Blog Post

Has the European Central Bank transformed itself into a hedge fund?

Some observers have accused the European Central Bank (ECB) of having transformed itself into a hedge fund because of the purchases of government securities from stressed countries under the Securities Market Program (SMP).

By: and Date: March 8, 2013 Topic: European Macroeconomics & Governance

Some observers have accused the European Central Bank (ECB) of having transformed itself into a hedge fund because of the purchases of government securities from stressed countries under the Securities Market Program (SMP)[1].

The accusation of course does not take into account, or does not believe, the argument made by the central bank that the purchases were needed to counter the fragmentation of the euro area financial market brought about by the crisis and the ensuing impairment, or even break down, of the transmission of monetary policy. In a nutshell, the argument of the ECB was that its ability to guide, through its control of the short-term interest rate, the cost of bank lending relevant for the economies of the different countries of the euro area was substantially impaired by the diverging behaviour of the yields on government securities in the periphery with respect to the core. For instance bank rates on small loans (up to and including EUR 1 million) have been on average 200 basis points higher in Spain than Germany during the last 10 months, given that the yield of Spanish government securities attracted Spanish bank rates up while that of German government securities attracted German rates down. And, of course, this is the wrong differentiation of monetary policy, given that Spain is in a recession, while unemployment in Germany is at historically low levels.

Whether one wants to follow or not the ECB reasoning that its purchases were dictated by macroeconomic and not investment reasons, like the ones of a hedge fund, it is interesting to ask what have been the financial consequences of the purchases: did the ECB loose or make money with its purchases of government securities from stressed jurisdictions? The question may get even more interesting for those who are convinced by the argument of Milton Friedman that only interventions that make money for the central bank are right from a macroeconomic point of view[2].

The recent publication from the ECB of the split per country of its purchases under the Securities Market Program, together with the available data on the weekly purchases and the difference between the market prices prevailing when the purchases were made and those prevailing in March 2013 allow estimating, albeit with some inevitable imprecision, whether the central bank has lost or made money with its purchases[3].

Table 1

Issuer country

Outstanding amounts

Average remaining maturity (in years)

Share of total holdings of each round[4]

Nominal amount

(EUR billion)

Book value[1]

(EUR billion)

Ireland

14.2

13.6

4.6

20.6%

Greece

33.9

30.8

3.6

46.7%

Portugal

22.8

21.6

3.9

32.7%

Spain

44.3

43.7

4.1

30.6%

Italy

102.8

99.0

4.5

69.4%

Total

218.0

208.7

4.3

 

Source: ECB

In this exercise we estimate the profits that the ECB would make if it were to sell its holdings of bonds purchased under the SMP at the current market value (as of March 1th, 2013); we thus estimate profits according to a “mark to market” approach. This is not the accounting convention followed by the ECB, which uses a “held to maturity” convention, which implies that the bonds are not sold and therefore are reimbursed at par at maturity, unless some bonds were defaulted. The situation is more complicated as regards the Greek bonds, because the ECB was exempted from the so-called Private Sector Involvement but has committed to indirectly return the profits it will realize on Greek bonds to the Greek government.

In order to carry out our estimate, given that the ECB has not released exactly which bonds were purchased at each date, but only the total weekly amount of SMP purchases, the following assumptions were made:

·         Each week the ECB purchases are assumed to have been made according to the reported shares of total holdings for each round, reported in table 1. For instance, during the second week of May 2010, the ECB purchased a total of 16.3 billion euro area bonds and it is assumed that 7.6 billion (46.7%) of these were Greek bonds, 5.3 billion (32.7%) Portuguese bonds and 3.4 billion (20.6%) Irish bonds.

·         To match the average remaining maturity reported by the ECB at the end of 2012, each week the ECB is assumed to have distributed its purchases according to the maturities in the following table:

Table 2

 

3Y

5Y

10Y

Greece

25%

35%

40%

Portugal

25%

30%

45%

Ireland

15%

30%

55%

Spain

45%

30%

25%

Italy

37.5%

32.5%

30%

Table 3 reports our estimate of “marked to market” profits, calculated comparing market prices[5] at the time of the purchases with current prices.

