticipated), the reduction of the real value of the stock of base money by inflation
    This document of dec 2011 refers to another publication from him in feb 2007 that was specifically about seignorage.

    How do you look at this seignorage idea?

    1. @walter, Fascinating set of slides Walter.

      This part jumped out at me:

      “For central banks there is no close relationship between conventional regulatory notions of capital/equity, Wb, and economic capital, that is, unconditional loss absorbing capacity, Wb.”

      So the key number for him then becomes the NILAC (non-inflationary loss absorbing capacity) of the central, I guess due to the ECB price stability mandate.

      The inflation calculations seem to be based on monetarist principle using a currency demand function.

  2. Hello Mosler, could I have some doubt :

    1) Fed print money (that 1 second before doesen’t exist) and then buy Treasury or Private Collateral to finance State & Banks with illiquidity/losses.. this is Quantitative Easing ?

    2) Bce first need to borrow money from Nations (that increase their Public Debt) and then lend this money directly to Private Bank (with illiquidity) and indirect to State (through the Private Bank because Treaty forbid direct financing).. this is LTRO ?

    3) so there the difference between QE vs LTRO is that Bce have a loan to repay to the States, while Fed have no loan to repay to Us Gov. ?

    Is this the real difference or there is ither that I don’t understand ?

    1. 1. no
      2. no
      3. yes, there is a difference. qe is where the central bank buys the securities of the central govt., exchanging an overnight deposit at the central bank for a time deposit at the central bank (govt securities). LTRO is a form of what’s generally called a ‘repo’ where the ECB lends euro to its member banks and takes their assets as collateral.

  3. Good comments Warren.

    Correct me if I’m wrong, but the main issue with all this is really to do with what the ECB (or FED or BoE etc) is allowed to do. They are in charge of monetary policy. If they choose to “bail out” a nation like Greece by buying their bonds and then suffer a loss on them, they have actually engaged in FISCAL policy – something they are strictly not supposed to do! As you say, the financial implications are not alarming – what’s somewhat disturbing is they are overstepping their boundaries.

  4. People tend to forget that the Eurosystem also has €400bn in revaluation accounts, apart from the €85.5bn in capital and reserves.

  5. The ECB is not allowed to discount its greek bonds as per treaty that establishes it. Nothing to do with capital losses. They could do it via a circumventing route, like have a bank or special purpose vehicle take that loss and then rescue them under the financial stability treaty mandate.

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