Welcome to the new version of European Tribune. It's just a new layout, so everything should work as before - please report bugs here.

LQD Draghi and the ECB

by melo Sun Oct 27th, 2013 at 07:04:03 PM EST

This caught my eye and immediately made me want to run it by the resident ET BS-busters for a comb-through.

Happy untangling!


Beppe Grillo's Blog

At first he pulled the LTRO rabbit out of his hat and then he produced two white OMT doves. In this way, Draghi has for the time being, won the two turns he's had at the gaming table of the Euro. But the game is still not finished because sooner or later, the market will call his bluff. It's these two magic tricks, the LTRO and the OMT, that for now are keeping Italy and its banks alive. For how much longer?
The first LTRO was announced in December 2011 followed by the second one in March 2012. The objective was to supply liquidity to our banks in exchange for guarantee taken to the ECB, given that the north European banks no longer trusted peripheral banks and no longer lent them money. In theory, this should have made it possible to finance the real economy: I, the ECB, am loaning you money in exchange for guarantees so that you can pass on the money in the form of loans to the SMEs and the families. In reality the real economy has seen very little of the 250 billion of LTRO money that the Italian banks got from Draghi. In fact they have reinvested nearly all that money in BTP that are giving a yield of 4.5% after having taken the ECB loan at an interest rate of 0.5%. That's roughly 10 billion in profits each year for the Italian banks in exchange for allowing the State to place its debt. In fact more than half the annual profits of the Italian banking system come from this little game: the ECB loans money to you the commercial bank and you the commercial bank loan money to your State. And the results? In the last two years the value of loans to Italian companies and families has gone down by 70 billion euro and the value of BTP government bonds being held by the banks has gone up by 190 billion euro, and now stands at 411 billion euro (more than 10% of the total value of holdings in Italian banks).
Having discovered what game is being played out, the market returned to the attack in the summer of 2012, by putting pressure on our BTPs: the central bank is the only institution that can give guarantees to the market on the solvency of the states in those places where it is buying debt by printing currency. The statute of the ECB does not allow this. But Draghi went very close to the wire, by announcing the Outright Monetary Transactions (OMT) programme in the summer of 2012. When faced with resistance from Germany, Draghi announced that the ECB is prepared to buy public debt in secondary sovereign bond markets where the bonds are due for redemption in up to three years, for those countries that happen to find difficulty in finding someone to take on their debt. This happens in exchange for rigid intervention on the part of the Troika (the IMF, the European Commission and the ECB) that is imposing reform in exchange for this help. In August 2012, no one thought that such an announcement of intentions would be enough to placate the market. At that time, there was a discussion about whether Italy should act before Spain to take the opportunity to get OMT support. What's happened in the last year tells us that Draghi has won and that for now, the market has placed its trust in the announcement without going calling the potential bluff, given that no peripheral state has had recourse to the OMT programme. Yes sure. It could be a matter of bluffing, because the German Constitutional Court has still not passed a resolution about the legitimacy of this programme. It'll do that in December.
There's nothing wrong in the fact that it is the central bank providing a guarantee for public debt. In fact, it is the right of a sovereign people and of its central bank to make use of all the tools of economic and monetary policy according to the phases of the economic cycle, including the power to "monetize" the debt by printing money. That has always been done by the FED, the Bank of England (BoE) and the Bank of Japan (BoJ) but not by the ECB. Its statute does not allow it to buy public debt but, for now, by using a semi bluff, the OMT programme has succeeded in convincing the markets that this could be possible.
Two years later, we find we have a banking system that gets its liquidity from Draghi (and not from the other banks) and then uses this to buy in BTP (and not to spend in the real economy), thus creating a vicious cycle in which the state's weakness has been transferred to the banks and only the announcement of the OMT, has, for the moment, kept the situation on its feet.

...

But the time that Draghi has managed to buy is not infinite: Merkel's "gong" on the OMT programme will arrive sooner or later and that day will be the last round. On that day, the Italians will be left with nothing but their underwear. Perhaps not even that.

Display:
so... where is the money? salted away for an even rainier day?

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty
by melo (melometa4(at)gmail.com) on Sun Oct 27th, 2013 at 07:07:20 PM EST
The first LTRO was announced in December 2011 followed by the second one in March 2012. The objective was to supply liquidity to our banks in exchange for guarantee taken to the ECB, given that the north European banks no longer trusted peripheral banks and no longer lent them money. In theory, this should have made it possible to finance the real economy: I, the ECB, am loaning you money in exchange for guarantees so that you can pass on the money in the form of loans to the SMEs and the families.
The whole spiel about "lending to the real economy" has never been true. It's possible that the ECBankers actually believe it, but it doesn't make it true. The goal of the ECB liquidity provision, and of governments' recapitalizations of banks is to prevent the banks from collapsing and taking chunks of the economy with them. But banks don't lend central bank or treasury "high-powered money", so all of this "enabling credit to the real economy" is nonsense.
In reality the real economy has seen very little of the 250 billion of LTRO money that the Italian banks got from Draghi. In fact they have reinvested nearly all that money in BTP that are giving a yield of 4.5% after having taken the ECB loan at an interest rate of 0.5%. That's roughly 10 billion in profits each year for the Italian banks in exchange for allowing the State to place its debt.
I may be wrong about this, but the LTRO is not free money for the banks, it's actually a net cost for them. Let's see if this makes sense:

The ECB always lends money to banks against collateral. In fact, the loans are always overcollateralised. The €250bn that the ECB loaned to the Italian banks was in exchange for, say, €265bn (maybe more) in illiquid assets. In addition to paying 1% (that's what the rate was at the time of the LTROs, not 0.50%) to the ECB for the loan, they forego the interest income on the asset they pledge as collateral (5% or more on average). If they buy government bonds, lending to the Italian treasury at 4.5% interest, and then they pledge the assets as collateral to the ECB, they not only forego the 4.5% interest but they must pay the additional 1% (lately, 0.50%). And they get less cash for the pledged collateral than they loaned to the Italian state.

