In his May 31, 2010 speech (see here), Jean-Claude Trichet, President of the European Central Bank (ECB), justified the ECB’s reversal of intervening in the secondary government bond secondary market with the launch of the Securities Markets Programme, “an extraordinary action”, on May 10. Mr. Trichet re-iterated the knock-on effect of a declining and mal-functioning government bond market on the banking system and broader economy.
As also stated in his speech, this neither significantly alters the urgency to address more deep-seated imbalances within some EU countries nor the need for a co-ordinated and well-functioning response to financial sector reform. Sovereign debt has preferential recognition under BIS II (and proposed BIS III) standards. Downgrades of sovereign ratings and their bonds has immediate implications for a bank’s capital position, level of write-downs, solvency and ultimately, viability. European banks own an estimated €1.2 trillion in PIIGS government debt, with German and French banks holding the largest share. The ECB’s balance sheet as of 12/31/2009 was €137.0 bn, down from €383.9 bn in 2008. Purchase of these bonds would result in an even larger expansion of the ECB’s balance sheet than the Federal Reserve’s actions during 2008.
The ECB’s recognition of continuing responsiveness to worsening conditions for European banks is applauded. But these actions are reactive, addressing the manifestations of the key underlying issue – gross malfeasance in the conduct of political and economic affairs by some European countries. Not addressing this elongates the risk of unabated market volatility and delay to a normalized growth outlook.