A Large Unquantified Problem at the ECB

There is an interesting piece in Der Spiegel Online about the massive -- and largely unquantified -- risks on the ECB's balance sheet. There is also a small bit of German consternation detectable which I predict will rise dramatically, thus limiting just how far Germany will go to save other countries in order to protect the Euro and the EU.

I have cherry picked the article for brevity, and have added emphasis.

Since the beginning of the financial crisis, banks in countries like Ireland, Portugal, Spain and Greece have unloaded risks amounting to several hundred billion euros with central banks. The central banks have distributed large sums to their countries' financial institutions to prevent them from collapsing. They have accepted securities as collateral, many of which are -- to put it mildly -- not particularly valuable.

These risks are now on the ECB's books because the central banks of the euro countries are not autonomous but, rather, part of the ECB system. When banks in Ireland go bankrupt and their securities aren't worth enough, the euro countries must collectively account for the loss. Germany's central bank, the Bundesbank, provides 27 percent of the ECB's capital, which means that it would have to pay for more than a quarter of all losses.

But even greater risks lurk in the accounts of commercial banks. The ECB accepted so-called asset-backed securities (ABS) as collateral. At the beginning of the year, these securities amounted to €480 billion. It was precisely such asset-backed securities that once triggered the real estate crisis in the United States. Now they are weighing on the mood and the balance sheet at the ECB.

According to AFME figures, the total value of all outstanding asset-backed securities in the euro zone and the United Kingdom is an almost unimaginable €1.8 trillion.

The ECB maintains a list of "eligible assets," a sort of seal of approval for securities. Every major bank in the euro zone must have such securities, such as bonds or government bonds, or it would be excluded from the money market. There are currently 28,708 securities on the ECB list, with a total value €14 trillion at the end of 2010.

The national central banks determine which securities are placed on the list and under what conditions. "The ECB has no obligation to supervise the central banks, nor does it have the ability to monitor individual central banks," explains an ECB spokesman.

In other words, ECB President Jean-Claude Trichet doesn't even know exactly what kinds of risks he is taking on.

No one really knows how high the central bank's risk is in the crisis-ridden countries of Ireland, Portugal, Greece and Spain. But Bundesbank statistics provide an indication of how drastically the situation has changed in Europe. They show that these countries' liabilities to the euro system have risen to €340 billion within about three years. Since the countries are disconnected from the international capital market and domestic savers have only limited confidence in their banks, other European central banks -- most notably the Bundesbank -- are forced to inject more and more money.

How long Germans will put up with standing in a cold shower tearing up €500 notes is unclear. They will soon reach a limit: political, social, and monetary.

Atlas will soon shrug, and the EU will look vastly different that it does today.

Yes, it was a noble experiment. But the long list of countries wanting to join the EU is not an indication of the union's success, but rather its downfall.

Turkey, Croatia, Albania, Serbia . . . they seek to borrow at the same rates that Germany borrows. That is what got Ireland, Spain, Portugal, and Greece into trouble. A frenzy of mad borrowing with the perceived backstop of OPM.

Other People's Money.