quick look at the 489 billion euro LTRO

When it comes to CB liquidity operations, as previously discussed, it’s about price- interest rates- and not quantities of funds. In other words, the LTRO is an ECB tool that assists in setting the term structure of euro interest rates. It helps the ECB set the term cost of funds for its banking system, with that cost being passed through to the economy on a risk adjusted basis, with the banking system continuing to price risk.

So what does locking in their funds via LTRO do for most banks? Not much. Helps keep interest rate risk off the table, but they’ve always had other ways of doing that. It takes away some liquidity risk, but not much, as the banks haven’t been euro liquidity constrained. And banks still have the same constraints due to capital and associated risks.

To it’s credit, the ECB has been pretty good on the liquidity front all along. I’d give it an A grade for liquidity vs the Fed where I’d give a D grade for liquidity. Back in 2008 the ECB was quick to provide unlimited euro liquidity to its member banks, while the Fed dragged its feet for months before expanding its programs sufficiently to ensure its member banks dollar liquidity. And the FDIC did the unthinkable, closing WAMU for liquidity rather than for capital and asset reasons.

But while liquidity is a necessary condition for banking and the economy under current institutional arrangements, and while aggregate demand would further retreat if the CB failed to support bank liquidity, liquidity provision per se doesn’t add to aggregate demand.

What’s needed to restore output and employment is an increase in net spending, either public or private. And that choice is more political than economic.

Public sector spending can be increased by simply budgeting and spending. Private sector spending can be supported by cutting taxes to enhance income and/or somehow providing for the expansion of private sector debt.

Unfortunately current euro zone institutional structure is working against both of these channels to increased aggregate demand, as previously discussed.

And even in the US, where both channels are, operationally, wide open, it looks like FICA taxes are going to be allowed to rise at year end and work against aggregate demand, when the ‘right’ answer is to suspend it entirely.

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6 Responses to quick look at the 489 billion euro LTRO

  1. Kostas Kalevras says:

    I am not so sure that the European banks interest rate and liquidity risk is removed. The 3Y-LTRO rate will be the average rate of ECB’s MRO during the operations lifetime (so it’s essentially not fixed), while ECB’s haircuts will still be ‘dynamic’, based on market values of posted collateral. The collateral relaxation is the biggest news in my opinion, especially given the fact that the NCBs will play a more active role in determining the risk premium (instead of ECB itself). As ECB writes in it’s monthly bulletin:

    “Second, to increase collateral availability by reducing the rating threshold for certain assetbacked securities (ABS). In addition to the ABS that are already eligible for Eurosystem operations, ABS having a second-best rating of at least “single A” in the Eurosystem harmonised credit scale at issuance, and at all times subsequently, and the underlying assets of which comprise residential mortgages and loans to small and medium-sized enterprises, will be eligible for use as collateral in Eurosystem credit operations. Moreover, national central banks will be allowed, as a temporary solution, to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the national central bank authorising their use.”

    Reply

    WARREN MOSLER Reply:

    thanks, as clarified in the subsequent post

    Reply

  2. Sergei says:

    Eurobanks DID have liquidity issues and serious ones. These liquidity issues are discussed everywhere under the Target2 imbalances header. Besides 3y operations ECB relaxed reserve requirements and will also relax collateral rules. However there is no good solution whatsoever for ECB to solve this problem. Taken to the extreme ECB might simply hit the market engineered wall of liquidity mis-allocation. Loans create deposits but ECB has no power to control those deposits. And it has to charge haircuts on loans it takes as collateral for liquidity to banks to settle deposits.

    Reply

    WARREN MOSLER Reply:

    any euro bank with collateral could always get the euro liquidity it needed, best I could tell?

    Reply

  3. Walter says:

    warren,
    from what I read some 309 of the 489 was a roll over. This leaves us with €180bn extra credit to the banks. Do you see this as already private sector credit expansion or do you see this as related to the €230bn that comes due in bank debt in q1 2012?

    Reply

    WARREN MOSLER Reply:

    it’s just substitute liquidity for whatever they had previously

    Reply

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