Thursday, September 12, 2013

12/9/2013: Lorenzo Bini-Smaghi Strikes... again

A very interesting article in Telegraph quoting from Lorenzo Bini-Smaghi's book on went inside Berlusconi's PMship at the 11th hour of his tenure. Bini-Smaghi is one of the key ECB and Euro system insiders and is hardly a naive or malinformed observer.


If true, there are massive implications (items 1 and 2) on political/governance side and a point of deflated rhetoric (item 3):

  1. According to information give by Bini-Smaghi, Berlusconi was effectively removed from democratically-held office due to his willingness to discuss Italy's exit from the euro. This puts a solid boot into the idea of democratic EU and limited sovereignty. If a democratically elected head of state raising concern about the suitability of his/her country membership in the common currency leads to the removal of the head of state, the notion of sovereignty is not limited (as in restricted by the letters of the treaties signed), but truncated (implying absolute exclusion of some considerations from the set of feasible policies).
  2. The only thing that held the Euro together in the end was not the ECB with its OMT, but convincing Merkel of the MAD consequences of Greek exit from the union. This in turn implies that there are no institutional constraints on German (or Germano-French axis) power within the union. This problem will not be fixed by all the policies harmonisation and banking supervision reforms anyone can imagine.
  3. Being not a specialist on Target 2, I cannot exactly / scientifically confirm or decline Mr. Evans-Pritchard's concerns about the risk transfer within the eurosystem. My understanding is that Target 2 'imbalances' on Bundesbank side are caused by deposits swelling, not assets. Here is how the system functions, in my view: peripheral bank borrows funds from the ECB against collateral. Collateral lands at ECB as an asset. Peripheral bank uses borrowed funds to repay liability to a, say, German bank. Peripheral bank writes down liability to offset the writedown of cash paid. Peripheral bank remains oweing to the ECB. German bank gets cash in exchange for writing down the asset (peripheral bank's liability) and deposits money with Bundesbank which enters as a positive entry on Target 2. Now, suppose the peripheral bank defaults on ECB loan. ECB still has a collateral claim. The net loss (loan amount less collateral value), shall one arise, is amortisable over the entire Eurosystem - all CBs, not just Bundesbank or ECB alone. And more, per Jorg Asmussen: "If a net loss remains even after taking into account all provisions and reserves, it could be recorded on the balance sheet as losses carried forward and be offset by any net income in the following years." (see: Finally, I do not know where he is getting the information that Bundesbank is selling offset securities to any banks to balance out inflows of funds to German banks from the periphery.

Note: many thanks to Lorcan Roche-Kelly (@LorcanRK) for acting as a sounding board for my doubts on Target 2 and the link to Asmussen's speech above.

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