Seeking Alpha
Long/short equity, deep value, special situations, contrarian
Profile| Send Message|
( followers)  

On August 14 the Greek government sold about 4 billion euros in three-month T-bills. From this amount, the Greek government payed 3.2 billion euros for a bond that was coming due payable to the ECB.

Until a few weeks before the sale of these T-bills, there was speculation among market participants if the Greek government was going to default. European officials however had told the Greek government, "don't worry, we will find a solution".

And indeed a solution was found.

Let me make an observation from a previous article I wrote a while ago, pertaining the protocol of the statute of the European System of Central Banks. Please read: How To Solve The Greek Debt Crisis Without Taxpayer Funds

Let me remind what article 14.4 (pdf) of the Protocol says:

14.4. National central banks may perform functions other than those specified in this Statute unless the Governing Council finds, by a majority of two thirds of the votes cast, that these interfere with the objectives and tasks of the ESCB. Such functions shall be performed on the responsibility and liability of national central banks and shall not be regarded as being part of the functions of the ESCB.

As I mentioned in this article, national central banks (NCB's) in reality can perform operations above and beyond what the ECB can perform. The only condition is that at least a third the ECB Governing Council agrees to such an operation, which also means that NCB's can do just about everything, as long as everyone agrees to it.

The codename for unsterilized NCB printing in Europe is ELA (emergency liquidity assistance). Since the Greek government did not have money to pay off the ECB bond, the Greek central bank was used to print this money and pay the ECB.

Technically speaking, the following procedure accrued:

  1. The Greek central bank loaned 4 billion euros to the Greek banking system (supposedly on sound collateral).

  2. The Greek government then auctioned off the T-bills and received the €4 billion from the Greek banks.

  3. The Greek government now has 4 billion euros in its coffers, which were printed by the Bank of Greece to pay the ECB bond.

Don't get me wrong, I'm all for Central Bank creative accounting. In fact two years ago I wrote that it would come to this, because there simply isn't enough money in Europe to replenish the losses on bad loans and sovereign debt that would be incurred by the banks.

Unfortunately, Europe is using the ELA loophole to keep the Ponzi scheme going by printing money to give bondholders a break that they don't deserve.

The correct thing to do would be to use the ELA loophole mechanism to replenish equity in the banking system (capital increases) and nationalizing whichever bank needs to be nationalized, while writing down bad assets, or assets than can't be paid back (senior debt for example).

On the one hand you would lower the leverage in the banking system, you wouldn't burden taxpayers with extra debt and, you would recapitalize the banks at the same time.

But instead of doing that and thus backstopping the debt crisis, Europe is printing money and giving it to the banking system, whereby the banks pay off bondholders, passing the bill to taxpayers.

At least with this mechanism (ELA), 80% of the profits that the Central Bank of Greece makes return to the Greek treasury. So the government pays the central bank but gets most of the interest back at the end of the year. It beats owing money to the ECB or some other public or private creditor.

Bottom line:There is no way the European debt crisis will be resolved. Politicians have to wake up to the fact that in a Ponzi scheme everyone looses. Debts that can not be repaid won't be repaid.

The only way to resolve this crisis is for bondholders to foot the bill and to use creative accounting to replenish the banking system with equity. One way to do this is to use the loophole with the codename ELA.

The Greek central bank has printed about 100 billion euros via ELA to finance the banks. So using this mechanism is not something new. The twist this time around is that it was used to pay off the ECB.

So yes the national Bank of Greece just printed four billion euros to payoff the ECB. Yes this operation is as fiat as they come. But keep this in mind that in order to solve this debt crisis, we will need a mountain of creative accounting and the best magicians we can find and if I am right, this little magic trick is just the beginning.

Source: Creative European Central Banking Tricks