[written on Sunday]
While not a problem in the US for the Fed to do this and more (in fact it should be standard operating procedure), the eurozone has self imposed treaty issues that make it very problematic.
If there are defaults its the national governments that will probably be called on to repay the ECB for any losses, but given the national governments didn’t approve the transactions the result will be chaotic at best.
Without bank defaults it will probably all muddle through indefinitely.
As before, the systemic risk is in the eurozone.
Valve repair tomorrow, going to try to smuggle in a knife under my gown to even the odds…
by Ambrose Evans-Pritchard
The European Central Bank has issued the clearest warning to date that it cannot serve as a perpetual crutch for lenders caught off-guard by the severity of the credit crunch.
Not Wellink, the Dutch central bank chief and a major figure on the ECB council, said that banks were becoming addicted to the liquidity window in Frankfurt and were putting the authorities in an invidious position.
“There is a limit how long you can do this. There is a point where you take over the market,” he told Het Finacieele Dagblad, the Dutch financial daily.
“If we see banks becoming very dependent on central banks, then we must push them to tap other sources of funding,” he said.
While he did not name the chief culprits, there are growing concerns about the scale of ECB borrowing by small Spanish lenders and ‘cajas’ with heavy exposed to the country’s property crash. Dutch banks have also been hungry clients at the ECB window.
One ECB source told The Daily Telegraph that over-reliance on the ECB funds has become an increasingly bitter issue at the bank because the policy amounts to a covert bail-out of lenders in southern Europe.
“Nobody dares pinpoint the country involved because as soon as we do it will cause a market reaction and lead to a meltdown for the banks,” said the source.
This “soft bail-out” is largely underwritten by German and North European taxpayers, though it is occurring in a surreptitious way. It has become a neuralgic issue for the increasingly tense politics of EMU.
The latest data from the Bank of Spain shows that the country’s banks have increased their ECB borrowing to a record ÃƒÂ¢Ã¢â‚¬Å¡Ã‚Â¬49.6bn (Ãƒâ€šÃ‚Â£39bn). A number have been issuing mortgage securities for the sole purpose of drawing funds from Frankfurt.
These banks are heavily reliant on short-term and medium funding from the capital markets. This spigot of credit is now almost entirely closed, making it very hard to roll over loans as they expire.
The ECB has accepted a very wide range of mortgage collateral from the start of the credit crunch. This is a key reason why the eurozone has so far avoided a major crisis along the lines of Bear Stearns or Northern Rock.
While this policy buys time, it leaves the ECB holding large amounts of questionable debt and may be storing up problems for later.
The practice is also skirts legality and risks setting off a political storm. The Maastricht treaty prohibits long-term taxpayer support of this kind for the EMU banking system.
Few officials thought this problem would arise. It was widely presumed that the capital markets would recover quickly, allowing distressed lenders to return to normal sources of funding. Instead, the credit crunch has worsened in Europe.
Not to miss out, Nationwide recently announced that it was setting up operations in Ireland, partly in order to be able to take advantage of ECB liquidity if necessary. Any bank can tap ECB funds if they have a registered branch in the eurozone, although collateral must be denominated in euros.
Jean-Pierre Roth, head of the Swiss National Bank, complained this week that lenders were getting into the habit of shopping for funds from those authorities that offer the best terms. The practice is playing havoc monetary policy.
“What we should avoid is some kind of arbitrage by banks, which say they are going to go to central bank X, instead of central bank Y, because conditions are more attractive,” he said.