Tuesday, March 27, 2012

And here is more on Target-2...

Just picture a wealthy German running into a wealthy Greek on a beach in Greece. The Greek laments that he has 10 MEUR in his account with, say, Alpha Bank which he would like to transfer offshore to his account with Deutsche Bank in Frankfurt. Alpha Bank has told him that they don’t have enough liquidity to make the transfer but if the Greek could come up with a new depositor who would put 10 MEUR into Alpha Bank, they could effect the transfer.

So the Greek now says to the German: “You are very wealthy. Why don’t you take 10 MEUR of the monies which you have on deposit with Deutsche Bank in Frankfurt and deposit them with Alpha Bank in Athens so that they can effect my transfer of 10 MEUR to my account with Deutsche Bank in Frankfurt?”

The German says to the Greek: “Do you still have all your marbles in place? You don’t expect me to transfer my money to a Greek bank so that you can transfer your money out of Greece; do you?”

That is exactly what Target-2 makes possible in an automatic way (i. e. the Greek bank doesn’t even have to condition the transfer abroad on the receipt of new deposits; it just makes the transfer and gets the necessary liquidity from the ECB).

The German on the beach thought that it was ridiculous to even think that he would put his money into a Greek bank so that his Greek counterpart could transfer his money offshore. Little does the German know that this is exactly what is happening behind his back. And not only for capital flight but, above all, to replenish the funds which Greece loses because Greece is spending so much on imports.

The German government has officially denied that this is taking place. They argue that Target-2 claims are not loans. They argue that Target-2 claims are just “reconciling items to make the books balance”. Well, the monthly charges to a credit card are not loans from, say, MasterCard. Instead, MasterCard sends out bills for payment of the monthly charges and those bills are “reconciling items to make sure that the books balance”.


  1. to summarise from "TARGET2 and the European Sovereign Debt Crisis" (Ulrich Bindseil, ECB & Philipp König, TU-Berlin), pdf available via googling.


    This article has provided a framework of financial accounts that can be used to analyze the development
    of T2 positions, Eurosystem refinancing credit and the liquidity deficit during the recent crisis. Such
    a framework is needed in order to understand the mechanics and economics behind T2 developments
    in the euro area. We explained that central banks word-wide (including the Eurosystem) assumed
    the role of an interbank market maker to counter the halt of interbank lending during the crisis and
    to secure the financial stability of their respective economies. While this caused a lengthening of the
    respective central banks’ balance sheets, it helped to close the funding gaps of financial institutions
    that would have otherwise led to devastating asset fire sales spirals and a credit crunch.

    We further explained that T2 constitutes the backbone of a well-functioning euro area and performs
    an adjustment-buffer function in the current crisis which buys the time to implement reforms that
    may revert the detrimental developments in crisis-ridden euro area economies. Accordingly, limiting
    T2 liabilities would not realign the incentives of governments to implement needed structural reforms.
    It would, however, put into question the existence of the monetary union, and therefore, if anything,
    create unprecedented capital dislocation.

  2. I agree with the content but my point is a bit different: common sense must also play a role. Thinking people cannot allow themselves to be driven by systems when those systems take them in the wrong direction.

    When I as a banker was involved in corporate restructurings, the first thing one looked at was how the company was using its cash. If it was using it wisely and modestly, everything was ok. If it was using its cash to pay huge interest amounts on shareholder loans and/or buying things they shouldn’t buy, one would stop that immediately even if this created “capital dislocation”.

    I am not saying that the ECB should have or should let the banking sectors of the PIIGS-countries come crashing down. That would indeed cause “capital dislocation”. In fact, I think it’s ok if the ECB finances a fair amount of current account deficit if that helps the country to reform its economy (but only then!). But what the ECB should never do is to send tax payers’ money to, say, Greece so that wealthy Greeks can send their money to an offshore bank account. From a common sense standpoint, that is plain silly. From the standpoint of responsibility to tax payers, it is utterly irresponsible.

