BAK Korper

Document Sample
BAK Korper Powered By Docstoc
					The economic crisis and the crisis of economics

Titel        How the European Central Bank monetary policy instruments have
             changed in the recent crisis

Authors      Clemens Korper

Date         July 2011

The recent crisis was not a normal recession at all. It was a global pandemic of
incomprehensible dimensions. To prevent a depression like in the thirties of the last
century governments and central bankers were forced to support the crashing
markets with fiscal and monetary stimulators. This paper discusses how the
monetary measures of the European Central Bank (ECB) have changed in
comparison with their standard measures. It explains what those new monetary
instruments had been created for and how efficiently they have been working in the
crisis empirically.
The first part of the paper shows how the ECB has extended its already existing
monetary instruments to serve the money market with enough liquidity to prevent a
series of bank defaults. The focus is on the newest invention in the ECB´s monetary
policy, namely the Covered Bond Purchasing Programme (CBPP) which is quite
similar to his “big American brother” the Quantitative Easing (QE) Programme. The
CBPP is from that point of view very interesting because it was never used before in
the history of the ECB. The paper will also prove that by contrast with the Federal
Reserve´s (Fed) QE the CBPP is only a small market intervention.
At the end of that paper, the Security Market Programme will be treated. Without a
doubt this programme is the most critical measure ever taken by the ECB. The fact
that an independent central bank acts as buyer of government treasury bonds gave
rise for critics from several sides. All those different ECB activities created questions
of their usefulness and needfulness. The following pages will try to give answers in
that respect by showing the grade of efficiency of those new monetary measures.
The economic crisis and the crisis of economics

1         Instruments of the ECB used before the crisis

1.1       Introduction
The following section gives a short introduction about the used instruments by the
ECB carrying out its monetary policy before and after the meltdown in the financial
markets and how the ECB has been responding with its “old” and “new” instruments.

1.2       Open market operations
Open market operations are a very important and a useful monetary policy
instrument, not only for the ECB, but also for other central banks over the world to
provide the money market with liquidity in form of loans. By providing the money
market with less or more liquidity, the ECB has the indirect ability of supervising the
key interest rate in the European money market. One often used instrument to
execute this operation is the reserve transaction in form of repurchase agreements
and collateralized loans with practically no risk. For its execution the ECB uses the
procedure of an auction with the so called “tender” method. There are three forms of
tender methods: standard tenders, quick tenders or bilateral procedures. (ECB, 2011,
p. 10) The open market operations can be divided into four categories (Executive
Board of the ECB, 2011, p. 96):
         The main refinancing operations (MROs) are reserve transactions which
          provide banks with liquidity coming from the ECB in a weekly frequency and
          with a short maturity of only one week. The standard tender method is used in
          this operation.
         The longer term refinancing operations (LTROs) are reserve transactions with
          a monthly frequency and with a maturity of three months. These operations
          are not used to send signals to the markets in form of interest rates. The
          diversification of loans happens in an auction, where the highest bidder gets
          first access to liquidity.
         Fine tuning operations (FTOs) are used to smooth out different liquidity
          fluctuations in the market, to keep the interest rates on that level which is
          preferred by the ECB. These operations belong to the reserve transactions but
          they can also appear in form of foreign exchange swaps or by the collection of
          fixed term deposits.
         Structural operations are a form of reserve transactions and issues of debt
          instruments by national central banks through standard tenders. These
          operations are used whenever the ECB wants to adjust the structural position
          of the Euro system in the financial sector.
The economic crisis and the crisis of economics

Table 1: Euro systems monetary policy operations

Source: Executive Board of the ECB (2011), The monetary policy of the ECB, p. 13

1.3    Standing facilities
Compared with open market operations the biggest difference is that banks can use
the marginal lending facility to obtain overnight liquidity. The interest rate of these
facilities gets fixed by the ECB which is called EONIA – European Overnight Index
Average. The EONIA is the ceiling of the overnight money market. Banks have to
offer collateral to get access to these facilities. But it is not only an opportunity for
banks to borrow it is also possible to park their deposit surplus money at the ECB at
an interest rate, which is the floor of the overnight money market interest rate. (ECB,
2011, p. 11)

1.4    Minimal reserves
The minimal reserve policy is a strong instrument of the ECB. With that instrument it
has the possibility to create liquidity shortages in the money market and is thereby
restricting credit institutions in their credit creation. The shortages in the liquidity
market make European banks more dependent on liquidity providing operations (see
section 1.3 and 1.3) offered by the ECB. That dependence makes it easier for the
ECB to control the money market rates. The minimal reserve responsibility of banks
depends on their balance sheets and its ceiling is 10 percent. Normally the reserve
rate lies between 1.5 and 2.5 percent. (ECB, 2011, p. 11)

1.5    The ECB´s monetary policy before the crisis

1.5.1 How the system worked
Every monetary policy decision of the ECB is done with respect to its main target -
the price stability. Price stability inside the monetary union is defined as an increase
of less but close to two percent of the consumer price index (CPI). Before the
financial market collapsed it was a complete no-go for monetary authorities to violate
this goal. To achieve this goal the Governing Council sets the key interest rates first
(signalling). The market communication in form of that signalling is an important
instrument in the hands of the authorities. It affects the future expectations of market
participants and so increases the effectiveness of monetary policy. The key rates
consist of the minimum bid rate, the main refinancing operations like reserve
The economic crisis and the crisis of economics

transactions, the interest rates, the marginal lending facility and the deposit facility.
These variables build the corridor around the minimum bid rate. The interest rates of
the standing facilities limit the range of variation of the EONIA. With that mechanism
the Governing Council can steer the short term interest rates. Through changes in
the money market interest rates the ECB has the power to set prices at which banks
can borrow money on the market. This affects the credit growth rate and asset prices.
Together in a pot with external factors this can lead to changes in demand and
supply in the goods markets and so they can indirectly influence inflation and keep
them under two percent. These external factors or “autonomous factors” which can´t
be influenced by the ECB are banknotes in circulation and government deposits for
instance. (ECB, 2010, p. 66-68)

1.5.2 Analyzing empirically the ante crisis interest rates
The empirical data shows that in the period from 1996 to 2008 the money market
rates in the euro system fluctuated in average around a value of about 4 percent.

Figure 1: money market interest rates

Source: Euro Area Statistics Online (2011), monthly bulletin (slightly modified)
The economic crisis and the crisis of economics

Compared to other leading economies (USA, Japan) the ECB followed a much
higher interest rate policy. After the financial meltdown this policy had been
eliminated as a consequence of the bankruptcy of Lehman Brothers on the 15
September 2008. The European Overnight Index Average (EONIA) fell from its
normal value that prevailed before from 387 basis points in 2008 to 71 basis points in
2009. This dramatically cut in the EONIA showed how massive the interventions of
the ECB have been. After Lehman the London Interbank Offered Rate (LIBOR)
reached historical heights because of the huge uncertainty which spreads through
the money markets.

1.6    Conclusions
To avoid a complete failure of the banking sector and the possibility of another Great
Depression the ECB invented and has been adopting some new instruments.
The main goal of price stability was pushed to the side. The next section will discuss
how the monetary policy has changed and which new instruments are playing a
crucial role in fighting the crisis.

