Outright
Monetary Transactions (OMTs) were announced on September 6th, so
what is the plan:
- ECB buying bonds up to a maturity of 1 to 3 years on the secondary market with new Euros
- Purchases will only occur in countries who request help from the EFSF/ESFSM (and subsequent ESM) bailout funds, which purchase debt on the primary market)
- Purchases are conditional on reform programme
- Purchases stop if country no longer needs help or if don’t comply with the agreed to conditions
- No exact amount of purchases will be outlined and determined by ECB governing council
- Purchases will be sterilized fully (e.g. buy Spanish bonds with ECB reserves and then sell German bonds, making reserves in system neutral and lowering inflation risk), TBD
- No yield caps
- Not senior to other bond holders
Here is what I think the result will be. This is what I sent internally relatively
verbatim on September 6th, after the announcement:
The plan goal is to save the Euro - preventing runs on
countries that investors feel may leave. In other words, capital flows
out of Spanish banks because as yields on Spanish debt rise, which is a result
of banks not bidding on Spain's debt due to default concerns, depositors are
nervous they will get a devalued Peseta (i.e. the new Spanish currency).
As of now, the market is on board as yields in the periphery
sank. In fact, Spain's 10-year was under 6 for the first time since
May. It should be noted though that this happened the last two times the
ECB announced a bond buying program only for yields to shoot higher.
However, longer-term is another issue.
The two keys are "unlimited" and
"conditions". The first would appear to be a bazooka, if
investors believe the quantity is unlimited then default is off the table and
there would be no reason for capital to flee banks. I think this would
hold true, even if you buy longer dated bonds (5 year bonds eventually have a
maturity less than 3 years). Still, conditionality will ultimately decide
this thing.
For instance, say Spain requests EFSF and subsequently is
involved OMT on the condition they keep their deficit at 3% GDP and insist on spending
cuts. Such austerity could actually cause the deficit to rise and/or
could be politically unpopular as the economy shrinks further. At which
point, Spain can't keep up the conditions, then what? Maybe it doesn't
matter, as Spain will then have leverage - destroying the Euro and hurting the
ECB balance sheet (now full of Spanish bonds). But if it does and the ECB
stops the funding once the conditions aren't met, then it could mean the end of
the Euro.
In short, a Euro breakup is off the table (maybe sans Greece)
for now, but it’s much of the same – kicking the can down the road. At
least IMO; however, the plan does seem to have more firepower.
