Last Thursday, September 6th, the ECB introduced its new goverment bond purchasing programme, known as the Outright Monetary Transactions (“OMT”). If you are interested in getting the information from the lion’s mouth, you can watch the press conference here,read its transcript here and get the technical points here.
Draghi highlighted 6 features, “Conditionality”, “Coverage”, “Creditor Treatment”, “Sterilization”, “Transparency” and the meaning of OMTs for the “Securities Market Programme“. The table below summarises these features and considers their meaning and implications regarding the effectiveness of putting an end to market pressure and effects on moral hazard.
Pari Passu Creditor Status as a Commitment Device?
The unlimited, transparent and conditional nature of the OMTs is a clear plus. The end to senior credit status, in favour of pari passu, while pleasing to the market creates a precedent for default, which could be considered akin to an indirect form of monetary financing (what is known as debt monetisation in economics).
Of course, if and once default happens, I suspect the ECB will have other concerns than Moral Hazard, such as the very survival of the currency. This concession on seniority it should also make the ECB reluctant to accept a default and exit scenario, as it would expose it to immediate losses. In a sense it can be seen as a commitment device. Given its large exposure to a loss, the ECB has given itself an added reason to stop a Euro-Zone break-up.
Some Legal Considerations about Monetary Financing
Monetary Financing is a construct rather than a specific issue clearly defined by law. The ECB offers a good overview here. Theoretically, monetary financing includes several dimensions. Legally however, my understanding is that as long as the ECB stays away from the primary market, it should be innocent of any such crimes against price stability, as this is the only act explicitly forbidden by Article 21, Chapter IV of the Protocol on the Statute of the ESCB and of the ECB in accordance with the principles laid out in Article 101 of the Consolidated Treaty on the Functioning of the EU. Nonetheless, the pari passu status of the ECB on these (risky) purchases exposes the central bank to accusations that it is not “preserving the integrity of the central bank’s balance sheet“. Monetary Financing is not what
Going Forward: The Ball is on the Member States’ Corner
However, there should be no confusion about what it means. The ECB has simply delineated the framework for crisis intervention. If it it is to activate its own lever, it will no longer do so alone. The ball is now in the camp of Member States who must request and approve assistance from and to each other. With 17 veto players and increasing mistrust and stereotyping, this will surely prove to be an arduous task. The crisis is certainly not yet over.
On this note we bid farewell to the SMP. It served the Euro-Zone well… when it was used.