The European Central Bank risks becoming the next big bank to face insolvency and recapitalisation if Greece fails. Quietly the ECB has broken its own house rules in staying arms length from EU politics and has taken on to its balance sheet, as collateral, highly questionable assets including loans on ghost housing estates in Ireland. It has also been lending against low grade bonds including those of Greece which was downgraded this week to the worst risk in the world - just a sliver above default.

The ECB which has capital reserves of €82 bn has morphed into Europes biggest bad bank and is today leveraged 24 times its capital against an increasingly large number of asset backed securities - packages of loans bundled together by banks seeking finance from national central banks that, together with the ECB, make up the Eurosystem. If that sounds vaguely familiar it should be, because it was toxic asset backed securities that caused the 2008 banking crisis. Lehmann’s, at the epicentre you'll recall was leveraged 30 times. By comparison the Swiss, Swedish and Norwegian lenders of last resort are leveraged between four and six times.

Last year European banks packaged to sell on €380 bn in existing loans 77% of which was designed purely as collateral to get national central bank funds. So does the ECB vet the quality of these as the lender of last resort? Well no, that’s a task it delegates to national central banks in a 37 page manual that covers over 28,000 potential securities valued at about €14trillion!

You’ve probably read that the ECB is vigorously resisting German Government plans that investors in Greek bonds should swallow a seven year delay as part of a second bailout. The ECB is horrified, not just because of the contagion it feels such a default could trigger but also the impact on its own solvency. According to the most recent studies the ECB is exposed to €444 bn of PIIGS assets, that’s Portugal, Ireland, Italy, Greece and Spain, but €190 billion of this are Greek. For example a write down of 50% on Greek collateral would all but wipe out the ECB’s precarious base of €82bn. The ECB is owed over €140bn by Ireland and €59bn by Portugal so a series of defaults and the ECB is toast.

So what happens then? The ECB could follow the USA lead and simply print money but that means debasing the Euro and runs contrary to its prime directive which is to fight inflation. It also horrifies Germans whose folk memory is of hyperinflation following World War One. Alternatively the ECB could pass the losses to national central banks but whatever formula would be used, the cost would ultimately be borne by Eurozone taxpayers, which is exactly what populations like the Germans are keen to avoid.

Germany would be on the hook for 28%, Sarkozy’s France for 21%, and Italy’s for 18%. Ireland would be well down the burden sharing list at 1.6% So despite popular resistence from national Governments hoping to lessen the cost of saving the Euro and with it the EU, the ECB, by shoring up potentially insolvent countries and their banks, is poised to spread the cost to taxpayers throughout the Eurozone. The price of solidarity will be to cough up the cash to prop up the ECB or pay the price with inflation.

Info; Open Europe; A house built on sand? Raoul Ruparel and Mats Persson www.openeurope.org.uk

Eddie Hobbs