2      New instruments used by the ECB in the latest crisis

2.1    Introduction
Jean Claude Trichet, the leaving president of the ECB pronounced on July 13,
2009:”Since October 2008, our key policy rate has been cut from 4.25% to 1%. In
addition, and just as importantly, we have embarked on a policy of fully
accommodating banks’ liquidity needs. This bold and necessary step has avoided a
situation in which stressed liquidity conditions spiral into a systemic threat to the
stability of our banking system as a whole.” (ECB Press, 2009) This dramatical cut in
the key policy rate was necessary to provide the dried up money market with liquidity
and to stimulate the whole economy. After the Lehman collapse the assessment of
the proper key interest rate set by the Governing Council became much more difficult
because of rising uncertainty in the markets. Standard models which have been used
to met the main targets (price stability) of the ECB became less reliable than it proved
in the past. Now it was nearly impossible to estimate the effectiveness of monetary
policy instruments. During the crisis the ECB had to consider different external
effects; such as developments in the oil prices or other externalities from the
American subprime market. The ECB decision for radical movements in their
monetary measures in August 2007 when the first European banks got liquidity
problems, the Euro system reacted quickly in that form that the timing (frequency)
and maturity of its liquidity providing operations has changed. It also provided liquidity
in foreign currencies against a standard Euro collateral set to eliminate the exchange
rate risk too. In September 2008 when Lehman collapsed, the turmoil spread over
from the US to Europe and to the rest of the world and caused an economically
downturn which subdued inflationary pressures. In the following days the Governing
Council adopted some standard and non standard measures. The first step was a
radical cut of the key interest rates by 325 basis points to a historical low of one
percentage point. (ECB Press, 2009)
The economic crisis and the crisis of economics

2.2       Enhanced credit support
The decrease of the key interest rate was not progressive enough to the ECB. It
decided to implement further new techniques to battle the recession. The first new
measure was the “enhanced credit support” which provided banks with new credit
conditions to make the access to central bank money easier. This was surely an
important step because the European economy depends strongly on bank financed
loans to the real economy. The main part of external financing of non-financial
corporations comes from the banking sector. Especially for small and medium sized
companies this was an important measure to tend them with short term liquidity
which kept their businesses running. (ECB Press, 2009)
The ECB also supplied liquidity to the European banking sector in form of loans
denominated in US Dollars. This could be done due to a special partnership with the
US Fed. The ECB and the Fed built a swap facility. The Fed agreed to provide Dollar
swaps (without any upper limits) against Euro-denominated collateral. In a statement
the Fed pronounced: ”These facilities are designed to help improve liquidity
conditions in U.S. dollar funding markets and to prevent the spread of strains to other
markets and financial centers” (Reuters, 2010) Now the ECB was able to provide
loans denominated in Dollar whenever a bank needs some. This step has been done
because the crisis made it very difficult for banks outside the US to refinance their net
large holdings of US-Dollar denominated assets. But the ECB also established swap
facilities with other European central banks (non-Euro countries); such as the Swiss-
and Swedish National Bank. These international corporations were clearly a sign that
some lessons have been learned in the Great Depression and that individualism has
no longer space in a global crisis. (ECB, 2010, p 68-69)

2.2.1 Summing up the credit support measures
All these measures were focused on the banking sector to ease their refinancing and
to provide the markets with liquidity. The ECB´s credit support measurers have been:
         The provision of unlimited liquidity at a fixed rate against adequate collateral in
          all   refinancing    operations     for     banks    within   the   Euro     area:
          In the following of this programme the ECB fixed the main refinancing rate.
          The ulterior motive for that programme was to support the short term funding
          of the banks to prevent liquidity risks which would have negative impacts on
          the availability of credits for households and companies in the Euro zone.
          (González-Páramo, 2010)
         The lengthening of the maximum maturity of refinancing operations from three
          months        prior      to     the       crisis     to      one       year:
          These longer-term refinancing operations (LTROs) reduced the refinancing
          requirements of banks in the short term. This programme started with a total
          amount of € 60 billion on November 23, 2007. The LTROs will be carried out
          through a standard tender procedure. By extending the maturity of these
          operations it should have positive effects through the normalization of the
          European money market. (ECB Press, 2008)
The economic crisis and the crisis of economics

         The      outright   purchases       in     the    covered      bond      market:
          The most radical operation of these new instruments was the Covered Bond
          Purchasing Programme (CBPP). The covered bond market is a very important
          financial market and the primary financing source for banks. The goal of this
          programme is reducing yields of bonds to make the refinancing for banks and
          corporations easier. This will be clearly discussed in section 3. (Beirne, 2011,
          p. 5)

2.2.2 The extension of the list of assets accepted as collateral
The Euro system decided to lower the credit rating for marketable and non-
marketable assets from A- to BBB to accept them as possible collateral. The only
exceptions are asset backed securities (ABS). In times of the crisis bank assets
become less valuable. So the ECB decided to implement some haircuts if the
accepted collateral appears to be overvalued with regard to their accounted value.
Consequently all BBB assets are suffering a haircut of 5%. These measures
enhanced banks to refinance a large share of their balance sheet with the Euro
system. The list of assets approved as collateral in their credit operations are:
         Marketable debt instruments denominated in foreign currencies such as US
          Dollar, Pound and Yen issued in the Euro area. Haircuts of 8 percent are
          possible if the ECB is unsure about reliability of this collateral.
         Euro-denominated credit claims governed by the law of the United Kingdom.
         Certificates of deposits (CDs) which are traded on non regulated markets are
          accepted as well, with the possibility of 5 percent depreciation.
         Subordinated deposit instruments are only accepted if they have an accepted
          guarantee. Haircuts by these instruments are possible from 5 to 10 percent.
With the expansion of the accepted collateral the ECB made a brave step. It was at
least one point where the ECB acted much more aggressive than the Fed to prevent
a total collapse of the financial markets. (ECB, 2008)

2.3       The phasing out of non standard measures
All these credit support measures have been designed for a limited maturity. These
measures have been established to compensate the negative effects of the financial
crisis and if the situation in the European economy returns to normality they are
going to be removed. This is what the Governing Council did. On the 3rd December
2009, they decided to gradually phase out those non-standard measures which
seemed to be no longer needed at the beginning of 2010. The first measures which
were stopped were the LTROs, which were conducted the last time in December
2009. The other shorter maturity operations followed a few months later. This
phasing out enabled banks to resume their task of offering sufficient liquidity to the
market. If they had not dismissed these new measures, this could have caused
distortions such as excessive reliance on exceptional central bank liquidity and
associated moral hazard problems. As we saw in the subprime crises where the
money markets had been flooded with liquidity this caused an excessive risk taking
behaviour. So the phasing out was a necessary step on the way to financial
The economic crisis and the crisis of economics

normality. But the abandoning of some operational instruments doesn’t mean that all
have been removed after all. The Euro system will continue to provide liquidity to the
banking system at favourable conditions. For more details about ECB´s exit
strategies see section 3.8.5. (ECB, 2010, p. 70-71)

2.4       Conclusions
These credit support measures are not comparable with the QE and other measures
which were implemented by the Fed, the Bank of England and the Bank of Japan to
boost their economies. As those systems are quite different - Europe needed other
solutions. In the Euro system most of the firms are financed externally by banks. In
the US and GB they are primarily financed by equity through financial markets (stock
markets). This may be an explanation why those countries react differently in the
recent crisis. In the next section we will analyze the new invention of the ECB to
support the money market with liquidity.

