For the coming year I’ll be watching to see if the ECB buys bonds
only on rate spikes to keep them from rising further,
or on a continuous basis regardless of yields.
I suspect the former.
It’s the difference between watering a flower only as it’s about to die,
or on a regular basis to keep it continuously perky.
As if QE is an inflationary bias.
They are all clueless.
MMT to the ECB:
QE addresses the solvency issue, not ‘deflation’ or aggregate demand issues.
Bini Smaghi Says ECB Should Use QE If Deflation Risk Arises
By Gabi Thesing
Dec 23 (Bloomberg) — European Central Bank Executive Board member Lorenzo Bini Smaghi said that policy makers shouldn’t shirk from using quantitative easing if deflation becomes a danger to the euro region.
“I do not understand the quasi-religious discussions about quantitative easing,” Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments. “It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation.”
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.
Reads to me like PSI discussion might come back after a firewall and bank recap is in place?
FT: And the fifth answer is that the idea of introducing private sector involvement (PSI) in eurozone bail-outs was, in retrospect, a mistake?
Mario Draghi: The ideal sequencing would have been to first have a firewall in place, then do the recapitalization of the banks, and only afterwards decide whether you need to have PSI. This would have allowed managing stressed sovereign conditions in an orderly way. This was not done. Neither the EFSF was in place, nor were banks recapitalized, before people started suggesting PSI. It was like letting a bank fail without having a proper mechanism for managing this failure, as it had happened with Lehman.
The talk is that the new ECB longer term euro funding policy will mean euro member banks will suddenly start buying member nation euro debt and thereby ease the funding issue.
That doesn’t make sense to me. I see the 20 billion euro/wk bond purchases as possibly being enough to stabilize things, but not this.
Here’s my take:
So even if a bank officer now wants to buy, say, Italian debt out to 3 years because he can get ECB funding for that term, he probably has to go to an investment committee, so it is unlikely to happen overnight.
And the investment committees go something like this.
Investment officer:
‘now that we can get 3 year term funding from the ECB, i recommend we add to our italian debt position and make a 3% spread, which is a 30% return on equity’
committee responses:
‘why does the availability of term funding alter our current policy of reducing holdings to reduce credit risk?
what are the regulatory limits?
will the regulators allow us to own more?
what about the risk of downgrade which could force a sale?
what about repo haircuts if prices fall?
what if it’s decided Italy is unsustainable and the euro ministers vote on private sector haircuts?
how will taking on this risk affect our ability to raise capital?’
etc.
While banks may indeed buy more euro member nation debt due to the availability of the new term funding, I don’t think that new funding is enough to cause them to make that decision.
I do think the term funding will be used by banks with problems obtaining term funding to lock in the term cost of funds.
It’s supports the notion that they understand that for govt debt to go down with the current institutional structure they need private sector debt (and/or exports) to increase.
However with the private sector necessarily pro cyclical (which is what Minsky boils down to),
at best this policy will keep mainly keep things from getting worse than otherwise.
ECB Wants New Capital Rules Amid Credit Crunch Fears
December 15 (MNI) — The European Central Bank, fearful of a looming credit crunch, is pushing regulators to alter new recapitalization rules in a way that will dissuade banks from shrinking their balance sheets to reach the 9% core tier 1 ratio required by the middle of next year, well-placed Eurosystem sources told Market News International.
In late October, the European Banking Authority (EBA) said it was requiring the region’s biggest banks to establish an exceptional and temporary buffer: the ratio of their highest quality capital to the assets on their balance sheet, weighted for risk, must reach 9% by the end of June 2012.
Eurosystem central bank officials as well as some EU governments are concerned that this new capital requirement could lead to a massive deleveraging by banks in Europe, which would entail selling off assets and significantly tightening conditions for lending.
There is widespread fear that such a development would depress loans to households and businesses. Some say it is already partly to blame for the big selloff in sovereign government bonds last month that led to sharply higher borrowing costs for Italy and Spain.
The original idea behind the EBA directive was that banks would need to maintain a constant 9% ratio over the entire period during which the requirement was in force. They could do so either by raising new capital — a big challenge in current market conditions — or by dumping assets and not acquiring new ones, which turned out to be the easier route.
“If you combine [asset] disposals with an aggressive fiscal tightening, you are creating the conditions for a sharp contraction,” a Eurozone central banker warned. He projected that the combined hit on GDP from fiscal tightening and bank retrenchment could be as much as two full percentage points. “That means a recession next year,” he said.
In recent public comments, ECB President Mario Draghi expressed concern about the potentially pernicious impact of bank deleveraging to meet the new capital targets. “We want to make absolutely sure that this process does not aggravate the credit tightening that is going on now,” the ECB president said. “It is important that banks raise capital, but not in a way that affects lending.”
