From the BBC:
Eurozone banks have rushed to take out cheap three-year loans offered by the European Central Bank, borrowing 489bn euros ($643bn; £375bn). The central bank had hoped to lend up to 450bn euros to stop another credit crunch crippling the banking system. When the plan was announced, French President Nicholas Sarkozy said banks could use the money to invest in eurozone sovereign debt.
Right, so the ECB, which is explicitly or implicitly backed by EU member state governments, has borrowed money from sources unknown the German central bank* (it has no real money of its own) and lent this to commercial banks cheaply, in the hope that the self-same commercial banks will then lend the money back to EU member states, thereby presumably generating a profit for themselves?
Yes, I know Article 123 of the Lisbon Treaty the EU Constitution says that member states aren't supposed to lend directly or indirectly to other member states** (since when have they ever cared about their own rules?), so they can't just brazenly cut out the middleman, but isn't the transaction entirely circular anyway?
If you strip out the commercial banks as middlemen, all that is happening is that member states have clubbed together to create their own supra-national central bank, the ECB and are not only financing this but also borrowing from it.
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* UPDATE: Ralph Musgrave emailed me that bit.
** UPDATE, Denis Cooper has emailed me to say this:
It's Article 125 which prohibits member states from becoming liable for or assuming the commitments of other member states, while Art 123 prohibits the ECB from direct purchases of debt instruments, but there's also Art 124 preventing
"Any measure ... establishing privileged access by ... central governments ... to financial institutions ... " and if the ECB is lending money to banks specifically to lend on to governments then that seems to me to be "privileged access".
Then there are articles about "the principle of an open market economy with free competition, favouring an efficient allocation of resources" and the ECB conducting "credit operations with credit institutions and other market participants, with lending being based on adequate collateral", and it seems that all of that is being disregarded so it's hardly worth reciting all the details.
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21 comments:
This is genuine Alice in Wonderland stuff. Nobody, but nobody (except eurocrats/euro-politicians) will fall for it. Just what are they on, and can I have some of it please?
As for Sarkozy....words fail me.
There is a Reuters article by James Saft making the same point. See:
http://blogs.reuters.com/great-debate/2009/07/28/europe-borrows-from-peter-to-lend-to-peter/
Mark, I don’t think you are correct to say the ECB “borrows money from sources unknown”. Like all central banks (and indeed private banks) the ECB creates money out of thin air.
As to why it does not lend this directly to EZ members, i.e. why it goes thru commercial banks, I think the reasoning is that it stops EZ politicians pressurising ECB for loans. That is, EZ members can only get hold of Euros from those cold, hard, commercially minded private banks.
And commercial banks are justified in taking a cut because of the “risk” they face (ha , ha). In fact the EU will never let big EU banks fail, so there is no risk!!! I.e. the emperor has no clothes.
L, but people do fall for all this clever sounding banking stuff.
RM, well yes and no. A bank's balance sheet always has to balance, so on the asset side, the ECB show "loans to commercial banks". What is equal and opposite entry on the liability side?
If a central bank prints notes and brings them into circulation, the notes themselves are correctly recorded as a liabllity, but what's the other side of the equation when they create electronic money (as they do nowadays?).
If a central bank prints notes and brings them into circulation, the notes themselves are correctly recorded as a liabllity
What's the asset?
F, notes are just IOUs. They are the same as government bonds, only small denomination and non-interest bearing.
If I'm short of cash and give you an IOU instead, then you have a financial asset and I have a financial liablity.
If you have a tenner in your pocket, that is your financial asset. And BoE records it as a liability.
cf BofE QE - the Bank buys assets in the form of bonds and other financial instruments and credits the banks' accounts held at the BofE - so debits and credits remain satisfyingly equal. The point is that the banks then find themselves with lots of lovely cash which they should want to lend, but for which there are very takers, so they end up buying gilts instead. Which keeps interest rates down.
Sorry - meant "very few takers".
Anon, QE was far clever/more insane* than that.
1. BoE buys gilts from banks and credits their accounts.
2. Banks withdraw the electronic cash and subscribe for new gilts a few days later.
3. BoE then buys these gilts from banks.
4. Repeat ad nauseam.
* Delete according to taste.
I do believe there is another element to this equation. The ECB has depositors in the form of banks who instead of lending to other banks because they do not trust them deposit their money with the ECB. I believe they are depositing around 350 billion so no doubt the ECB can leverage this out at 1% which the banks can buy dodgy bonds at 5 to 6%. So everybody gets rich except the taxpayer who is now on the hook for another load of debt if the scam goes bad.
