European Central Bank (ECB) president Mario Draghi announced a new plan for helping out the embattled eurozone, based on large-scale purchases of countries’ sovereign bonds in secondary markets. The last time it did this, it called it the Securities Market Programme (SMP). This time it’s “Outright Monetary Transactions” (OMT). Both plans assume that buying sovereign bonds will substantially raise demand for them, so as to push the countries’ borrowing costs (the bond yield) down. But the SMP was widely derided as a failure: it had little to no impact on bond yields, and in fact signaled that a country was under pressure, thus making it a target for speculators. So what’s new this time?
ECB aid comes with conditions. The ECB will only purchase bonds of those countries already getting a bailout (currently Greece, Portugal and Ireland are on sovereign bailouts, and Spain has a bank bailout) or with access to a something new called an “Enhanced Conditions Credit Line” (ECCL)—which means that they have to follow certain guidelines and reform programs. This is supposed to quell the fears of more spendthrift states, like Germany and Finland, that the ECB is simply giving profligate southern countries a longer leash.
Short-term bonds only. The bank will focus on buying bonds that mature in one to three years. (The SMP didn’t have an explicit maturity target.) This should alleviate pressure on sovereigns in the near term while still forcing EU leaders to make long-term reforms.
The ECB gets no favored status. If the bond issuers (the sovereigns) default, the bank will take losses just like private investors. This principle, known as pari passu, is meant to reassure investors that they will not bear the costs of a debt restructuring alone should a country not be able to pay its debts, as they did in Greece.
More transparency. The ECB will publish a breakdown of its sovereign debt holdings by country once a month, and data about aggregate holdings of sovereign debt every week. It didn’t publish country-specific data while the SMP was running.
On a separate note, Draghi also announced that the ECB would relax requirements on the collateral banks have to post against ECB loans, thus making it easier for banks to borrow. There were two big changes on this front:
The ECB will give banks cash for more of their trash. If banks post government-guaranteed securities as collateral, the ECB is now (temporarily, at any rate) putting no bottom limit on that government’s credit rating. Spanish government bonds in particular are coming perilously close to being considered “junk bonds”. That would have made it difficult for Spanish banks—which hold a lot of securities guaranteed by their own government—to call on the ECB for cash.
The euro is not the only coin. The ECB will accept securities denominated in US dollars, pounds sterling and the Japanese yen as collateral, not just in euros. This revives a policy implemented during the financial crisis.
All the same, none of these developments is particularly revolutionary. Bond purchases have not done much to push down lending rates in the past, and the strict conditions imposed on countries like Italy and Spain may be damaging to their economies rather than beneficial. Draghi did not disappoint, but his new plan at best offers a temporary reprieve from the crisis.