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Greek default could bankrupt ECB

Thursday 2 June 2011 - by Andrew Hickley

Further debt problems in Europe could lead to the European Central Bank needing to be recapitalised after the "unqualified failure" of its bond purchase programme.

According to F&C Asset Management, the ECB has squandered so much money supporting the secondary bond markets in the financial crisis that it cannot afford to make further risky loans to its crisis-ridden countries.

Director of global strategy Ted Scott launches a defence of the ECB's refusal to allow Greek bonds to be traded as collateral if the country were to default or to have a "soft reprofiling", as members of European Commission have proposed.

The ECB's stance would cut off funding to several Greek banks, likely precipitating several bankruptcies and a major European banking crisis.

However Scott urges the bank to leave the IMF and European Commission to "put their heads together" to reach a compromise that would not undermine confidence in the banking sector.

"It [the ECB] desperately wants to distance itself from the debt crisis and normalise monetary policy rather than being used as an emergency lifeboat for the sinking periphery countries," the note reads.

Scott argues that this threat to cut off Greek funding has acted as a warning to other members of the 'troika' that the eurozone would be unable to afford a default, even if it were only 'soft'.

However the ECB's refusal to help also serves as an indication of its vulnerable capital levels, he says.

"The reality is that, with the periphery countries it is trying to provide assistance to, the ECB has become so embroiled in the crisis that its own assets and capital have been severely weakened.

"The importance of this should not be lost on investors because it has, and will, limit the ability of the ECB to help shore up the periphery countries and, in the event of a default, the bank itself may need recapitalisation from the 17 Eurozone central banks."

The ECB would suffer a manageable loss of €15.8bn ($22.9bn) on its loans to Greece if the country's debt ratios were reduced to 90 per cent of GDP via a restructuring, given that it has holds capital worth €81.2bn ($117.5bn), Scott says.

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2011-06-02 15:10:06 | Mira
Our monetary system is based on credit or debt, and without constantly continuing issuance of debt, the whole thing falls apart. Our system of ‘fractional reserve banking’ gives commercial banks a licence to literally create money out of thin air – and then charge interest on the money they created. Fractional reserve banking is the cause of spiralling debt.

A public campaign has started to end fractional reserve banking, and I recommend readers to look at the website which explains further.