Home > Uncategorized > Is the Bundesbank really independent?

Is the Bundesbank really independent?

from Erwan Mahé (guest post)

Today I would like to briefly examine an issue that might seem to be a major point, but which cruelly exposes the current eurozone construction fault lines and which shows how much “image” can dissimulate reality.

In the last two years, we have seen many of our German friends express their dismay at the supposed adventurism of the ECB’s unorthodox measures, like the SMP and the easing of collateral eligibility for the second VLTRO. They have also denounced the supposed desire of certain governments to use the ECB as an instrument of fiscal policy by making it play a role incompatible with its restrictive mandate.

But yesterday we were treated to one more example of the saying, “do as I say and not as I do”, with the very mediocre results of the 10-year Bund auction in Germany when the Bundesbank again intervened to buy a portion of it in order to head of a big, fat flop! In effect, the German central bank bought €1.13 billion (22.60%) out of the €5 billion in Bunds put on sale! And that came after having served the entirety of non-competitive bids made by banks during the auction process, i.e., €2.257 billion or 55% of total demand. In reality, competitive bids, totalling €1.852 billion, represented just 37% of the total amount that the German government sought to raise. I don’t think I need to draw a picture of what would have happened if the Buba had not fulfilled its role as “protector” of the image of German debt.

But isn’t this modus operandi a little inconsistent with the budget discipline lectures regularly served up to us by this very same Bundesbank, the same ideological focus that led two of its top officials to resign from the ECB due to its so-called deviation from the aforementioned discipline?

Bear in mind that the such purchases of government debt on the primary market is strictly forbidden to the ECB, and, unless I am mistaken, to all other central banks on the eurozone. Ditto for the Fed.

For those who have the slightest doubt about the fiscal character of such Bundesbank operations, I have kept under my pillow for you a little excerpt from the GIC conference which I had the pleasure of attending three weeks ago: the speech by Mr Weber himself on this matter. His frankness just about knocked me off my chair!

Here is a transcription that I carried out myself, but I strong advise you to go directly to the source in the attached video (from 22nd to the 25th minute):

http://www.interdependence.org/resources/re-examining-central-bank-orthodoxy-for-un-orthodox-times-session-iii/

Excerpts (emphasis mine):

“Central banks fulfill a very core function for policy making by being focus on price stability. State financing on the other hand is not compatible with good monetary policy and we’ve seen that in the past.

(…)

Just to give you an example, when the German debt is issued on the market, the Bundesbank all over the years and still today, has a role in managing those debt issues. So if there is less subscription then is needed, in order to preserve pricing, the Bundesbank take this onto their portfolio, and then sells them in a more opportunistic way later on.

It’s a pure fiscal agent role; it has nothing to do with monetary policy. It is basically related to market marking in the German debt market. And somebody needs to do that, it does not have to be the Central Bank, but if it is the Central Bank it has to be clear: it is a fiscal agent role under the auspices of fiscal policy.”

Incredible but true!

However, don’t believe for a second that yesterday’s Bundesbank intervention was an exception. Not only does it intervene in all debt auctions, regardless of the maturity of the debt issued, but its 22.60% take-up is far from being a record! After a little digging, I was able to find the amounts involved in each of these operations. I then recalculated the percentage of the primary market debt bought by the Buba for own account.

From these figures, I have created a revealing little graph for you. In the graph, I have excluded interventions on 2-year issues, which are less significant, but it is worth noting that in June 2008 the Buba had to buy 40.5% of the Schatz amount issued that day. The record high for the Bund is 39.27% in November 2011 and for the Bobl it is 41.51% in 2003.

The Buba very present on primary market

This sort of intervention appears all the more surprising at a time when the Bundesbank seems to consider the ECB’s rates too low for the German economy.

