ECB loans banks $645bn underlining the gravity of the banking crisis but will this gamble work?
Posted on 21 December 2011 with 3 comments from readers
The European Central Bank loaned 523 banks an unprecedented $645 billion over three years at just one per cent in a new initiative to keep the banking system afloat. That so many banks were prepared to borrow so much just underlined the gravity of the crisis in the eurozone which it still far from resolution.
European stocks initially rallied on the news and the fell back into negative territory. The ECB’s action is in the expectation that the banks will use this money to buy sovereign debt as the record amount of refinancing comes due in the New Year. But they could choose to keep the money and ignore government debt auctions.
Solvency solution
So the solvency of European banks is assured for a while but the sovereign debt crisis is as far from resolution as ever. Pimco, the world’s biggest bond fund, still puts the chance of a chaotic break-up of the eurozone at one-in-three.
Flooding the eurozone banking system with cheap money allows the ECB to get around rules that prevent it directly buying sovereign debt. But it maybe asking too much to expect banks to double up on bond holdings that so recently threatened to make them insolvent.
Gold and silver both rose in price after the announcement which is a clear commitment to money printing by yet another global central bank. ‘Stealth QE’ was one banker’s verdict.
Even more debt!
However, we are still left in the same basic quandry: how does creating more debt solve a problem caused by too much debt? Ultimately inflating the money supply will reduce the real value of nominal debt but it is a horrible instrument with nasty side-effects.
Besides the crucial link between giving out almost-free cash to the banks and bond refinancing is still missing. There is no compulsion here or necessary connection. For that the ECB would have to buy these bonds and replace them with its own eurobonds. That the ECB, unlike the Fed has no mandate to do.
So did pumping $645 billion into the eurozone banks make the crisis better or worse today? That is a question that will soon be answered in the New Year and the ECB may not like the response.
3 Comments posted by readers:
No
But… at least the EU states already do what they’re supposed to do: cut spending, austerity, cut welfare programs. Whether this combined with other measures will be enough to calm markets remains to be seen. But I can’t help but notice that the US is so far from such measures that it’s years away from even considering implementing them.
When the ECB, and national government officials tell the banks to buy X amount of sovereign debt with the money, or get nationalized and have their salaries cut and get fired, they will obey. I would. Get ready for more next spring.
It won’t solve the crisis, but it will buy time for the new punishment treaty to be adopted next year. The new treaty will buy another couple of years until a United States of Europe can be created which will be a fiscal transfer union. Germany will go along, once enough punishment has been metered out to the lazy southerners.
That is how I think it will finally play out in another 5 years, or so.
Of course, about a million things could go wrong to cause another outcome.
FedEx has a new form of air-mail. Throw it over the fence.