ECB Buying Up Greek Bonds: German Central Bankers Suspect French Intrigue

The senior members of the German central bank, the Bundesbank, regarded Axel Weber with a look of anticipation. What would Weber, the Bundesbank president, say about the serious crisis that had them all so worried, they wondered? And what did he intend to do about it?

Weber said nothing and, as some who attended the meeting report, even his facial expression was inscrutable. The Bundesbank president remained stone-faced as he acknowledged the latest figures, which indicated that by the end of last week the European Central Bank (ECB) had already spent close to €40 billion ($50 billion) on buying up government bonds from Spain, Portugal, Ireland and, in particular, Greece.

The ECB already has about €25 billion of Greece's mountain of debt on its books, and it is adding another €2 billion a day, on average. The Bundesbank, which has a 27 percent stake in the ECB, is responsible for €7 billion of the ECB's Greek government bonds.

Many Bundesbank members are wondering why the ECB is buying Greek bonds in the first place, particularly on this scale, now that the euro-zone countries' €110 billion bailout package for Greece has been approved, and the first tranche of the funds has already been disbursed.

The general €750 billion rescue fund for the remaining highly indebted countries has been approved but not yet set up. For this reason, it certainly makes sense to stabilize the prices of Spanish, Portuguese and Irish bonds. Nevertheless, some of the central bankers have a sneaking suspicion that there is a French conspiracy at work.

Bailing Out French Banks

By buying up Greek debt, the ECB keeps the prices of the bonds artificially high. French banks, in particular, benefit from this policy because it enables them to sell their Greek bonds to the ECB, as an inexpensive way of cleaning up their balance sheets. France's banks and insurance companies have a total of about €80 billion in Greek government bonds on their books.

German banks, on the other hand, are not potential sellers, because they have made a voluntary commitment to Finance Minister Wolfgang Schäuble to hold their Greek bonds until May 2013.

Thus, in a roundabout way, the Bundesbank, by spending €7 billion to purchase the Greek securities, has already made a substantial contribution to bailing out banks in neighboring France.

It was ECB President Jean-Claude Trichet, a Frenchman, who, in an alarming and provocative speech, initiated the extensive euro rescue package that was approved on the weekend of May 8-9. And it was Trichet who yielded to massive pressure from French President Nicolas Sarkozy and, soon afterwards, violated a long-standing ECB taboo, namely that the central bank should never buy its member states' debt. This, however, was precisely what Sarkozy had demanded of his fellow European leaders, including German Chancellor Angela Merkel.

Clear Signal

Weber, the Bundesbank president, voted against this measure in the ECB council and criticized it the next day in an interview with the German financial newspaper Börsen-Zeitung. For a central banker, this is a very clear signal of dissatisfaction. But the Bundesbank president faces a dilemma, because he hopes to take over as ECB president when Trichet's term expires next year. The general consensus in the German government is that if he continues to fight against the purchase of the bonds, his prospects for securing the top ECB post will dwindle.

But many German central bankers expect Weber to remain steadfast and not give in. For them, the purchase of government bonds is a betrayal of the principles of the once-proud institution. By deciding to do so, they say, the ECB has lost its status as an independent central bank -- and, along with it, so has the Bundesbank. And then there is the fear of the consequences of such a purchase, which many central bankers believe could jeopardize the very existence of the ECB.

However, European central bankers do not know how long the ECB will continue to buy government bonds. That depends on how bond prices fluctuate in the euro-zone countries in question.

Managing the Crisis

Every morning, the so-called Market Operations Committee (MOC) of the ECB analyzes the situation. The committee, whose members the ECB does not identify, supports the central bank in its monetary policy affairs, foreign currency transactions and the management of currency reserves. But the MOC has also become the bridge from which the central bankers are managing the euro crisis.

The Bundesbank's representative on the MOC is Joachim Nagel, head of the central bank's markets department. In closed-door sessions, he and his fellow committee members determine when and for what amounts the ECB and the euro-zone central banks, in concerted actions, buy up the government bonds of highly indebted euro countries to support their prices and thus maintain yields at a tolerable level.

The central bankers have informally agreed on what constitutes this tolerable level. The MOC's goal is to manipulate the markets in such a way that bond prices level off at the values that were in place on April 9, before investors, fearing that the governments could default on their bonds, launched into a massive sell-off of the securities.

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• Part 1: German Central Bankers Suspect French Intrigue
• Part 2: The Euro Zone's Bad Bank