  3. Dear Mr Kastner

    You say:

    The German government has officially denied that this is taking place. They argue that Target-2 claims are not loans."

    There seems to me to be a lot of not-telling-of-truths going on around here. Factually the German government is right, but the words would be "weasel words" in English because they are essentially fraudulent.

    In your comment above, sending taxpayer's money to bail out banks because of withdrawals is necessary. That it is irresponsible is neither here nor there: it is the system that is in place. As it is the system in place, nothing can be done about it. Yes, this is bureaucrat-speak but it is also bureaucrat-think. To them there is no changing a system for it is fixed and since it works, does not need changing.

    The problem for you and me is that the system does not work, and needs changing. By the time it does not work, Germany will be BB- and will be defaulting as it did in 1953. By that time, the bureaucrats will be worried. But what could they do?

    1. Gemma, I disagree that nothing could have been done about the system. What should have been done was to leave the system in place as originally designed. The original design was that T2 liabilities had to be collateralized by investment grade securities. No more investment grade securities, no more T2 funding.

      One of the major constraints on bankers’ follies is the scare resource of funding because they know that if they couldn’t balance their books one day, they would have to close the bank. That is why every bank keeps a liquidity reserve. That reserve is essentially the amount of investment grade securities which they could use as collateral if they needed Central Bank funding as a lender of last resort.

      You say that we have this problem because the system doesn’t work. Correct. But who should run the show? Systems or people? Suppose a plane goes on automatic pilot and the pilot realizes that there is a glitch in the software which will make them crash. Is he supposed to observe that the system works as designed and wait for the crash to prove it, or should he assume responsibility and intervene?

      T2-claims were near-zero before the crisis and they very quickly increased as early as 2008. The ECB, of course, knew why they exploded beginning in 2009 (current account deficits, cancellations of short-term funding by private banks and capital flight). At that point, the ECB would have had to go public on this issue; at least behind the scene to avoid panic.

      Governments would have had to be alerted that here is a problem developing which will make the financing of government deficits look like peanuts. And that this problem needs to be addressed on a Eurzone-wide level. The ECB would have had to give governments a deadline of, say, 6 months during which they would continue sending money South. And that they would stop doing this on the 1st day of month 7. This could still be done today, almost 600 BEUR later, but governments – as just proven by the German government – prefer to ignore that there is a problem. Unfortunately, that problem will not go away; it will just get larger.

      That is what I mean by irresponsibility versus the tax payers.

    2. Thankyou for your answer, Klaus.

      My comment about not being able to change systems was aimed at bureaucrats, not skilled pilots. A bureaucrat steers paper across a desk in a warm office, all day, every day. A pilot is flying an aircraft at 10km altitude and knows full well that turbulence means trouble. One of my childhood memories is of a glass of coke somewhere above my head. The plane had gone down and not told the glass.

      A pilot is always aware of the shortcomings of his equipment because he (or she nowadays!) is always dealing with natural elements. A bureaucrat can deal with such natural elements as a change in economic circumstances by choosing which figures to read. A pilot faced with a thunderhead cloud has two choices. A bureaucrat will not recognize the signs until it is too late.

      Remember that the figures a bureaucrat is given are in the past tense. They are not trained in characterizing patterns of figures that will tell them if a cloud is nice - or nasty. For a bureaucrat, the heating is always on and will be warm whatever the weather. That there is an economic hurricane going on outside their window is of no matter.

      Your Goldman Sachs boys will know of what I speak, and mis-use it. (I am being kind here). They know that the average bureaucrat has a manner of thinking that allows them to sit for long hours in warm offices. Not thinking things through is part of that. Being comfortable with what they are given is another. A pilot in his warm cabin has shudders and bumps to worry about. A glitch in the software is the least of his worries! That the bureaucrat has the lives of millions not hundreds at his fingertips will be something he never realized the truth of for they will never have had an emergency landing.

      This is how a government like Germany can ignore the realities behind the facts. Somebody like you does not just see numbers on a page, but traces and patterns that tell quite a different story. The numbers on their own stand mute and characterless.