3         The Euro system’s covered bond purchasing programme

3.1       Introduction
The CBPP is a programme to stimulate the covered bond market in the European
money market. From the view how it works, it is quite similar to the QE programme in
the US. Like Roubini formulated suitably: “When the government created a demand
for the bonds by buying them up, their price went up, and their yield went down.
Because bond prices and bond yields move in opposite directions. That meant they
became less attractive as a place for banks to park money.” (Roubini, 2010, p. 128)
What Roubini further explains in those simple sentences is that bonds have an
inverse relationship between their market value and their yields. If now the ECB buys
bonds, the result will be an increased demand for them. But the supply does not
change. So, to keep the bonds market in equilibrium, the price for bonds has to rise.
When the price rises, the market value of the bond rises too. The coupon and
repayment are already fixed when respectively before the bond is being emitted. So
the only variable which has the possibility to change is the individual bond yield. In
this case it has to decrease. The shrinking of covered bond yields was or is exactly
that what was aimed to achieve by that programme.

3.2       Facts and objectives of the CBPP
The CBPP was first announced on 7 May 2009 to stimulate the bonds market in the
Euro zone. The Governing Council decided to spend an amount of € 60 billion into
the programme. The time span, during which the bonds should be purchased, bit for
bit, was fixed from the 6 July 2009 to the end of June 2010. All in all 422 different
bonds were purchased. From those 422 bonds were 27 percent purchased on the
primary market and 73 percent on the secondary market. The maturities of those
bonds lie between three and seven years with a modified duration of 4.12 years.
(Beirne, 2011, p. 5)

The four objectives of this programme were:
         Pushing the money market term rates further down.
The economic crisis and the crisis of economics

      Make funding easier for credit institutions and enterprises.
      Encouraging credit institutions to expand their lending and to stop their
       investing in relatively save long term government bonds.
      Improving market liquidity in important segments of the private debt securities
(Beirne, 2011, p. 12)
Another reason for this bond financing package of the ECB was that covered bonds
provide banks with a refinancing instrument which has a longer maturity than the
standard ECB operation facilities. The announcement of the CBPP caused
immediately a market reaction. In the secondary market, the market where
bondholders trade with each other, the yield spread tightened in the Euro area and
lead to a recovery in the primary market. To prevent any uncertainty in the markets
the Governing Council decided to present the technical modalities of the CBPP. On
the 4 July 2009, Jean Claude Trichet published a detailed programme in the official
journal of the European Union. (The Governing Council of The European Central
Bank, 2009, p. 1-2) It was stated in this journal that the ECB would purchase covered
bonds in the amount of € 60 billion through Euro system´s portfolio managers. These
purchases would be conducted in the primary and secondary covered bond market.
Eligible bonds for the programme have to fulfil the following criteria:
      The collateral have to fit with the Euro system credit operation norms.
      They have to fit criterion in Article 22(4) of the directive on undertaking
       collective investment in transferable securities (UCITS) or similar safeguards
       for non-UCITS-compliant covered bonds. UCITS are investment funds suitable
       for small investors.
      They must have an issue volume of about more than € 500 million and in any
       case not lower than € 100 million.
      Additionally they also must have an AA rating or equivalently rated by at least
       one of the big rating agencies Fitch, Moody´s, S&P or DBRS. Anyway the
       rating is not allowed to be lower than BBB-/Baa3.
      The covered bonds must have underlying assets that include exposure of
       private or public entities.
Error! Reference source not found.Figure 2 shows the accumulated covered
bonds of the ECB under the CBPP. Since the ECB bought every day nearly the same
amount of bonds the accumulated amount of covered bonds can be illustrated as a
quiet linear gradient with a positive slope. The average daily purchase conducted
was about € 240 million. So, the whole amount of € 60 billion was diversified over a
year. (Beirne, 2011, p. 5)
The economic crisis and the crisis of economics

Figure 2: accumulated covered bond purchases

Source: European Central Bank (2011), The Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets, p. 13 (slightly modified)
During the time of the CBPP 148 new eligible covered bonds were issued. The total
amount of those issuances reached € 150 billion. High debt countries like Greece
saw its first publicly placed covered bonds. Overall 24 new issuers for covered bonds
entered the European bond market. Also huge economies like Italy saw a significant
increase in the number of new issuers. (Beirne, 2011, p. 13)
The CBPP seemed to be successful in the short run when looking at the stats. It
seemed to have a boosting effect for the issuer of new covered bonds and was
supposed to recuperate the confidence for further investments. Hence market
liquidity seemed to improve too. To stop an excessive enthusiasm about the success
of the CBPP it must be added that parallel to this some European governments
started a guarantee programme for uncovered bonds. This guarantee programmes
had a direct impact on interbank and capital markets, which further attracts new
investors for uncovered bonds. A government guarantee eliminates nearly all credit
risks. This rendered possible or re-opened financing sources for banks in order to
stabilize their balance sheets. What kind of problems such guarantees or bond
purchasing programmes are causing in form of notably moral hazard is a question
that can´t be answered yet. (Beirne, 2011, p. 13)

3.3    The importance of the covered bond markets for the European financial
The covered bond market is the most important privately issued bond market in
Europe. In October 2008 covered bonds were the main funding instrument for Euro
area banks. The whole market had a volume of € 2.4 trillion in the year of 2008. This
is an improvement of 60 percent against the year 2003 where the market had a
The economic crisis and the crisis of economics

