ECB Decision in the Details

This past Thursday, the European Central Bank made a historical decision in announcing its first ever quantitative easing program. This decision to undertake a QE program was highly expected by the markets, but the pace and size of this program, €60 Billion per month for a total size of €1 Trillion, sent stock markets across the globe rallying. While the headline numbers were often the most discussed, much of the important features of this bond purchase program comes from the details buried further down the page.

One of the most important details of this program comes from the loss sharing provision, or the small size of it, that is in the QE program. In an article posted to Medium in the Bull Market page, Karl Whelan breaks down exactly how and how the risk will not be shared:

As flagged, any risk from the "additional asset purchases" will not be shared apart from the 12% of purchases used to buy debt issued by European institutions. The ECB will also be making 8% of the purchases under the program and it is jointly owned by the NCBs, so effectively this means 20% of the purchases will feature risk sharing. However, the vast majority of the purchases-national sovereign bonds bought by NCBs-will not have risk shared. Thus, if a national government defaults, the NCB that purchased its debt will not be compensated by the other central banks.

This feature of the QE program was critical for the larger countries, such as Germany and France, to agree to this deal. While 20% of the program will be risk shared, these countries whom have significantly safer debt ratings will not have to be overly concerned about the increased risks associated with the more risky countries in the Euro Zone. In addition, making each NCB responsible for holding their sovereign debt removes most of the possibility for moral hazard, as it does not incentivize governments to default if their loss sharing would have been shared equally.

An additional detail of the ECB's decision to begin a QE program was the handling of Greece. As the results of this weekend's election, the controlling party in Greece is now one of anti-austerity philosophies. This brings a complication to the QE program, which was described by Nektaria Stamouli and Selios Bouras in their WSJ article Greek Austerity Review Needs To Be Completed for ECB QE:

The review of cutbacks and reforms in Greece must be completed to receive the next installment of international aid...Greece needs to stick to the terms of its bailout, footed by the European Commission, the European Central Bank and the International Monetary Fund, to be included in the ECB's bond-buying program.

As the outcome of the election is now clear, we can see that the anti-austerity party could cause a double hex to be placed on the Greek economy. First, as promised in their campaign, the Syriza party will push to end austerity measures as imposed as part of their bailout. With this push, they could compromise the continuation of receiving their bailout funds, leading to an eventual default and negatively impact their economy. Second, the ECB's decision to include Greece in the bond buying program is dependent on their continued bailout; again being involved with this program, which can aid in pulling down bond yields, is at risk with the Syriza party in power.