My former colleague, Mike Casey, wrote the following in this article in today’s Irish Times:
When Nama is up and running, the banks will be able to borrow far greater amounts from the ECB. Some of this money may be lent to the private sector (one hopes), but it is likely that substantial funds will be made available to the Government to finance the budget deficit.
This may be the main reason why the Irish banks were not nationalised. If they had been nationalised this transfer of funds could not occur, since the ECB cannot lend directly to government.
I’m afraid I have to disagree with this argument for why Irish banks cannot be nationalised.
First, as I have written here before, while the ECB is forbidden from directly lending to governments by the Maastricht Treaty, the treaty also states that this particular clause “shall not apply to publicly owned credit institutions.” So the ECB can, and does, lend to nationalized banks.
Second, there is an argument doing the rounds that, while the ECB can lend to nationalised banks, these banks cannot use government-backed bonds as collateral to secure ECB loans. One commenter on this website has justified this argument with reference to Page 39 of the ECB’s documentation “The Implementation of Monetary Policy in the Euro Area” which prohibits banks using as collateral any bonds issued by other institutions with which it has “close links” where close links are defined in terms of a percentage of cross-ownership. The purpose of this provision is clearly to prevent troubled banks from setting up SPVs which issue debt that the bank can then use as collateral for ECB repo loans.
In theory, this could rule out ECB lending to nationalised banks if it were not for the fact that the next paragraph after the description of the meaning of close ties states:
The above provision on close links does not apply to: (a) close links between the counterparty and the public authorities of EEA countries or in the case where a debt instrument is guaranteed by a public sector entity which has the right to levy taxes.
So that settles that.
Finally, the EU Commission has stated that there is no problem with nationalized banks using bonds issued by their government in repo operations. The Sunday Business Post recently reported
A commission official confirmed that, in its view nationalised banks could continue to subscribe for Irish bonds as long as they were not buying them on any kind of preferential terms.
It has been suggested that if the government nationalised the banks the state would lose them as potential subscribers for Irish sovereign debt. The commission spokesman has also said it would take a neutral stance on the ECB exchanging Irish Nama-type bonds with Irish banks if they were nationalised.
A commission official at the Economic and Financial Affairs Council (Ecofin) confirmed that ‘‘the commission would have no difficulty with the use of the securities in ECB monetary operations, irrespective of whether the bank concerned is in private or public ownership’’.
Finally, I’d note as an aside that I think highly of Mike and don’t enjoy disagreeing with him. But, contrary to what some people think, I won’t refrain from disagreeing with him just because we’re both economists and bump into each other at local events. To adopt that attitude would indeed reflect a mediocrity that I know Mike would certainly disapprove of.