volume of € 1.5 trillion. This market became more and more important over time.
(Beirne, 2011, p. 9)
The structure of covered bonds is explained in the following sentences: “Covered
bonds are debt instruments secured by a cover pool of mortgage loans (property as
collateral) or public-sector debt to which investors have a preferential claim in the
event of default. While the nature of this preferential claim, as well as other safety
features (asset eligibility and coverage, bankruptcy-remoteness and regulation)
depends on the specific framework under which a covered bond is issued, it is the
safety aspect that is common to all covered bonds.” (European Covered Bond
Council, 2009) This citation makes clear why the volume of this market has exploded
in the last years. It is a save investment where investors can basically expect a good
compensation in the event of default. In comparison with mortgage backed securities,
a financial instrument which gained notoriety in the subprime crises, there isn´t any
transfer of credit risk. So, covered bonds gave no incentive for a moral hazard
problem - at least for those who sell bonds! The risk of default by the issuer of
covered bonds is backed by a pool of normally high quality collateral. In the case of
asset backed securities (ABS) the underlying pool of collateral is transferred to a
special purpose vehicle (SPV). Through the transfer to a SPV they disappeared from
the banking balance sheets. (Beirne, 2011, p. 9) Another reason for those transfers
were that so the banks affected would no longer have to be forced keeping high
reserve requirements. The complete contrary is the case by covered bonds. Covered
bonds remain in the banking balance sheet and so those banks keep only high
quality assets. (Roubini, 2010, p. 59). Although there is that advantage over ABS the
covered bond market couldn’t nevertheless be immune against the Lehman collapse
in the middle of September 2008. As a result of this historically bankruptcy the
spreads in the secondary market widened and issuances slowed down in the primary
market. The risk aversion of investors rose and the so called “Minsky moment” in
Europe set in. ”A sudden aversion to risk, a sudden desire to dismantle the pyramids
of leverage on which profits have until so recently depended, is the key turning point
in a financial crisis.” (Roubini, 2010, p. 80) This caused major problems for banks
because their main funding source deteriorated massively. Through the wide panic in
the financial market the trust of banks in each other’s solvency lead to a halt in the
interbank money market lending. If this drying up in the interbank money market
keeps rising, the real economy can get infected through declining loans by banks.
Solvent corporations can become - from one day to another - illiquid and unable to
pay their bills or wages to their employees. This was the time when the ECB was
forced to react. It decided to manufacture the CBPP that was developed to supply the
market with enough liquidity additionally to the measures in section 2.

3.4   Channels by which the CBPP theoretically works
The main goal of this programme was to inject money into the economy, to stimulate
spending and to keep the banking sector intact. There are four main channels how
the CBPP affects the real economy. The primary channel of this programme affects
the expectations of investors. This is called the pronouncement effect. Through the
announcement of new programmes the ECB gives a positive signal to support the
financial markets. This causes more confidence and stimulates future investments.
The economic crisis and the crisis of economics

New Keynesian models have the strong opinion that asset purchases can only work
trough a signalling channel. The second channel which was described by Tobin as
the “portfolio balance” effect transmits itself through the announcement of the
programme and through the purchasing of the covered bonds. These massive
purchases of bonds lead to an increase in bond prices and a reduction of the supply
in the market. This reduces the medium term interest rate of those assets and results
in a decline of the yields. The third channel is the liquidity premium effect. That effect
should have a reducing impact on the liquidity premium. Investors are less refused to
invest when they know that there is a big buyer in the market, in our case the ECB,
which purchases huge amounts of bonds. They know if they want to sell their assets
it is now no problem for them to get rid of it since the taxpayer will have to bail them
out. Another important aspect shouldn´t be forgotten. If investors hold different types
of bonds to those which the ECB is purchasing or possessing, their yields increase
relatively to covered bond yields. The rise in the risk premium increases their income
and so their wealth (if it’s hold till maturity) and boosts their willingness to spend. The
liquidity premium effect is just a temporary effect because it works only as long as the
CBPP is running. The fourth and last channel of the CBPP is the “real economy”
effect. When the ECB buys the covered bond from a seller it pays with their reserves.
The money a seller gets could in turn be invested into other bonds or could also be
used to pump up the real economy. If he or she spends his or her earnings for
consumption, production is boosted which helps the economy to pick itself up faster.
(Beirne, 2011, p. 10-11) Apart from these channels and effects ECB’s main ambition
for this programme was stabilizing markets and giving confidence to potential

3.5    An empirical analysis about CBPP’s impact on the primary market of
       bank bonds

3.5.1 Empirical long run relations between covered and uncovered bonds before
      and after the crisis
It is empirically proved that the amount of covered bank bonds in circulation has
always been higher than those of uncovered bank bonds. During normal times charts
of those bonds are used to perform similar to the line you can see in

The economic crisis and the crisis of economics

Figure 3: amount of covered and uncovered bonds

Source: European Central Bank (2011), The Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets, p. 16 (slightly modified)
Both bond markets showed a stable upward trend by a stable spread of about € 100
billion between those bonds. The turmoil of the financial markets in August 2007
disturbed this positive development. While the covered bond market seemed quite
unaffected at the beginning of the crisis, the uncovered bond marked went through
harsh times. From August 2007 until September 2008 (before the Lehman collapse)
the growth of uncovered bonds stagnates. During the worst phase the spread
between those bonds reached € 300 billion. It is quite normal or logical that in times
of panic and uncertainty investors are showing a higher risk aversion and so they
prefer to enter in the save covered bond haven. After the Lehman collapse in
September 2008, we observed a complete reverse development in both markets.
While the slope of the growing covered bond market became flatter, the uncovered
bond market showed an impressive recovery. This phenomenon can be explained by
the huge government guarantees for uncovered bank bonds made in the first quarter
of 2009. At the beginning of 2009 the covered bond market took a negative
development. Only as in July 2009 ECB’s CBPP started and in follow of the issuance
of new covered bonds they began to rise again. (Beirne, 2011, p. 16) The last
records from January 2011 showed that the spread of covered and uncovered bonds
has narrowed to 60 billion.

3.5.2 Empirical long run relations between bank bonds and corporate bonds before
      and after the crisis
The idea behind that empirical analysis is to check whether bank bonds and
corporate bonds follow a long-run trend and how much influence the CBPP had on
The economic crisis and the crisis of economics

those bonds. Corporate bonds are a suitable comparison because both react the
same way on common influential factors. The comparison between bank bonds and
corporate bonds should make it clear whether the CBPP was really a boost for the
bond market or just driven by the substitution of uncovered bonds for covered bonds.
Error! Reference source not found.Figure 4 shows the developments of bank
bonds (consists of uncovered and covered bonds) and corporate bonds. The scale
for corporate bonds is on the left side ordinate and those for bank bonds on the right
side ordinate. (Beirne, 2011, p. 16)
Figure 4: amount of bank and corporate bonds

Source: European Central Bank (2011), The Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets, p. 16 (slightly modified)
In August 2007 during the turmoil of the financial crisis the corporate bond market fell
in a condition of stagnation for about one year. The bank bond market seemed quite
unaffected by the recent crisis until June 2009 where the growth of the bank bond
market stocked. After the start of the CBPP (at the beginning of July 2009) the
growth increased again. This evidence suggests that the CBPP had a positive
influence on the bank bond market. But this short term effect seemed to be triggered
by substitution effect of uncovered bonds for covered bonds. The negative
development of corporate bonds showed that the CBPP hadn’t any aggregate effect
because both bonds normally move in pro-cyclical way. But at the end it can’t be said
that the CBPP had no real impact. Without the CBPP it would have become much
harder for banks to refinance themselves than with it. The programme made it easier
for banks to recover.
It is empirically proven that the CBPP is to evaluate positively regarding the covered
bond market. But maybe the positive impact on the primary market is not as big as
the Governing Council of the ECB expected. Was the effect high enough for paying
the price of broken rules and disregard price stability? Or was the amount of € 60
The economic crisis and the crisis of economics

billions spent too low to stimulate the European economy? At least the young
institution ECB has now some empirical data to learn from.

