Credit vs. Collateral

Implications: The question to answer here is whether or not the ECB is a collateral-based lender.

Analysis: Central banks and in the US, the Federal Home Loan Banks, are not collateral-based lenders, they are credit-based lenders that require at a minimum full collateralization of their borrowers' indebtedness.  The article states, "Spanish mortgage bonds are being valued by the ECB at 95 cents on the euro or higher, Buiter said. The debt currently trades at about 91 cents. The bonds haven't traded near 95 since before the collapse of Bear Stearns Cos., said Jean David Cirotteau, a Paris-based analyst at Societe Generale SA. Bear Stearns was acquired by JPMorgan Chase & Co. after a bail-out orchestrated by the Federal Reserve on March 16."  The fact that someone can make the statment that the ECB's haircuts are incorrect in the amount of 4 cents on the dollar (euro) suggests the market is either very efficient, or the person making the statement is doing so simply to make a statement.

Central banks must provide liquidity especially in impaired markets.  The fact that purchasers might not buy these asset-backed bonds at the ECB's haircut is not important.  What is important is whether or not the borrowing entity can generate enough cash flow from normal operations to repay their debt to the ECB.  The ECB as a central bank should be in a position to answer this question well before the matter of liquidating the collateral becomes relevant, and if it determines the borrower cannot repay its debt, it should take steps to require additional collateral.