European Central Bank Loses Its Virginity

Fri, Dec 23, 2011 - 12:03pm
This post is adapted from analysis which appeared in The Strategic Planning Group.

So yesterday, the European Central Bank (ECB) doled out €489 ($639) billion in loans to the European banking sector.

Why’d they do it? ‘Cause Europe’s banks are broke: That is, if all the crap they collectively hold on their books were marked to market, their liabilities would be greater than their assets. American banks shouldn’t smirk: The only reason they aren’t declared bankrupt for the same reason is because of the suspension of FASB 157 back in March 2009.

The ECB lent out the €489 billion against any and all collateral the European banks would put up. In exchange for this collateral—no matter how damaged—the banks got 1% loans, which is not merely free money but essentially subsidized money: Eurozone inflation is around 3%, and except for German and Dutch debt, all sovereign bonds are yielding more than 3%. Thus a 1%-interest loan from the ECB is like being paid to take out a loan—and who wouldn’t want that deal?

Ordinarily, no bank wants to be seen to be taking money from the central bank, because it makes the bank look weak, and therefore hurts its reputation on the markets. But in this case, 523 banks—count ‘em, 523—took the ECB money: Which proves both how fragile the situation really is, and how generalized that fragility really is. European banks no longer care what it looks like, as survival has trumped appearances.

Be that as it may, the banks took the money. And like their American counterparts, who took the Federal Reserve’s $7.7 trillion of free money and used it to buy Treasury bonds, the European banks are likely to plow this ECB largesse into sovereign debt: Thus they will make risk-free profits. And what bank doesn’t want that.

This was a major move, by the way: The ECB—after protesting for months that it was not and would never be the lender of last resort—has become . . . the lender of last resort: It has finally lost its virginity. Not only that, the ECB—like every recently deflowered naïf—will find it next to impossible to say “No” the next time the European banks come looking for nookie.

There are three aspects to this situation that I want to look at here:

The first—the least financially important, but an aspect which explains why Americans are so blissfully unaware of the seriousness of the situation—is the reaction of the financial press on either side of the Atlantic. I think the reporting gives a window on the biases of mainstream financial reporting in America, and why it cannot be trusted to give an accurate view of the historic events taking place—and how in fact it is blinded.

The second issue I want to look at is how this money will not go into every European sovereign bond in equal measure: Rather, some countries will benefit from the banks’ bond-buying spree, while some other countries will be hurt precisely because their bonds will be shunned. And this analysis of sovereign debt winners and losers will not be a financial calculation, but rather a political one.

The third issue is, I’m going to look at the effects of this initial ECB free-money program, and how it augurs the break-up of the Eurozone. Closely tied into the second item of sovereign bond winners and losers, this free money’s effects on the European sovereign debt markets will determine both who will be able to keep on getting financing, and which countries will inexorably be forced out of the eurozone.

A Tale of Two Analyses

This is what Floyd Norris, the chief financial correspondent of the New York Times, wrote yesterday about the ECB lending program:

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