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: Macroeconomic policy

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.

Read about event More on this topic
 

Upcoming Event

May
25
14:30

How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy
Read about event More on this topic
 

Upcoming Event

May - Jun
31-1
10:30

MICROPROD Final Event

Final conference of the MICROPROD project

Speakers: Carlo Altomonte, Eric Bartelsman, Marta Bisztray, Italo Colantone, Maria Demertzis, Filippo di Mauro, Wolfhard Kaus, Steffen Müller, Gianluca Santoni, Verena Plümpe, Andrea Roventini, Valerie Smeets, Nicola Viegi, Markus Zimmermann and Javier Miranda Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event
 

Past Event

Past Event

[Cancelled] Shifting taxes in order to achieve green goals

[This event is cancelled until further notice] How could shifting the tax burden from labour to pollution and resources help the EU reach its climate goals?

Speakers: Niclas Poitiers and Femke Groothuis Topic: Green economy, Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 12, 2022
Read about event More on this topic
 

Past Event

Past Event

How are crises changing central bank doctrines?

How is monetary policy evolving in the face of recent crises? With central banks taking on new roles, how accountable are they to democratic institutions?

Speakers: Maria Demertzis, Benoît Coeuré, Pervenche Berès, Hans-Helmut Kotz and Athanasios Orphanides Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 11, 2022
Read article Download PDF More by this author
 

Book/Special report

European governanceInclusive growth

Bruegel annual report 2021

The Bruegel annual report provides a broad overview of the organisation's work in the previous year.

By: Bruegel Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: May 6, 2022
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article More on this topic
 

External Publication

What drives implementation of the European Union’s policy recommendations to its member countries?

Article published in the Journal of Economic Policy Reform.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: Macroeconomic policy Date: April 13, 2022
Read article Download PDF More on this topic More by this author
 

Working Paper

Measuring the intangible economy to address policy challenges

The purpose of the first work package of the MICROPROD project was to improve the firm-level data infrastructure, expand the measurement of intangible assets and enable cross-country analyses of these productivity trends.

By: Marie Le Mouel Topic: Macroeconomic policy Date: April 11, 2022
Read about event More on this topic
 

Past Event

Past Event

Macroeconomic and financial stability in changing times: conversation with Andrew Bailey

Guntram Wolff will be joined in conversation by Andrew Bailey, Governor of the Bank of England.

Speakers: Andrew Bailey and Guntram B. Wolff Topic: Macroeconomic policy Date: March 28, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article More on this topic More by this author
 

Opinion

The week inflation became entrenched

The events that have unfolded since 24 February have solved one dispute: inflation is no longer temporary.

By: Maria Demertzis Topic: Macroeconomic policy Date: March 8, 2022
Load more posts