3.6   Empirical analysis of the CBPP’s impact on the secondary market
The secondary market is a market where bond holder trade bonds with each other.
On the secondary market the bond holder has two possibilities. He/she can hold the
bonds until the end of their maturity to earn the outstanding payments (the coupon
and the redemption amount) or he/she can sell them on the secondary market. The
next section will show how the secondary market responded to the crisis and to the

3.6.1 The announcement effect (short-term impact)
This empirical analysis focuses on the impact of the CBPP on the yield spreads of
covered bonds in different Euro zone countries. In this case is the yield spread the
difference between a covered bond yield of a Euro zone country and a risk free
benchmark yield (Treasury bond yield of a country with AAA rating). The observed
countries are the two leading economies in Europe, Germany and France and two of
the “PIIGS” (is an acronym for high debt countries in the Euro zone that refers on
Portugal, Italy, Ireland, Greece and Spain) states Spain and Ireland. Error!
Reference source not found.Figure 5 shows how the four country’s covered bond
yields reacted to the announcement of CBPP. The hoped effect occurred and it
diminished in all four countries. A special case is Ireland which was hit by massive
bank insolvencies during the crisis. The Irish covered bond spread increased at 10
basis points on the day of the announcement. Why Irish covered bonds experienced
such a counter reaction in comparison with other covered bonds is unknown. The
only thing we can exclude is that the Irish yield spread increased because of adverse
news. This reaction was only a temporary event and one week after the
announcement the spread decreased like in the other Euro zone countries. The
German yield difference gave the most positive response. It tightened by 7 basis
points on the day of the announcement and declined in the following week on
average for 3 basis points. In all four countries the gap decreased more than 4 basis
points on average. (Beirne, 2011, p. 19-20)
The economic crisis and the crisis of economics

Figure 5: covered bond spread (short-term impact)

Source: European Central Bank (2011), The Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets, p. 20 (slightly modified)

3.6.2 Long-term impact of the CBPP on covered bond yields
To execute an exact analysis of long-term effects of the CBPP; agency bonds will be
a suitable benchmark because of their similar market movements to covered bonds.
Agency bonds have other suitable advantages too. Namely it allows control for
country-specific effects and the agency yields are not strongly affected by floods of
liquidity. It’s an agency bond because this type of bond is issued by a government
sponsored agency. The offerings of these agencies are backed by the respective
governments. Nevertheless they are private entities. In this analysis the two biggest
economies in the Euro zone (in fact Germany and France) are compared to observe
the long term impacts of the CBPP on their yield spreads. The spread now is the
difference between the yield for a covered bond and an agency bond. The German
agency is the “Kreditanstalt für Wiederaufbau” (KfW) and the French agency is the
“Caisse dÁmortissement de la Dette Sociale” (CADES). Both agencies have a full
government debt guarantee. In Figure 6 the spreads of both countries remained
mainly stable before the crisis erupted. In the case of Germany it stood around 10
basis points and in France it reached 20 basis points. When the crisis began the
spreads in both countries started to grow. The German yield spreads remained in the
crisis more stable than the French ones. French covered bond spreads achieved
heights of 125 basis points before the CBPP’s announcement. The interesting
development in Germany is that ahead of the announcement the spread remained
stable and fell at 35 basis points into a negative area after the CBPP had been
publicised. That means that after the announcement yields for German covered
The economic crisis and the crisis of economics

bonds remained smaller than for agency bonds. This is quite surprising because
covered bonds have a higher credit risk than agency bonds. In France the
announcement had a huge effect too. The covered bond spreads there declined by
about 50 basis points and since July 2010 it stood 30 basis points above their pre-
Lehman level. (Beirne, 2011, p. 20-21)

Figure 6: covered bond spreads (long-term impact)

Source: European Central Bank (2011), The Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets, p. 21 (slightly modified)

3.7    Conclusion on the CBPP
The collected empirical data of the last sections demonstrated that the CBPP
lowered the yields of covered bonds. The shrinking of covered bond yields hasn’t
been small during the programme. The yields were clearly cut and so it could offset
the upward pressure triggered by the crisis. But the question is if the dampening
effect of averaged 12 basis points on Euro area covered bond yields are enough to
further new issues of covered bonds? At least it seemed so because finally the
empirical analysis made clear that after the announcement and during the
programme the issuance of new covered bonds on the primary market increased -
especially in critical economies such as Greece and Italy. Due to increase of
The economic crisis and the crisis of economics

issuances of new covered bonds, ECB accomplished his mission of lowering the
overall funding costs of banks successfully.

3.8    Comparing the Fed´s QE with the ECB´s CBPP

3.8.1 Introduction
When the federal funds rate was cut to nearly zero in December 2008, the Fed has
eventually reached its limits for open market operations. Ben Bernanke (current
chairman of the Fed and an expert for what happened in the Great Depression) came
up with an idea which was used before during the Kennedy administration in the
sixties and the last time in Japan 2006. This idea has the name Quantitative Easing.
Ben Bernanke tried to call this revival instrument “Credit Easing” to separate it from
the unsuccessful programme of the Japanese but his version hasn´t gained
acceptance in public anyway. (Blinder, 2010, p. 1)

3.8.2 What is QE and how does it work?
In 2008 when interest rates were close to zero in most of the leading economies, a
situation prevails that is called a liquidity trap. Nouriel Roubini formulated it suitably:
“It’s what happens when the Fed has exhausted the power of open market
operations. That dreaded moment arrives when the Federal Reserve has driven the
Federal funds rate down to zero…’s almost impossible to drive policy rates below
zero. You can’t make banks lend money if they’ll be penalized for doing so. Policy
makers find themselves in a serious quandary. They’re in the dreaded liquidity trap.”
(Roubini, 2010, p. 66) In this situation conventional monetary policy is useless. Such
a case can have dramatic consequences if deflation captures the economy. In such a
case the real interest rates are rising and the monetary authorities’ can´t do anything
to stop this deflationary impulse. In such situation QE will be a solution. By buying
market assets such as bonds, the central bank has the power to decrease risk
premiums and flattening the yield curve of these bonds, so they can stimulate
aggregate demand. It works the same way like the CBPP in the Euro zone. Another
positive side effect of QE is that it can reduce the risk or liquidity spreads of bonds
over Treasuries. This can boost investments and consumption too because private
borrowing, lending and spending depends on non-Treasury rates. A central bank can
do this in the way that it buys risky or less liquid assets or by selling some Treasuries
out of their portfolio. So they can steer supply and demand of the asset and Treasury
market. By selling Treasuries out of their portfolio a central bank changes its own
balance sheet by creating new base money. This market intervention increases than
the size of central bank´s balance sheets and this is exactly what can be watched by
looking at the Fed´s balance sheet. (Blinder, 2010, p. 2-4)
The effectiveness of QE depends mainly on the substitutability across the assets
which are traded. If all assets in the markets are perfect substitutes of each other, a
purchase of a segment of assets will not change the supply of the market and
therefore this won´t have any change on prices or on the yields of these assets.
Investors would have the ability to switch to other assets at any time.
The economic crisis and the crisis of economics

