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Sunday, March 25, 2012

Update on Target-2

This post should be read in the context of my previous update on Target-2 and an interview which Prof. Hans-Werner Sinn gave Der Spiegel earlier this year.

Der Spiegel now comes with another article on this never-ending saga. It is quite amazing how many learned people can make a never-ending debate out of the question whether Target-2 claims represent risk or not. They undoubtedly do!

Once again: Target-2 is the name of the Eurozone's cash management system. The system balances liquidity surpluses with liquidity shortfalls within the individual Eurozone countries. When the Greek banking sector loses liquidity due to the current account deficit and capital flight, that liquidity is being replenished by other Central Banks through the Target-2 system.

There used to be a check/balance on the amount of liquidity which could be taken out of the Eurozone's liquidity system via Target-2 and that was the collateral requirement for "overdrafts" under Target-2: such overdrafts needed to be collateralized with investment grade securities (such as Greek bonds before the crisis). Beginning with the crisis, those securities lost their investment grade status. The formal consequence would have been for the Eurosystem to refuse to cover more overdrafts and to call for settlement of those overdrafts which were no longer sufficiently collateralized (margin calls). Had the ECB done that, entire banking sectors (like the Greek banking sector) would have collapsed.

The ECB found a Salomonian solution to the problem of the insufficient availability of eligible collateral. They delegated the responsibility for checking collateral to the national Central Banks (like the Bank of Greece) and signalled to them that they could/should be quite liberal in determining what kind of collateral was eligible or not. In many cases, this has lead to the following: a, say, Greek bank issues a promissory note for funds owed and the Greek state guarantees it, thereby making it an eligible security. In short, a national banking sector can get funding from the Eurozone basically at its own will.

Target-2 has become the equivalent of an unlimited credit card issued by the ECB in favor of national banking sectors. It is not a loan in the sense that the ECB can decide whether or not to disburse the funds. Instead, it's like a credit card where, at the end of each day, you see the amount of charges which have been posted during the day.

At February 28, 2012, the Bundesbank hat a total of 547 BEUR of claims against BIIPS-countries under Target-2. Italy and Spain were by far the largest "takers". Greece owed well over 100 BEUR under the Target-2 system.

Normally, the limitation of trends like current account deficits (overspending abroad) and capital flight comes through the lack of funding from abroad. Since Target-2 offers unlimited funding, a country like Greece can continue to overspend abroad and to lose banking deposits without any constraint. The only constraint would be that, at some point, ECB and the national Central Banks of surplus countries get cold feet and stop making funds available under Target-2.

That will be the day when national banking sectors of the PIIGS-countries will come crashing down.


  1. TARGET-2 should be renamed SAGA-T-2

    Freudian slip perhaps - "The ECB found a Salomonian solution" - is that as in Salomon Smith Barney, or whatever it's called this week.

  2. "Target-2 has become the equivalent of an unlimited credit card issued by the ECB in favor of national banking sectors."

    The European Distress Card -- don't leave home without it.