Thursday, February 9, 2012

Does it matter that Eurozone banks are pledging more and more of their assets to the ECB?

With the unsecured Eurozone bank debt market essentially frozen like a block of ice, does it matter that more and more of the assets of the Eurozone banks are being pledged to the ECB?

Said a different way.

While existing unsecured Eurozone bank debt holders are becoming structurally subordinated to the ECB, does this matter given that these debt holders are not rolling over their existing debt, but instead taking their investment and going elsewhere?

Isn't it also true that government deposit guarantees are becoming structurally subordinated to the ECB as the ECB has first claim to the pledged assets?

Finally, isn't the issue of structural subordination just a symptom of the real problem:  no one knows if Eurozone banks are solvent or not.

Solvency is defined as the market value of the bank's assets exceeds the book value of its liabilities.

If a bank is insolvent by this definition, then the follow-up question is 'how large is the shortfall?'

It is entirely possible that the market value of the bank's assets is less than the book value of its guaranteed deposits.  In this case, the ECB is clearly increasing the amount at risk for the government guarantor -- the government guarantee has effectively become the 'equity' supporting the bank -- and the unsecured debt holders have to be happy with additional borrowing from the ECB as it is used to pay them out at maturity when they would otherwise not be entitled to repayment.

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