3.8.3 The extent of the Fed´s QE programme compared with ECB´s CBPP
The first Quantitative Easing programme (QE 1) was introduced by the Fed on the
25th November 2008. The initial plan was to purchase Treasury bonds with an
authorized height of $ 600 billion. That amount has been extended to the
incomprehensible amount of $ 1.725 trillion which is about € 1.185 trillion calculated
with the exchange rate from 22 April 2010 (1,455 $/€). The programme started at 1st
January 2009 and ended on 31st March 2010. Against this high amount which was
pumped into the American economy the ECB´s CBPP with an amount of € 60 billion
seems like a drop in the bucket. The main difference between the Fed´s and the
ECB´s programme is that the ECB mostly purchased collateralized bonds with
maturities of three to seven years. The Fed´s quantitative easing was much more
excessive concerning its assets purchasing. QE 1 was generally focused on
purchases of direct obligations of housing related government sponsored enterprises
(GSEs) and mortgage backed securities (MBS); backed by Fannie Mae, Freddie Mac
and the Federal Home Loan Banks. The idea behind this was to support the
mortgage and housing markets, in way that reduces residential mortgage rates. But
the Fed bought government bonds as well, like the ECB in its Security Market
Programme (The Federal Reserve, 2010). On the 23 August 2010, Ben Bernanke
communicated that the Fed will start another Quantitative Easing programme (QE 2)
that was authorized for new purchases of Treasuries with an amount of $ 600 billion.
The programme was officially announced on 3rd November 2010 and should end on
30th June 2011. (Swanson, 2011, p. 1)

3.8.4 Central bank´s balance sheets rising
When in summer 2007 the first waves of the financial crisis showed up, the Fed
reacted, in cutting the federal funds rate, much too slowly, most economists criticized.
The FOMC (Federal Open Market Committee) cut the federal funds rate down to 2
percent until April 30, 2008. While the Fed was criticized for its slow reaction, the
ECB was doing nothing in that way. The ECB´s key interest rate was kept constant,
(4 percent) until July 2008. Then the ECB decided to increase the rate at 250 basis
points to 4.25 percent because of their concern about rising inflation. This was a
complete different reaction to that what the Fed had done before. These actions can
be seen in
(pink lines). (Klyuev, 2009, p. 4)
The economic crisis and the crisis of economics

Figure 7: US and European balance sheets

Source: Vladimir Klyuev, Phil de Imus and Krishna Srinivasan, Unconventional Choices for
Unconventional Times: Credit and Quantitative Easing in Advanced Economies (2009), p. 5, (slightly
QE in a weaker form started at the beginning of 2008 when the Fed decided to sell
government securities (Treasuries) and bought less liquid assets instead. Through
that procedure the Fed tried to support dried up markets with liquidity and to
decrease the liquidity premiums of those assets. The real QE programme had started
after the bankruptcy of Lehman and changed the liability side of the Fed´s balance
sheet tremendously. The Treasury began to prop up the Fed for its QE and deposited
there an excess of funds at the central bank. This enabled the Fed to acquire more
securities to increase their assets and to widen the lender of last resort abilities.
(Stark, 2009)
After the Lehman collapse the ECB was constrained to act. Through the widening of
the maturities of their standing facilities and other credit support measures, the
ECB´s balance sheet grew massively at October 2008 (see
). Another reason for it was that banks had the opportunity to deposit their excess
liquidity (which they had borrowed before under special conditions) at the central
bank´s deposit facility. At the beginning of 2008 the ECB held € 1.53 trillion in assets
and at the end of that year this amount increased to € 2.08 trillion (about $ 3 trillion).
That means an increase of 36 percent of the ECB´s balance sheet in one year! In
2009 their balance sheet decreased continuously until the ECB started its € 60 billion
costly CBPP, on 6th of July 2009. (Randow, 2009)
The failure of Lehman gave the Fed new incentive for even more radical measures.
First of all the FOMC pushed the interest rates down to zero in the middle of
December 2008. The most remarkable act was the huge expanding of the Fed´s
balance sheet through QE. The total amount of assets rose from $ 907 billion on the
3rd September 2008 to $ 2.214 billion on November 12, 2008. That means the
balance sheet has far more than doubled within two month (see
)! Cranking up aggregate demand became the main priority for the Fed - as
pronounced in a press release from December 16, 2008: “The Federal Reserve will
The economic crisis and the crisis of economics

continue to consider ways of using its balance sheet to further support credit markets
and economic activity.” (Federal Reserve, 2008)
In those days, after the Lehman disaster, the Fed became very creative in building
new facilities like it is the Maiden Lane facility which was designed to help the
tattered investment bank Bear Stearns and the financial insurer AIG. The Fed bought
almost everything what could be bought on the financial markets. Under its
purchases have been securities such as commercial papers to carry non-financial
institutions. For that reason the Commercial Paper Funding Facility (CPFF) was
founded in September 2008. Not only the asset side of their balance sheets
increased to historical heights, also the liability side increased extremely. Bank
reserves exploded practically from the before crisis level of about $ 11 billion to an
incomprehensible amount of $ 860 billion at the end of 2008. In the following of these
massive market interventions the Fed´s balance sheet got extremely leveraged. The
Fed´s leverage (debt to equity ratio) rose from 22:1 to 53:1. The high leverage ratios
of banks all over the world were a catalyst for the crisis. Is it right of the Fed to follow
the same strategy? It will be interesting to see in the upcoming years how the Fed
gets rid of this high amount of liabilities. Aside from the high amount of liabilities that
the Fed already has accumulated, there is also always the danger that the purchased
assets become worthless if diverse bankruptcies or defaults take place. (Blinder,
2010, p. 7-9)

3.8.5 The ECB´s and Fed´s exit strategies
Together the ECB and the Fed were working out suitable exit strategies for their non-
standard monetary instruments. In matching their decisions they try to avoid
uncertainty about rising inflation in the financial markets. Such concerns are not
without reason because central banks have experienced huge rises of their balance
sheets (see section 3.8.4). Now both central banks try to get rid of it. On the 4th of
September 2009, Jean Claude Trichet published some scenarios how the exit
strategies for the non-standard measures could look like. The main goal concerning
these strategies is still to keep prices stable – which has been the main task of the
ECB up to now respectively in the recent past. The ECB has to be transparent to
make those exit strategies effective. If this is not the case, fears in public about
increasing inflation and uncertainty about the stability of financial markets will come
up. This will provoke rising long-term interest rates which harms the recovery of the
European economy. (Trichet, 2009)
The ECB exit strategies for several financial instruments are:
      Repurchase agreements: A huge amount of the provided liquidity for banks in
       the heat of the crisis was equipped with repurchase agreements. So these
       problems are self-releasing if those banks are still solvent.
      The widening of the accepted collateral: At the beginning of that measure it
       was clear that the widening of accepted collateral to a BBB- rating is only
       temporary. The whole programme was stopped in December 2010. The
       accepted collateral remains in the ECB´s balance sheet.
The economic crisis and the crisis of economics