So I don't see the free lunch for the banks anywhere. The banks are paying a real cost in exchange for much-needed liquidity. The ECB is taking in illiquid assets in exchange for cash, which is a net benefit for the banks in today's liquidity squeeze, and for which the banks are willing to pay.

In the Neurozone, there can be only one.

by Migeru (migeru at eurotrib dot com) on Sun Oct 27th, 2013 at 08:00:45 PM EST
Why would you forgo interest on something you pledge as collateral?

If it's because the actual mechanics take the form of a repurchase agreement, then that would very much depend on the coupon dates and the actual mechanics of the repo.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Nov 2nd, 2013 at 01:42:45 PM EST
[ Parent ]
Interestingly, the ECB's "general documentation" mentions both repo mechanics and collateralised loan mechanics, and makes no distinction between the two.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Sat Nov 2nd, 2013 at 02:46:45 PM EST
[ Parent ]
If Germany publicly disavows Draghi and the ECB on OMT, the resulting state of confusion and distrust will certainly send interest rates zooming up again for certain Eurozone countries' bonds.

So the problem is not whether Draghi has pulled a cheap trick (afaik the central banks of the US, the UK and Japan don't need to do massive bond purchases, the threat of intervention is sufficient), but whether the ECB is credibly independent, or whether it's Germany that in fact gives its orders to the central bank.

Plunging EZ bond markets into chaos again would almost certainly lead to an orderly or disorderly break-up of the euro. So it's down to what Germany wants in that regard.

Grillo seems to be building a Draghi strawman instead of talking about power.

by afew (afew(a in a circle)eurotrib_dot_com) on Mon Oct 28th, 2013 at 03:04:37 AM EST
The bit I don't get is how the German Constitutional Court can be the final arbiter of what the ECB can and can't do. Can't the German representative on the ECB Board simply be outvoted?

Index of Frank's Diaries
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Oct 29th, 2013 at 07:52:49 PM EST
Can't the German representative on the ECB Board simply be outvoted?

In theory he could be. In reality I suspect that the other countries are afraid Germany would retaliate in ways to dreadful to contemplate. But what could Germany do that would be worse than leaving the Euro? And Germany leaving the Euro might be the least messy way to resolve the current situation, provided those who remain had the good sense to insist that the ECB start acting like a central bank and to create an EMU treasury as a fiscal agent. This might be the least radical means to get to the sorts of benefits and policies I had suggested for a Seuro Zone. Would Holland really be so stupid as have France follow Germany out of the EMU and off the Euro?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Oct 30th, 2013 at 12:33:56 AM EST
[ Parent ]
ARGeezer:
But what could Germany do that would be worse than leaving the Euro?

Staying in and bullying everybody else?

by afew (afew(a in a circle)eurotrib_dot_com) on Wed Oct 30th, 2013 at 02:41:51 AM EST
[ Parent ]
The only real solution to the current problems is to deal with the bad debt. That applies equally to the USA, the UK, Japan and the EMU. The problem is that the bad debt belongs to the wealthiest people in each country and if it is properly handled they will take a big hit. The effects of that hit would be to reduce the Gini coefficient significantly while enabling the remaining banks and the rest of the economy to start a new economic cycle. Everything else just prolongs the agony.

By 1934 almost all the bad debt from the Crash of '29 and subsequent crashes had been written down. That has not happened yet this time only because we have figured out how not to deal with the bad debt. If we do write off the bad debt then all we have to do is see what would be required to restart the economy.

A crash program to deal with global warming and to provide for real social needs, pursued on an ever increasing scale right up to where wage push inflation starts to be a problem would probably do it. But it should be accompanied by fiscal reforms to increase taxes on the wealthy, including large inheritance taxes. That will insure the value of the money and lead towards greater social equality and stability.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Oct 30th, 2013 at 12:46:56 AM EST
Mediobanca hints at Italian euro exit unless Germany shifts on EMU policy - Telegraph

Mediobanca is Italy's second biggest bank. It does not call for a withdrawal from EMU and a return to the lira, stocially accepting that discipline is the only way forward. Yet the logic of their Magnum Opus is that Italy would be far better off outside EMU, and the implicit threat is that Italy will have to do so if the Northern creditor powers persist with their destructive regime.

Italy is not a basket case. Its net international investment position is -30pc of GDP, compared with -92pc for Spain, and -100pc for Portugal. It has very low mortgage debt. Their median wealth is €173,500, making them four times richer than Germans at €51,400.

It is the most virtuous of the big EMU states, with a primary surplus of 2.5pc of GDP. This of course means it can leave the euro whenever it wants without a funding crisis, and it is big enough to weather the shock.

Everything comes down to the national mood in the end. There was a time when the cause of Europe was unquestioned in Italy, but the long slump has taken its toll. An Ipsos poll this week found that a record 74pc of Italians are dissatisfied with the euro. It is a loveless marriage now. One more spat with Berlin and it will turn acrid.

Europe's leaders can stop the rot at any time by embarking on a reflation strategy that entirely changes the contours of the crisis and lifts the South off the reefs. But if they do not do so - and there is no sign yet - Italians will be forced to take back their own sovereign destiny.

weird but true, berlu's band of thieves and scoundrels are in sync with grillo on this.

i don't see a political tent big enough to fit them both into though ever happening!

bilderburger letta has no answers except to continue debt slavery...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Sat Nov 2nd, 2013 at 02:31:24 PM EST


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]