Table 3

 

Profits (bn euro)

Yearly return

Greece

-6.2

-6.6%

Portugal

2.3

3.7%

Ireland

3.7

10.0%

Spain

6.4

10.9%

Italy

8.0

5.9%

Total

14.3

4.8%

In conclusion, if one wants to see the ECB has a hedge fund this has been a successful one, with profits of 14.3 billion over an investment of 222 billion, equivalent to 6.4 per cent, taking into account capital gains and coupon income, recently published by the ECB. Capital gains on the purchases of Italian, Spanish, Irish and Portuguese securities have in fact more than compensated the losses on Greek securities. If one believes the argument of the ECB, that it carried out the interventions for macroeconomic reasons and is further convinced by the reasoning of Friedman, that financial and macroeconomic reasons coincide, then the evidence is that the interventions under the Securities Market program were, so far, successful also from a macroeconomic point of view. Of course, it is obvious that the ECB has incurred additional risk with its purchases, but this should surprise no one, as risk and return are necessarily interrelated, both in investment and in macroeconomic operations.

References

Friedman, Milton (1953), “The case of Flexible Exchange rates”, in Essays in Positive Economics, (Chicago: Chicago University Press).


[1] Of course, the relevant entity is the Eurosystem, comprising the European Central Bank as well as the 17 National Central Banks of the countries of the euro area.  However, for simplicity, the term ECB will be used as a short cut for Eurosystem.

[2] Milton Friedman referred to foreign exchange interventions, but the argument applies in analogy to any kind of interventions, Friedman Milton (1953).

[3] The underlying spread sheet is available on request from the authors.

[4] The SMP was started on May 10th 2010, purchasing Irish, Portuguese, and Greek securities and continued until the beginning of March 29th 2011 (first round). Then it paused and started again on Aug 7th 2011 with purchases of Italian and Spanish securities until September, 6th 2012 (second round).

[5] Not having precise information about the bonds that were purchased, these estimates were made calculating the implicit price of equivalent zero coupon bonds at each given date using the yields of sovereign bonds of 3, 5 and 10 years maturities. For more information see the appendix.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Revision of the Posted Workers Directive misses the point

The Commission’s proposed revision of the Posted Workers Directive has been approved by the European Parliament’s Employment Committee, which welcomes the arrival of “equal pay for equal work”. But the revision will have little impact, and was largely unnecessary. Instead we should focus on the fight against bogus self-employment, social security fraud and undeclared work.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 18, 2017
Read article Download PDF More on this topic

Policy Contribution

Spotting excessive regional house price growth and what to do about it

Rapidly rising house prices are a well-known source of financial instability. This Policy Contribution examines whether there are regional differences in house price growth within European countries and, if so, whether this warrants more targeted measures to address vulnerabilities.

By: Grégory Claeys, Konstantinos Efstathiou and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: October 18, 2017
Read about event More on this topic

Upcoming Event

Oct
26
14:30

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

An update: sovereign bond holdings in the euro area – the impact of quantitative easing

Since the European Central Bank’s announcement in January 2015 of its quantitative easing programme, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, updating calculations that we published initially in May 2016.

By: Pia Hüttl and David Pichler Topic: European Macroeconomics & Governance Date: October 10, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article More on this topic

Blog Post

What has driven the votes for Germany’s right-wing Alternative für Deutschland?

The AfD vote in East Germany was consistently stronger than in the West, even after controlling for income, age, education, religion and the overall rural nature of the new Bundesländer.

By: Alexander Roth and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: October 5, 2017
Read about event

Upcoming Event

Nov
28
12:30

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Jean Pisani-Ferry, Sergei Guriev and Debora Revoltella Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

External Publication

European Parliament

The single monetary policy and its decentralised implementation: An assessment

This paper assesses the decentralised implementation of monetary policy by the Eurosystem in terms of its transparency, efficiency and simplicity. Compared to the Fed, the Eurosystem seems to have higher staff numbers and operational costs for similar tasks.

By: Francesco Papadia and Alexander Roth Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: October 4, 2017
Read article More on this topic More by this author

Blog Post

Ukraine’s oligarchs are bad for democracy and economic reform

Ukraine’s late and incomplete economic reform created a class of super-wealthy oligarchs who now stand in the way of further liberalisation. The oligarchs’ oversized influence only deepens public distrust in a structurally weak political system. Nevertheless, Ukraine is making some attempts to uproot corruption and the next steps are clear.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: October 3, 2017
Read article Download PDF More by this author

External Publication

An innovation deficit behind Europe’s overall productivity slowdown?

Reinhilde Veugelers' chapter in "Investment and Growth in Advanced Economies", conference volume of the European Central Bank’s Forum on central banking in Sintra.

By: Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: October 2, 2017
Read about event More on this topic

Upcoming Event

Nov
30
10:30

Responsibility to reform Europe

At this event, we will host Vice President of the European Commission Jyrki Katainen and the President of Nea Demokratia and Opposition Leader in Greece, Kyriakos Mitsotakis who will have an interactive discussion on how to reinvent the EU and the eurozone.

Speakers: Maria Demertzis, Jyrki Katainen and Kuriakos Mitsotakis Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Load more posts