Set aside the multiple breaches of the EU treaties in the actions of the ECB, and set aside the hypocrisy in the constant assurances that the treaties must be respected.
Set aside also the fact that the government of a country like Spain need no longer live in terror of private investors in the bond markets, but must now instead live in terror of the ECB which could at any point cut off its funding.
And set aside the argument that €489 billion is nowhere near enough, because the ECB could just produce the same again and again to the extent of many trillions.
The question is whether the economic policy dictated by the ECB to these governments will work, so that the economies of those countries will grow and with increased tax revenues the governments can eventually start to pay back, rather than constantly roll over and increase, their debts.
If so then the eurozone will pull through, and maybe after five or ten years the governments can free themselves from the control of the ECB, if they want to.
If not, then sooner or later the governments won't be able to repay the banks, and then the banks won't be able to repay the ECB.
What would happen then, when it became undeniable that the ECB was sitting on irrecoverable losses running into trillions of euros?
And this enormously magnified economic risk to the whole continent, and the rest of the world, is being taken not for good economic reasons, but for crazy ideological, political or rather geopolitical, reasons.
Anti, so you think that commercial banks are now lending to each other via the ECB rather than lending to each other directly, so as to pool risks a bit? Fair enough, that's a good way of deferring the inevitable chaos, but how on earth is that supposed to help governments fund their debts?
DC, I agree that the EU in the wider sense is dictating economic policies, but the ECB (as an institution) is at one remove from governments, as it can only lend to them indirectly via banks.
MW I think the logic goes that if the ECB lends out at 1% then it is attractive for the borrower to buy dodgy bonds that are returning 5 to 6% (déjà vu here but that is for another time). QE if you remember was about getting banks lending more it did not work of course and I do not believe that banks will buy dodgy bonds either well at least not dodgy ones.
Anti, RM, to answer my own question of where the ECB got the money from... from The Guardian:
"The ECB said 523 banks had taken advantage of the scheme that allowed them to offer lower-grade collateral in exchange for loans pegged to the central bank's main interest rate"
Quite possibly this 'lower grade collateral' was PIIGS bonds, in which case the ECB gave comm banks cheap money in exchange for PIIGS bonds, so that the comm banks could then lend the money back to PIIGS, i.e. buy more PIIGS bonds.
The €489 billion LTRO three-year money is a gross figure. It is different from normal central bank operations because it is for three years. Central banks always provide liquidity to qualifying banks in exchange for collateral. However, it is normally shorter duration. The money does not come from anywhere, they just increase the commercial banks reserve account at the central bank. In Europe, the commercial banks still go through their national central banks who deal with the ECB. The net LTRO figure is €182 billion because the banks repaid €307 billion of 12-month, three-month and seven-day money to refinance with three-year money.
The Sarkozy trade of borrowing from the ECB at 1% - buy government bonds yielding 6%+ - pledge as collateral at ECB for 1%, rinse and repeat is just not going to happen with the big banks. Some of the small banks may do this, but the larger banks are derisking and dumping sovereign bonds from their balance sheets. Therefore, the LTRO is about trying to ensure that the commercial banks have adequate funding next year and do not set off a credit crunch in the EZ.
Mark Wadsworth said...
Anon, QE was far clever/more insane* than that.
1. BoE buys gilts from banks and credits their accounts.
2. Banks withdraw the electronic cash and subscribe for new gilts a few days later.
3. BoE then buys these gilts from banks.
4. Repeat ad nauseam.
The BoE specifically did not buy gilts from the banks in the first round of QE in 2009. In fact, the UK banks hardly had any gilts on their books in 2009. The BoE bought £200 billion and all the banks together only had £25 billion in gilts. The BoE bought from pension funds and insurance companies etc. The money ends up being credited as reserves on the central bank account of the bank who the seller of the asset banks with. For example, if the BoE bought £1 billion gilts from Legal and General and they banked with Barclays, the BoE would increase Barclays reserves by £1 billion.
QE effect from a monetarist perspective is through portfolio rebalancing.
It has nothing to do with expanding credit like the media regularly claim.
That can happen but it is not the point of QE.
QE has nothing to do with reducing the interest rate that the government pays to issue debt.
That may happen initially, but QE is expansionary monetary policy so if successful interest rates will rise. Gilt yields rose during the 2009 QE and fell when QE ended. The spread between corporate bonds and benchmark gilts should narrow as institutions buy more corporate bonds in their portfolio rebalancing.
QE has nothing to do with providing more money to buy government debt. They are specifically trying to get institutions to stop parking money in gilts and invest in the wider economy.