Sources said that under a new proposal intended to address this problem, banks would be required not to reach a 9% ratio but to raise a specified, fixed amount of capital by the mid-2012 deadline.
Based on figures banks provided to the EBA as of end-September, the regulators would calculate the amount of capital a bank would have needed to hit the 9% capital ratio at that time. Banks would then be required to raise that level of capital regardless of what they had done with their assets since then or what they might do with them in the future.
Because banks would be required to raise the same amount of core tier one capital regardless of subsequent balance sheet moves, they would no longer have the same incentive to dump assets as a means of meeting the capital requirement.
A senior EU source said that a recent letter from the chairman of the EBA and the Polish EU presidency had noted that bank deleveraging was hurting the recovery, and it laid out a plan by which the 9% ratio would be calculated on the basis of risk-weighted assets on banks’ books as of September 30.
If the plan is approved, “you won’t see a change to the actual ratios or the sums [to be raised], but there will be a clarification that this should not be achieved through asset disposal,” this source said. “It should slow the aggressive [asset] disposal, which many people think is killing any chance of an upswing.”
After releasing new figures last Thursday on the total capital shortfall of European banks, totaling E114.7 billion, the EBA told banks to raise the money from investors, retained earnings and lower bonuses. Banks may only sell assets if the disposals do not limit overall lending to the economy, the EBA said.
However, it is not clear how bank regulators and supervisors would enforce this and whether there would be a level playing field, a well-placed Eurosystem source said. A new EBA requirement of the type now being discussed could address this issue, he said.
The decision on whether to switch from a capital ratio to a fixed amount of capital that each bank must raise lies in the hands of supervisors and regulators. It is too early to tell whether regulators will adopt the recommendation, since deliberations are still going on, another Eurosystem source said.
In its own effort to ensure the Eurozone’s economy won’t be starved for credit, the ECB last week announced a radical set of new liquidity measures, including a looser collateral framework and refinancing operations with a maturity of three years.
While not my first choice for public policy,
the 20 billion euro ECB bond buying isn’t nothing.
It’s something over $1.3 trillion per year at current exchange rates.
At the macro level it sort of funds the entire euro zone deficit spending.
And deficits are currently reasonable high.
So, even while recognizing that timing is everything,
the solvency issue could be in the process of stabilizing as the various ‘new’
‘E’ funding proposals and IMF come closer to fruition.
Not that the euro economy will boom anytime soon
as austerity measures take their toll,
but that ‘leg 2’ of the relief rally could be in progress.
*ECB SAID TO CONSIDER TWO-YEAR LOANS FOR BANKS
*ECB SAID TO LOOK AT ALLOWING MORE UNCOVERED BONDS AS COLLATERAL
*ECB SAID TO PLAN LOOSENING
Meanwhile the ECB continues to look at liquidity enhancement to try to get a private sector credit expansion
going.
Good luck to them. It’s not about liquidity. It’s about private sector lending being pro cyclical.
yes, it will keep a lid on dollar libor so bma ratios aren’t so much of a blowup trade from that aspect anymore.
And the lower rate could mean most all dollar funding in the eurozone goes this route which could be both a political problem for the US and a financial issue if it all goes bad and the ECB should somehow cease to exist. The ECB is a ‘shell company’ with a bit of gold and no member nation guarantees.
Also, if I were a US bank regulator seems I wouldn’t let member US banks invest FDIC funds in any euro member nation debt and/or related securities. I might not even allow lending to corporations with exposure that could interfere with their ability to service their loans. Regulators do this via increasing risk weights accordingly.
The US regulators have a fiduciary responsibility to US tax payers and if I were one of them I’d act accordingly unless specifically told otherwise by Congress.
Subject: Huge allotment at ECB 84days USD operation:
sizeable USD allotment at ECB 84-day $ operation: $50.685Bn at 59bps.
The total number of banks participating was 34.
With the halving in cost, the facility provided much cheaper than market x-ccy basis levels, clarly all the chatter around the stigma attached to the use of the line was inaccurate to say the least!
My takeaway from two days in DC is that Europe is headed to a blood in the streets outcome.
While ECB funding remains ongoing even as it’s uncertain,
in any case the underlying theme remains austerity.
There is no plan B.
Just keep raising taxes and cutting spending even as
those actions work to cause deficits to go higher rather than lower.
So while the solvency and funding issue is likely to be resolved,
the relief rally won’t last long as the funding will continue to be
conditional to ongoing austerity and negative growth.
And the austerity looks likely to not only continue but also to intensify,
even as the euro zone has already slipped into recession.
So from what I can see,
there’s no chance that the ECB would fund and at the same time mandate the
higher deficts needed for a recovery,
In which case the only thing that will end the austerity is
blood on the streets in sufficent quantity to trigger chaos and a change in governance.