As a bonus, I invite you to go back to the GIC video (link above) at 1h12 and listen to Bank of France Governor Mr Noyer answer questions about the measures to ease collateral eligibility for the second VLTRO. In response to the Bundesbank’s current criticisms of these measures, he defended the measures by recalling the reality of what occurred during the provisions losses booked following the Lehman Brothers bankruptcy:

“We all made a check to the Bundesbank.”

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  1. Ramanan
    April 13, 2012 at 12:50 pm

    This is not right. This is pure myth.

    The Bundesbank does not purchase the German government’s debt which is unsold in auctions.

    I covered this here sometime back

    http://www.concertedaction.com/2011/11/23/todays-auction-fail/

    The Eurex document I quote clearly states that the issuer is not credited until the bonds are sold in the secondary markets.

    and Part 2 here:

    http://www.concertedaction.com/2011/11/24/yesterdays-auction-fail/

  2. merijnknibbe
    April 13, 2012 at 1:22 pm

    @Ramanan,

    I get your point, but….

    As I always understood it, the secondary market is the market in which nog the issuing party but other parties sell and buy debt. If that’s the case – the Buba still owns it, though it only has to pay once it’s sold to a third party.

    Or does the Buba ‘only’ acts as a broker?

    The point – there are too much discussions going on in economia which are about vague concepts and fuzzy definitions. If the Buba is ‘only’ a broker the debt is still sold in the primary market, if it’s sold in the secondary market that shows that the Buba owns the debt (though the risk is transferred to the tax payer).

    • Ramanan
      April 13, 2012 at 1:43 pm

      Merijn,

      Buba is in no sense the owner but is acting as the agent (and not the principal) at all times.

      All other governments in the Euro Area can do the same. The difference is that the German government has financial assets in the Euro Area and outside which it can sell if it runs into a cash management problem (or can borrow against it by repoing). Other governments cannot do so – or can only do as long as they have sufficient financial assets.

      But in no sense is the Bundesbank purchasing the debt directly from the government. It is only acting as an agent and is not underwriting the issue.

      Buba cannot purchase government debt directly from the German government as it is forbidden by law.

      The reason the phrase “retained” is used is because the German debt agency will sell the unsold securities in the secondary markets opportunistically under the same ISIN as the issuance.

      • Michael
        April 13, 2012 at 2:32 pm

        If the Bundesbank isn’t “underwriting” the debt by finding friends to buy it, why is the government willing to accept it promissory notes on auction?

        This is a distinction without a difference. When the Bundesbank says I’ll get my money, I get my money.

      • Ramanan
        April 13, 2012 at 3:34 pm

        Michael,

        I don’t follow you.

        If the German government is issues 5B of bonds, allocates 4B to bidders and retains 1B, the 1B is _not_ purchased by Buba.

        It (the remaining 1B) is sold directly by the German government (ie its its debt agency) in the secondary markets later.

      • merijnknibbe
        April 13, 2012 at 4:19 pm

        Oke, seems you’re totally right.

        However (not just for face saving): wikepedia defines the ‘secondary market’ as: “The secondary market, also called
        aftermarket, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. Another frequent usage of “secondary market” is to refer to loans which are sold by a mortgage bank to investors such as Fannie Mae and Freddie Mac”. I was led astray not just by my ignorance but also by the use of the phrase ‘secondary market’ – which indeed should not be used in this case.

      • April 13, 2012 at 5:28 pm

        The Secondary Market is anyone not involved in the primary issuance of the security. In this case, the Bundesbank was acting as Distribution Agent in the primary issuance of these bonds, so for the CUSIPs left unsold, the Bundesbank is still a Primary Issuer.

        For all other securities (including the CUSIPs of the referenced German bonds that were already sold by the Bundesbank), the Bundesbank is a secondary market participant. Everyone is a secondary market participant. The ‘Secondary Market’ is ‘the market’. The only carve-out that defines whether you’re a Primary market participant is whether you were paid by the Issuer to act as it’s Agent in the origination and distribution of the Issue at origination.

        The definition of Primary and Secondary has to do with pricing. At Issuance, the securities are priced by the Issuer – meaning the group that has originated the securities, ie. whoever is raising the money, and their Agents.

