ECB’s LTRO conducted in Dec 2011 for about Euro 500 billion has proven a game changer for the liquidity driven risk appetite across the globe. This money printing binge by the ECB has not met with usual stiff resistance from Bundesbank.
We speculate here that the possible reason for this silence from Bundesbank can be found in the TARGET2 balances of Bundesbank, as shown the chart below.
TARGET2 balances – mostly assets, which depict imbalances in the payment system in the Eurozone, has risen rapidly for Bundesbank since the start of the current crisis in 2007, and is now just shy of Euro 500 billion.
It is interesting to note that the creditors for TARGET2 are PIIGS. For example, Greece Central Bank owes more than Euro 109 billion to TARGET2. Though theoretically, these liabilities are “secured”, the question is secured against which security? If the PSI for Greece transforms into OSI, as has been demanded by market players, Buba may end up taking direct losses of more than Euro 70 billion, if these are secured by Greek Bonds. Again, in theory, these losses are underwritten by the Eurosystem. However, pragmatically, which component of Eurosystem is able to pay to Buba at this stage?
One way would be to provide liquidity to Greece banks from ECB, and adjust the funds to pay down TARGET2 liabilities. So, losses would eventually come in on the books of ECB.