OMT: Slouching toward Eurobills?

The Eurocrisis has many dimensions—bank solvency crisis, sovereign debt crisis, political unity crisis, and economic/unemployment crisis—but time after time it has been the liquidity crisis dimension driving events, and ECB response to the liquidity crisis driving institutional evolution.  The reason is simple.  Liquidity kills you quick.

Most people, probably, think that the real point of Outright Monetary Transactions is to support the price of sovereign debt, notwithstanding Draghi’s claim that it is about fixing a broken monetary transmission mechanism, since low policy rates seem not to be transmitted to low sovereign debt rates.  But maybe Draghi has more of a point than most people realize.  From a money view perspective, let’s consider the possible connection between proposed Outright Monetary Transactions and the ongoing problem of burgeoning Target 2 balances between surplus and deficit national central banks of Europe.
If there were Eurobills, balances could be settled periodically by transfer of assets, just as is done in the Federal Reserve System.   More precisely, if there were a System Open Market Account at the ECB, in which all of the national central banks held shares, settlement could be made by transfer of shares.
From this perspective, OMT can be seen as the first step toward a kind of system open market account, and the shares in that account would be a kind of first step toward a Eurobill.   
We know that the Bundesbank is not happy that it has accumulated such large Target 2 balances, which are essentially unsecured claims against the Eurosystem as a whole.  We know also that the Bundesbank would be quite happy receiving German bonds as settlement for those claims, but that is not going to happen and everyone knows it.  So the question is whether Spanish sovereign bills would be acceptable, and it seems that maybe the answer is positive, especially if the sovereign commits to some kind of conditionality before hand.  
Even better however if the Bundesbank could receive shares in a system open market account, representing a portfolio of the various assets held by the Eurosystem.  The point is not so much diversification as it is security.  In effect, these shares would be a kind of proto-Eurobill, maybe not yet traded in private money markets, but traded nonetheless in settlement between national central banks.  So maybe we should  be pushing for a package deal, not just Spanish OMT but also others (Italy and maybe also France), in order to begin creating a system open market account at the ECB. (See here for such a proposal).
If it works, OMT holds out the prospect to finally settle the Target 2 overhang.  Start with Spain.  Suppose that Rajoy asks for OMT.  Spanish banks sell Spanish bills to the ECB, use the proceeds to repay loans from their national central bank, which then uses the proceeds to repay Target 2 loans from the Eurosystem.  Hey presto, settlement.  
But now the ECB has new Spanish bills as an asset, and new deposits as a liability, and both have to be booked at one of the national central banks.  Book them at the Bundesbank and the deposit liability cancels against the Target 2 repayment, leaving Spanish bills as an asset.  In effect, Target 2 balances are replaced by Spanish bills.  That's why the crux of the matter is whether the Bundesbank commits to accept Spanish bills.
The larger point of this post is the simple observation that the Bundesbank will more readily accept Spanish bills if in some sense these bills are the joint and several liability of all the European sovereignties.   If Spain, Italy, and France all went in for OMT together, and the resulting assets were segregated in a system open market account in which all national central banks held shares, we would be halfway there.
The unsecured liabilities of the Eurosystem, such as Target 2 balances, are already the joint and several liability of the national central banks which capitalize the ECB.  A system open market account in which national central banks hold shares is just a secured version of the same thing.  This is the sense in which Draghi’s OMT offers the prospect of a kind of backdoor Eurobill, essentially a secured clearinghouse certificate now, but possibly something more in the future.

Liquidity, Down the Drain

China released quarterly GDP figures this week. Wen Jiabao emphasized the parts of the release that pointed toward stabilization, and one can certainly find some logic to that view. Stabilized or not, China's target of 7.5% growth marks a steep slowdown over recent growth rates. Read more

Ring-fencing Explained

Everyone wants to ring-fence something, but they can’t agree on what:  Vickers, Liikanen, Volcker.

In all proposals, the idea is to have bank capital separately allocated for some activity, and to prevent that capital from being exposed to any other activity.  Some people want to lock the wild animals in a cage to keep them away from us; some people want to lock the tame animals in a cage to keep them safe from the dangerous world outside. Read more


Last Thursday, the Fed announced its anticipated third round of balance-sheet expansion, at a fixed rate of about $40B per month "until [substantial] improvement [in unemployment] is achieved in a context of price stability". A relief, perhaps, to see some attempt at boosting the economy. But in a column that appears to praise Bernanke for doing something—anything—Martin Wolf still suspects the policy will fail to live up to hopes, and I am inclined to agree. Read more

The fix was in

In Friday's FT, former Morgan Stanley trader Douglas Keenan traces banks' LIBOR manipulations back to 1991, when he observed, from the futures desk, LIBOR fixings come in at levels different from where he new the market to be. "My naivety seemed to be humorous to my colleagues," he writes. Read more

Lethal Embrace? A Thought Experiment

At the heart of the Eurocrisis lies a vicious circle where once there was a virtuous one.  Over the last week or two, the FT has been reflecting on the connection between the sovereign debt crisis and the bank crisis, conjoined twins (as George Soros has put it) of the current Eurocrisis.  See here, here, here.

Read more

Swexit - When will Switzerland exit the euro?

Since September 2011, the Swiss National Bank has held a floor of 1.20 francs per euro. This floor has in practice been a peg, as the pressure has been in only one direction, downward (that is, in the direction of CHF appreciation).

Image via FT Alphaville Read more

Maynard's Revenge: A Review



Below is a revised version of a talk I gave at the New School University, at a conference to launch Lance Taylor's latest book.  The date of the event was April 28, 2011, more than a year ago, and the delay in revision was entirely my fault--overcommitment and pressing deadlines on many fronts.  Sorry about that. 

Lance Taylor, Maynard’s Revenge:  The Collapse of Free Market Macroeconomics (Harvard 2010). Read more

Insights from Bagehot, for these Trying Times

Here is a talk I gave recently at Wake Forest University.  It is pretty long, but you can page through the video (on the left) by paging through the powerpoint (on the right), and anyway the last twenty minutes are devoted to questions.  I couldn't figure out how to embed it in the blog, but the link will get you there.

Banks as creators of money

In conversation recently, I was called upon to defend the claim that banks are in the business of creating and destroying private money. This has been for me a working hypothesis for so long that I was unable to respond effectively or cogently to the argument. My interlocutor followed up in e-mail with a Cowles Foundation paper by Tobin in support of her case. Here is my response to Tobin, hopefully better articulated than I managed on the fly. In this post, I'll stick to the theoretical claim (the practical context was bank capital requirements).

I agree wholeheartedly with Tobin's dismissal of the Read more

The Clash of Economic Ideas: A Review

When Paul Krugman paints John Maynard Keynes as a pioneering critic of dominant free-market economics, he exaggerates wildly, both about the rigidity of orthodoxy and about the pioneering character of Keynes’ critique.  So says Larry White in his book The Clash of Economic Ideas and, speaking as a sometime historian of economic thought, I am inclined to agree.   It's less black and white than Krugman makes it out to be. Read more