Wed Dec 21st, 2011 at 08:39:10 AM EST
It's late so I can't be bothered to dig up sources, but basically, the ECB is screwing us over even worse than we thought, and it's doing it for entirely ideological reasons. More below the fold.
front-paged by afew
If I get any facts wrong, please correct me, but as far as I've understood it, this is the deal.
The ECB does not want to be a lender of last resort. To governments. While it refuses to bring rates on sovereign bonds down for the periphery and unconstitutionally meddling in fiscal policy it doesn't understand, it is actually acting as a lender of last resort on a massive scale. To the banks.
Yes indeed. As we speak, the ECB is issuing massive loans to European banks at about 1% interest and with a duration of up to three years, while accepting basically anything as collateral, no matter how noxious or toxic, including periphery sovereign bonds. For troubled banks with major problems with lending from the markets, this is, as they say in Italy (or at least in the Godfather), "an offer you can't refuse".
And as you might know, all sovereign bonds have a capital coverage ratio of 0%. This means banks can lend as much money as they like for free from the ECB, put the money in periphery bonds, use the bonds as collateral, and receive a 6% "risk-free" arbitrage profit, without straining the equity side of their balance sheets! The ECB has basically created a free arbitrage machine for these banks! Quite an interesting way to manage the recapitalisation of these banks... and in the end counterproductive, as you pump the balance sheets of the banks even fuller with bonds the periphery nations might well still default on! It seems the ECB is trying its best to turn the entire European banking sector into Dexia or MF Global.
The only way this might work is if the banks double down and go all in, creating such a massive private demand for periphery bonds (entirely fueled with free and unlimited ECB credit), that the interest on those bonds is pushed down to 2-3%. That might at least save Italy and Spain.
The price of this ideological sleight of hand, channeling the lender of last resort money through private banks instead of doing it outright, is a massive transfer of wealth to bank shareholders and executives, from periphery tax-payers. But as Mr. Draghi might explain it: unlike the banks and their owners, periphery tax-payers are not members of the financial world, the financial cosa nostra... so who cares about them!