Richard; "The money does not come from anywhere, they just increase the commercial banks reserve account at the central bank."
OK, it doesn't look like the ECB borrowed it from anywhere, in which case the ECB splits the zero into an asset (money lent to banks) and a liability, being..?
"The BoE specifically did not buy gilts from the banks in the first round of QE in 2009. In fact, the UK banks hardly had any gilts on their books in 2009. "
Quite probably true, but that does not matter. Once it got going, banks were buying up new issues of gilts from the DMO on Tuesday and selling them to the BoE on Thursday. See here.
"[QE} has nothing to do with expanding credit like the media regularly claim."
Agreed.
The 'lower grade of collateral' MW refers to is NOT piigs debt - the EB is obliged to accept all eurozone sovereign debt as good collateral. The lower grade of collateral is generally made up of corporate bonds.
As for Richard's point - yes, it's true that the BofE bought its gilts from giltsholders (who tended not to be banks), but that doesn't really make much difference. The giltsholders end up having cash, which they've parked at the banks, who haven't been able to do anything very much with it.
Anon 10.33. Good, now we are getting somewhere. The 'lower grade collateral' is corporate bonds. What are the chances that these turn out to be bonds issued by commercial banks?
Mark,
I was quite possible that the BoE were buying as many gilts from the market as the DMO were issuing However, they were not buying them from banks. The UK banks ended 2009 with more gilts than they started with. See chart here where UK banks are other banks.
http://av.r.ftdata.co.uk/files/2011/02/Gilt-holdings-IFS.jpg
The commercial banks needed to fill their balance sheets with gilts for capital requirements and they hardly had any government securities before the financial crisis.
The commercial banks tend to only buy gilts below 5-yr maturity and the BoE were buying only longer maturity gilts. Long-gilts are no use to them for repo operations.
Buying from the DMO and arbing by selling to the BoE only worked in the first BoE auction. A couple of hedge funds did that in the first auction. Thereafter, it was not possible to know what issue the BoE were going to buy. Someone could have bought 10-yr gilts and the BoE only bought 15-yr at the next auction. They would have been stuck with them.
At the BoE auctions it is always the bank that decides what maturity of gilts that they will buy. If the year of maturity that a holder has is different to what the bank was buying, they did not buy them in QE. Moreover, they specifically avoided buying the same length of maturity that the DMO had been recently issuing for the next few auctions.
Here is your fellow UKiper, Tim Congdon describing the portfolio rebalancing effects of QE. Considering some of the drivel that one reads in the press about QE, I think he is the last person left in the UK who actually understands monetary policy.
http://www.standpointmag.co.uk/node/1577/full
http://critical-reaction.co.uk/2975/21-10-2011-what-works-what-doesn-t
http://www.cato-unbound.org/2011/12/12/robert-hetzel/tim-congdon-on-liquidity-traps-vs-portfolio-rebalancing/
Richard, I don't want to argue the finer points of QE, because nobody really knows.
Suffice to say, we are agreed that the commercial banks (whether on their own account or on the account of their clients) now have +/- £150 billion in reserve at the BoE, which is considerably more than they had before QE.
I take your point about BoE buying back different maturities on Thursday to what the DMO had issued on Tuesday, but seeing as DMO and BoE are both part of HM Treasury which in turn is part of the government which in turn runs/is run by commercial banks, I don't think that matters much. If BoE went out and snapped up 15 years then this would also push up the price of 10 years.
So whatever the aim of QE was, the outcome is pretty clear - f- all happened apart from banks making money.
As my consumption of anything alcoholic has been very low these days past it can't be the demon drink that has left me totally befuddled after reading this snippet today - so the banks borrowed oodles on the cheap from the ECB and then parked most of the borrowed funds with the ECB, with the ECB paying them interest at one quarter of the rate they were having to pay the ECB to borrow the money from the ECB in the first place ... anyone awake enough and care enough to try and explain um what this means (in plainspeak if possible ...)aside from my immediate thought that "most bankers are clearly vastly overpaid steaming idiots" obviously ...
'Banks parked a record €411bn (£344bn) with the European Central Bank (ECB) last night.
The record amount was deposited just a week after the ECB lent 523 eurozone banks a total of €489bn in cheap loans in an attempt to keep credit flowing through the economy and prevent a full-scale credit crunch.
Banks borrowed the money at the ECB's benchmark rate of 1pc, but receive an overnight rate of just 0.25pc, well below what they could earn in wholesale markets.'
Anon, good find. That's even more puzzling to me than the UK version of QE, where the commercial banks sold gilts and then parked the money with the BoE at a small overall profit.
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