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Government debt: A cosmetic collateral solution

The ECB’s reprieve doesn’t solve the underlying problems surrounding European government debt.

There was some relief but little surprise for bond markets on March 25 when European Central Bank president Jean-Claude Trichet announced that the central bank wouldn’t be restoring pre-crisis minimum collateral rules. That would have required a minimum credit rating of A3 from Moody’s and BBB+ by Standard & Poor’s to qualify as eligible collateral for the ECB’s repo facility.

It was an issue Greek bondholders had sought to clarify because Moody’s had effectively become the sole arbiter of Greece’s ability to fund itself in the bond markets, because it held the final card that kept Greece’s debt eligible when the threshold changes next January. The big risk was that should Greece fail to meet Moody’s expectations in implementing its austerity plan the agency would cut the rating below A3. The result would be catastrophic for Greece and its banking system.

Moody’s said it couldn’t envisage the ECB raising the threshold while Greece’s credit rating remained on such shaky ground. The rhetoric from central bankers, however, suggested something different. In late February ECB member José Manuel González-Páramo said it was unthinkable to change the rules to solve the specific problems of any individual country or bank.

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