      The provision of foreign currency swaps with the Fed will not be maintained if
       there is no demand for additional Dollar currency in the European financial
      The plan for € 60 billion expensive CBPP is to hold them in their balance sheet
       until maturity. So they will shrink over time as a result of their redemption
The Fed´s exit strategies are more complex crisis supporting measures than those of
the ECB. The complete concept hasn´t been fixed yet but the several speeches of
Ben Bernanke gave some insights how the Fed is about to handle it. The key
elements of the Fed´s exit strategies are (Blinder, 2010, p. 11-14):
      The extraordinary liquidity facilities (Maiden Lane, CPFF) which were keenly
       implemented in the crisis were running out if they wouldn’t have use anymore.
       The Fed´s implemented CPFF to sustain non-financial institutions were closed
       on 1st of February 2010. The same happened to the lending facility for primary
       dealers - the Term Securities Lending Facility.
      The discount window was closed on 18th of February 2010. It was installed by
       the Fed for emergency loans to banks with a maturity of 90 days with quasi no
      In the case of the assets which were being purchased under QE (mortgage
       backed securities and asset of government sponsored enterprises) the Fed
       will have to need stamina. As those asset purchases are primarily responsible
       for the exploding balance sheet, the Fed can phase those assets out through
       open market operations. Anyway it will take years if not decades to return to
       the prior crisis balance sheet level.
      Another step for lowering the balance sheet is to reduce the quantity of
       reserves by repurchase agreements and selling securities through open-
       market operations. As these actions affect the market interest rates, the Fed
       has to be very careful in doing so. Because of the huge amount of securities
       the Fed has accumulated over time, the FOMC has to consider different macro
       signals in the markets to avoid any disturbing or harming of an upcoming
       recovery of the US economy.

3.8.6 Conclusions of the comparison of the two programmes
The biggest problem for an exit strategy in any country is to find the right time to do it.
If a central bank stops their non-standard measures too early the growth of the
economy will be harmed or rather slowed down. If their strategies are implemented
too late, inflation and moral hazard problems either will be boosted. In comparison
with the bailout programme of the Fed to those of the ECB it was only a small market
intervention taking place in the EU. But as already mentioned both economical
systems are quite different regarding many areas. It seems that the ECB was quite
more carefully in their intensity of their actions than the Fed did it. The future will
uncover what way was the more effective one eventually.
The economic crisis and the crisis of economics

4      The Security Market Programme

4.1    Introduction
On the 9th of May 2010 the Governing Council publicly announced that under the
special circumstances of a European debt crisis and the associated risk for a
devaluation of the Euro currency to undertake interventions in the Euro area’s public
and private debt securities markets. The Security Market Programme (SMP) is part of
the Euro system´s single monetary policy and will only be used for a limited duration.
(Trichet, 2010, p. 1-2)

4.2    Facts about ECB’s government bonds purchases
The main aim of this programme is to restore an appropriate monetary policy
transmission mechanism and to keep the ECB´s main target of price stability upright.
The ECB thereby takes into account to do measures which should help to meet fiscal
targets, which were adopted in the following of excessive deficit procedures of
diverse countries (PIIGS states) and to ensure the sustainability of their public
finances. The Governing Council decided that it would be allowed for the Euro
system central banks to procure eligible marketable debt instruments under the
programme. Which purchases are allowed to implement for central banks in the Euro
zone is fixed in Article 1 of the publication of the ECB from the 14th of May 2010:
“Under the terms of this decision, Euro system central banks may purchase the
following: (a) on the secondary market, eligible marketable debt instruments issued
by the central governments or public entities of the Member States whose currency is
the Euro”. (Trichet, 2010 p. 1-2) That means that national central banks which are
within the Euro zone are allowed to buy government bonds of their home country.
This is definitely a questionable step as it harms the independence of national central
banks from their governments and this in turn is one of the most fundamental central
bank rules. The ECB has bought about € 73.5 billion in government bonds from
Ireland, Greece and Portugal until the end of 2010.

Figure 8: ECB government bond purchases under the Security Market Programme

Source: Megan Greene (2011), Sceptical on the European Risk Board, Article, (slightly modified)
The economic crisis and the crisis of economics

After the EU bailout package of € 110 billion of emergency loans for Greece had
been granted, the ECB had to ‘snatch’ Greek government bonds at the amount of €
25 billion in May 2010. This is also shown in Error! Reference source not
found.Figure 8. The amounts of orders for Irish and Portuguese government bonds
were much less than those for Greek bonds. (Fernando, 2010) In the critical days of
July 2011, when the yields for Italian and Spanish government bonds began to rise,
the ECB invested another € 22 billion. So the SMP counts total expenditures of € 96
billion and there is no end in sight until those critical countries are able to give the
market signals for a drastic debt reduction. (Reuters, 2011)

4.3    Empirical analysis of SMP’s effects
In this section we are going to analyze how the Greek bond returns reacted to the
European SMP. Figure 9 shows the development of a 10 year Greek government
bond yield. The chart shows how the yield has changed after the ECB had started to
purchase Greek bonds in the amount of € 25 billion in May 2010.

Figure 9: Reaction of the greek´s government bond yield

Source: The Independent (2010), Ben Chu, Did Georg Osborne save the world
After the real amount of the Greek debt disaster had been published, (the Greek
government had manipulated their balance of payments in the last years) the
probability of a Greek default rose steadily. That would imply that a lot of bondholders
(most of them are banks from Germany and France) wouldn´t get their money back.
Because of the downgrade of Greek government bonds to (BB+/B) in April 2010 the
interests increased dramatically. At the beginning of May 2010 they reached a height
of 12.45 percent. If this Price for Greek government bonds increases further they
wouldn´t be able to issue new bonds or serve their interest payments. After the
intervention of the ECB trough massive purchase of Greek government bonds the
yield decreased to 8 percent. That proves that this intervention was at least effective
to decrease the yield temporary at 4 percent. In June it went up again and stabilized
until August 2010 at a value close over 10 percent – what is still high enough. The
bond yield from 8 July 2011 lies between 16 and 17 percent and the rating of Greek
The economic crisis and the crisis of economics

bonds have been downgraded to the status of default! This empirical data show that
the SMP had no long-run effects on the bonds and was not enough to justify giving
up temporarily ECB’s golden rule of independence of European governments.

4.4   Critical voices on the ECB´s Security Market Programme
One of the main critics is that the only thing that the ECB and Euro zone gained of
these expensive government bonds purchases from high debt countries like Greece,
Ireland or Portugal was time. In the case of Greece dark clouds are gathering
together. The massive tax increases implied by their strict saving programme and the
shrinking of the Greek economy is making it quite impossible that Greece will be able
to pay back their debt burden. The whole rescue programme seemed to be more a
bailout for German and French banks, which are the main bondholders of those high
debt European countries, than a support for Greek to get out of this self caused
mess. As mentioned before, the ECB bought Greek government bonds in May 2010
in the amount of € 25 billion. That is a huge amount of reserve which the ECB
invested in government bonds which were meanwhile down rated in the category of
default (D). In the best case the ECB will have to accept a haircut. So part of the
invested money (reserves of the ECB) will be simply lost.
Other critical observers mean that this programme produces massive moral hazard
problems for governments with bad fiscal policies. Thus the ECB is sending signals
that in the case of an impending bankruptcy of a Euro country it will intervene again
and rescue them. This will give such debt “sinners” no incentive to keep a strict fiscal
policy discipline. One of the most famous critics on this programme is Axel Weber the
president of the German Bundesbank and one of 22 council members in the ECB.
Weber has the opinion to stop a further government bond purchasing. He said: ”The
risk of “exiting too late” from the emergency measures was greater than pulling out
too soon.” (Bloomberg, 2010) That critic on the Governing Council has cost Weber
the chance to be the next ECB president in the election terms 2011. Other Governing
Council members stand by to this programme and intervened to the harsh critic like
the Austrian Governing Council member Ewald Nowotny who argued: ”It makes
sense to use it as a safety belt”.(Bloomberg, 2010) The majority of the Governing
Council members is having the opinion that exceptional times need exceptional
measures. Although there are disagreements among council members over the
SMP, it is still running and it will not stop until the European debt crisis is solved or
when Jean Claude Trichet has to leave his chair in October 2011 and a new ECB
president with new ideas gets elected.