        Once the securities are sold ‘into the secondary market’, ie. to anyone not involved in the origination of the security, then ‘the market’ (ie. the secondary market, ie. everyone else in the marketplace) sets the price, and those securities are then considered ‘in the secondary market’, ie. in the public marketplace.

  3. April 13, 2012 at 4:14 pm

    I’m with Ramanan. This sounds all perfectly fine to me. The German government doesn’t actually get paid for the unsold component of the bond issuance until it’s sold into the secondary market by the Bundesbank. The Bundesbank acts as a distribution agent only. The bonds are issued/registered, but not sold yet due to insufficient demand in the secondary markets. So, I don’t see a problem. Did I miss something?

  4. merijnknibbe
    April 13, 2012 at 4:47 pm

    Some additional information (Hat Tip Remco Schrijvers from Monalytics):

    “The Bund uses a multiple price auction procedure. In other words, bids for Bunds, Bobls and Schaetze accepted by the German Federal Government are allocated at the price
    quoted in the respective bid and are not settled at a uniform price. Bids priced above the lowest accepted price are allotted in full, while bids priced below the lowest accepted price receive no allotment. Non-competitive bids are allotted at the weighted average price of the accepted price bids. The Federal Government reserves the right to re-allot the bids at the lowest accepted price as well as the non competitive bids, e.g. to allot them only at a certain percentage rate. The same procedure is applied on a yield basis for Bubills.”

    http://www.deutsche-finanzagentur.de/en/institutional/primary-market/auction-procedure/

    See also: http://www.bundesbank.de/kredit/kredit_tenderverfahren.en.php

    If there are not enough bids below the maximum interest rate, the Finanzagentur can withhold part of the debt (“retention”):

    “In addition, the German Federal Government Finance Agency supports the market makers’ presence in the secondary market by helping out in case if needed, e.g. in exceptional cases when the liquidity of a given security should become a little stretched. For these purposes the German Finance Agency retains on its own books a certain portion of the nominal amount tendered at the auction of a new or reopened issue.”

    http://www.deutsche-finanzagentur.de/en/institutional/secondary-market/

    “At each auction the German Federal Government can retain a portion of securities for secondary market operations which is then sold successively in the market afterwards. The volume of securities retained for market operations varies widely from auction to auction. Since 2005, the amount retained has averaged about 20% of the issuance volume (which also included money market paper and inflation-linked German Government securities).”

    http://www.deutsche-finanzagentur.de/en/institutional/secondary-market/secondary-market-activities-finance-agency/

    These retained bonds are not auctioned at the primary market but sold privatly at the primary market (“onderhands’ in Dutch, could not find a nice english or German translation).
    Buba is just a broker and does not own the bonds:

    “The Bundesbank is not financing Germany; it just operates as an agency for Finanzagentur. It is worth repeating that Finanzagentur always retains part of the bonds, so this part of the process is normal.”

    http://www.economist.com/blogs/freeexchange/2011/11/german-bund

  5. John S.
    April 15, 2012 at 6:59 pm

    Merijn,

    The original point of the Bundesbank “buying” the new bond issue to aid in the pricing of the new issue seems to hold true. The essential fact appears to be the inability of the primary market to handle the new issue, thus the bond auction was a failure.

    Either the Bundesbank or the government holds the bonds and perhaps sells them at a later date in the secondary market. Sly devils those central bankers are.

  6. paolo leon
    April 17, 2012 at 12:21 pm

    Greece, Spain, Portugal, Italy and France are all measured in terms of spread between their govt bonds and the German ones. But if Buba buys German bonds it makes their price higher and, pro tanto, increases the spread of all the other govt.debtors. If I am not wrong, some European authorities shoud examine each case in which the spread has been influenced by Buba, and take measures, as it looks much like market tinkering. A secondary market is a secondary market is a secondary market, besides, when in time this market is used by Buba?

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