Thread by @clemfon

"A page-turner" "Agatha Christie in Frankfurt" "The essential beach holiday reader" says the press on @jvtklooster' PhD. I would simply point out that Jens (second!) PhD might be the most crucial research on central banking these last years. A thread explaining why👇

Jens analyses a seemingly obscure, über technical topic: the politics of risk management at the @ecb. But beyond the technocracy gloss lies crucial political decisions that shape €bn financial flows.

When providing liquidity to the financial sector, central bankers ask for collateral to secure the operation (the collateral framework is the set of rules for this): if the bank collapse and cannot repay its loan, the central bank sells the asset to recover the loss.

Even though they have the power to create liquidity, central banks don't like to make losses on their balance sheet: they fear that losses tarnish their reputation on financial markets and put their independence at risk since states might have to recapitalize them

How does the ECB manage the risk attached to its operations then? Jens research shows that European central bankers disagreed a lot on this issue. Before the creation of the €, each NCB came with its traditional collateral framework and could not agree on common standards...

As often with European integration, national disagreements led to a depoliticisation of the collateral framework and, in turn, to activation of market mechanisms. in the mid-2000s, the ECB started to rely on credit ratings to define which collateral is acceptable (Single List).

The Single List defused many national tensions and allow the ECB to implement its monetary policy in a more uniform way across the eurozone but the global financial crisis revealed that there was a catch-22

When financial uncertainty started to unsettle European sovereign bond markets from 2010 onwards, credit rating agencies started to downgrade the debt of Eurozone peripheral countries such as Greece, Italy,....

Since the ECB framework was aligned on credit ratings, it added fuel to the fire. Since banks were unsure that they could get enough liquidity from the central bank with downgraded peripheral sov bonds, there was less demand for these bonds, which rose the spread with Germany

In @DanielaGabor words, the ECB collateral framework amplified pro-cyclical tendencies, making the ECB act more like a hedge fund than a proper central bank. This stopped with the famous Draghi "whatever it takes", which dissociated CB mon policy from market ratings.

Jens' PhD shows that Draghi's words did not solve the conundrum associated with risk management. As @KatharinaPistor explains, central bankers are at the apex of the financial system; they know that including or excluding assets from the framework strongly impact their valuation

Because independent central bankers don't have the political legitimacy to assume such distributive consequences, they try to obfuscate them. Jens' chapter 7 exposes how the ECB tried to do so when purchasing corporate bonds via the flawed concept of "market neutrality"

In the future, central bankers will continue to face hard choices with the collateral framework: should they tweak the rules of the framework to incentivize more green investments? Should we let central bankers decide by themselves such crucial allocative decisions?

Jens' PhD provide clear answers to these questions (yes we should green the framework, no central bankers should not decide alone) while exposing the roots of the problem (the obfuscation of the political dimension of central banking).This is rare. Read it

https://twitter.com/jvtklooster/status/1384528597235519488