4.5   Conclusions drawn from the Security Market Programme
The critic done by Axel Weber may be mainly appropriate. The effects of lowering the
governmental bond yield through the SMP have shown only short term effects and
the price of losing confidence in the ECB´s independence regarding European
governments was too high and therefore not acceptably.
The economic crisis and the crisis of economics

5     Conclusions

Altogether, after all those empirical facts which had been analysed, the ECB
responded too late and not active enough in the crucial span of the crisis. In
comparison with the Fed that might be true but if the more drastically measures of
the Fed have been more successful than those of the ECB cannot be said yet with
certainty. From the actual point of view Europe is recovering better as there are
higher growth rates and less unemployment rates than in the US. Both economies
have now to handle a huge debt deficit which is threatening the value of their
currencies. As a matter of fact the crisis isn’t over yet although many people want to
think that. It just entered into a new phase where the former rescuer, namely the
governments, got infected as well or put it this way: Many states are already at critical
point regarding their deficit. Banks still have a huge amount of leverage and they act
in the same manner as before the crisis. The predicted moral hazard problem has
occurred. But there are some glimmers of hope too. In the US, the Obama
administration reintroduced the “Glass-Steagall Act” which twists commercial banks
from investment banks with the purpose to reduce speculation in unlimited
dimensions. In Europe, the stricter rules for bank equity of Basel III will become
binding for every bank in the European Union.
Concerning the change in the European monetary policy it must be said that some
measures, like the expansion of the lending facilities in the heat of the crisis, were
more than necessary. The CBPP seemed also to be satisfying in some way. To my
opinion the SMP didn´t hurt only the credibility in the independence of the ECB; it
was also a waste of money because of its mere temporary effects. An orderly
bankruptcy of Greece and an investment programme in a productive infrastructure of
the high debt European countries with the same amount of money would be much
more effective to restore the competiveness of those countries within the global
The crisis showed us at least where the European economy is vulnerable and what
European central bankers have to change in the future. Euro-countries have to grow
together more closely to lose their economical asymmetry and should give the ECB
the chance to establish a monetary policy which suits all member countries as good
as possible to handle future crisis more efficiently.
The economic crisis and the crisis of economics

Belke, A (2010), ‘Financial Crisis, Global Liquidity and Monetary Exit Strategies’,
Deutsches Institut für Wirtrschaftsforschung, pp. 2-10.
Beirne J, Dalitz L, Ejsing J, Grothe M, Manganelli S, Monar F, Sahel B, Susec M,
Tapking J and Vong T. (2011) ‘Impact of the Eurosystem´s Covered bond purchase
programme on the primary and secondary markets,’ European Central Bank, NO
122, pp. 3-24.
Blinder A S (2010), ‘Quantitative Easing: Entrance and Exit Strategies’, Princeton
University, CEPS Working paper No. 204, pp. 1-16.
Bloomberg, ECB´s Trichet rejects Weber´s call to End Bond Purchase Programme,
viewed on 7 June 2010,
Deepak M, (2011), ‘Lessons for monetary policy from the global financial crisis’,
Reserve Bank of India, pp. 1-12.
ECB Press release (2008), Measures to further expand the collateral framework and
enhance     the     provision    of   liquidity, viewed    on   5     May   2011,
ECB Press release (2008), Renewal of the supplementary longer-term refinancing
operations of 23 November 2007 and 12 December 2007, viewed on 30 April 2011,
ECB (2010), ‘The ECB´s Monetary Policy stance during the financial crisis’, monthly
Bulletin, pp 63-71.
ECB (2011), ‘The Implementation of Monetary Policy in the Euro Area’, General
documentation on Eurosystem Monetary policy instruments and procedures,
Eurosystem, pp. 3-14.
European Covered Bond Council (2009), About Covered Bonds, viewed on 17 April
Executive Board of the ECB (2011), ’The monetary policy of the ECB’, Eurosystem,
pp. 55-115.
Fernando, V. (2010), The ECB Is Running Low On Capital, viewed on 1 June 2011,
González-Páramo J. M. (2010), The European Central Bank and the policy of
enhanced       credit      support,     viewed     on      15   April 2011,
Klyuev V, Phil de Imus and K. Srinivasan, ‘Unconventional Choices for
Unconventional Times: Credit and Quantitative Easing in Advanced Economies’,
International Monetary Fund, pp. 4-11.
Randow J. (2009), ECB Expands Balance Sheet by 36 Percent to Revive Lending,
viewed on 10 May 2011,
The economic crisis and the crisis of economics

Reuters (2010), U.S. Fed reopens currency swap lines with ECB, viewed on 17 April
Reuters (2011), ECB reactivates bond-buy plan with record amount, viewed on 22
August          2011,
Roubini N. and S. Mihm (2010), Crisis Economics - A Crash Course in the Future of
Finance, New York: Penguin Press.
Stark J (2009), Montetary Policy before, during and after the financial crisis, viewed
on 19 April 2011,
Stella P. (2009), ‘The Federal Reserve System Balance Sheet: What Happened and
Why it Matters’, International Monetary Fund, WP/09/120, pp. 4-44.
Swanson Eric (2011), ‘Let’s Twist Again: A High-Frequency Event-Study Analysis of
Operation Twist and Its Implications for QE2’ , Federal Reserve Bank of San
Francisco, version 1.4, pp. 1-34
The Federal Reserve (2008), For release at 8:15 a.m. EST, viewed on 30 May 2011,
The Federal Reserve (2008), Press Release: For immediate release, viewed on 7
June 2011,
The Federal Reserve (2010), A QE1 Timeline, viewed on 3 May 2011,
Trichet J. C. (2009), Decision of the European Central Bank of 2 July 2009 on the
implementation of the covered bond purchasing programme, viewed on 21 April
Trichet J. C. (2009), The ECB´s enhanced credit support, viewed on 16.04.2011,
Trichet J. C. (2009), The ECB´s exit strategy, viewed on 19 April 2011,
Trichet J C (2010), Establishing the Security Market Programme, viewed on 15 May
Trichet J. C. (2010), The ECB´s response to the recent tensions in financial markets,
viewed on 18 April 2011,
Trichet J. C. (2010), Establishing the Security Market Programme, viewed on 15 May

Shared By: