Dec 12th 2011, 13:09 by Buttonwood
THE grand bargain postulated before last week's fruition - that the euro zone governments would agree a fiscal pact in return for the ECB buying lots of government bonds - hasn't quite happened. But perhaps it is being done via a different route.
The ECB did agree to lend money on extended terms to European banks, and relaxed its collateral rules. The move was generally welcomed as a sign that Europe was ready to stop a Lehman-type collapse resulting from the freeze in the interbank lending markets.
But euro zone leaders have been hinting quite broadly that the banks can take that money from the ECB at 1% and invest the proceeds in government bonds, and earn a very nice yield premium along the way. This is a sort of back door QE, or perhaps bank door QE is the better name for it. In the early 1990s, the Fed deliberately engineered an upward-sloping yield curve to allow US banks to rebuild their balance sheets after the savings & loan crisis; borrowing at 3% and investing in Treasury bonds at 6-7%.
There are some questions over whether banks will take this risk, given that they might have to mark to market any losses on their government bond holdings. And there is no sign yet that this bargain is having much of an effect on bond yields.
Of course, this bargain is on a cynical view, like two drowning men hanging on to each other; bankrupt banks supporting bankrupt governments. The taxpayer stands behind both, of course, but this kind of deal is designed to create an implicit commitment on the part of taxpayers without making the costs explicit to voters.
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That's how they do, these days, and everywhere. All democratic government nowadays is by slight of hand. I expect lateness, extra complication and a certain degree of lying from elected officials but I still think transparency is possible. It's just a backwards hunger strike.
It is akin to two lunatics dancing, and deciding on dinner fifty kilometres from an inn, in a dark forest, with many unmarked paths, as darkness falls.
As Italy's government is doling out serially favors to banks, I'd expect the payback is their buying bonds. At the expense of the taxpayer, yes. But where is the alternative?
Here's an article that shows how much disagreement there is among central bankers about the effectiveness of quantitative easing and other measures used by central banks to influence interest rates:
http://viableopposition.blogspot.com/2011/10/dissension-at-federal-reser...
Economics is not a science. Predicting the economic behaviour of human beings is like herding cats; it looks good on paper but does not work in practice.
Europa To Her Coy Central Banker
Had we but world enough, and time, This coyness, Draghi, were no crime. We would sit down and think which way To walk, and pass our long loan's day; Thou by the Indian Ganges' side Shouldst Rupees find; I by the tide Of Humber would complain. I would beg you ten years before the Flood; And you should, if you please, refuse Till the conversion of the Jews. My importunate debts should grow Vaster than empires, and more slow. An hundred years should go to praise Thy laws, and on thy assets gaze; Two hundred to adore each quest, But thirty thousand to the rest; An age at least to every part, And the last age should show your heart. For, Draghi, you deserve this state, Nor would I seek at lower rate.
But at my back I always hear Time's winged chariot hurrying near; And yonder all before us lie Deserts of vast insolvency. Thy glory shall no more be found, Nor, in thy trash-stuffed vault, shall sound My plaintive cries; harsh words shall try That long preserv'd recusancy, And your quaint honour turn to dust, And into ashes all my trust. Berlin's a fine and wealthy place, But none there Bagehot's words embrace.
So, therefore, while a sanguine hue Sits on thy brow like generous dew, Let not a timid soul conspire, To add thy voice to the German choir. Now let us save us while we may; And now, like half-starved birds of prey, Rather at once our time devour, Than languish in his slow-chapp'd power. Let us roll all our strength, and all Our greatness, up into one ball; And drive our measures, leaving strife, Thorough the iron gates of life. Thus, though we cannot make our sun Stand still, yet we will make him run.
Tyler Cowen anticipated something even more brazen, namely that governments will set up banks that would then borrow from the ECB to buy government debt only.
If done in conjunction with real measures to end the crisis it would be a nice way of simultaneously bringing down yields and recapitalising banks. In effect US banks and the Fed used the same trick in 2008/9.
The taxpayer stands behind both, of course, but this kind of deal is designed to create an implicit commitment on the part of taxpayers without making the costs explicit to voters.
It's a good thing gov'ts don't have to follow "truth in lending" type laws.
(Andy Rooney voice:) Ever notice how gov'ts pass laws and exempt the gov't and the lawmakers? Why is that? Is it because....
Regards
Good job on highlighting the taxpayer-financed yield arbitrage custom made for the banks to make money - both now and historically - injustice on a grand scale.
Isn't it correct to view the anemic bank lending despite monetary easing as a process of 'cleaning' banks' books? Are there alternatives for monetary authorities to bypass the banking system and go direct to borrowers? Also, are there alternatives to the banking capital structure where 90%+ is borrowed?
You don't say? Seeing as it's worked so well in Japan and, as you point out, the US... If it means an end to headlines decrying the end of of the Euro then I'm sure we'll put up with it. In fact, I think that's been the point of the headlines all along - "investors" screaming for someone to open the floodgates/get the presses printing. Of course, funding for companies remains a casualty but that probably opens new opportunities for other "members" of the market.
Now Buttonwood, what we really want to know is how long before "markets" decide to bet against Britain? After Cameron so spectacularly failed to face down the "militant" tendency* of the Tory party and became the Davie-No-Mates of European politics unable to find anyone to help him look after his erstwhile friends Investment Bank, Hedge Fund and Private Equity.
* The Militant (named after the rag of the same name they produced) Tendency of the Labour party effectively marginalised the party throughout the 1980s and into the 1990s. This clever "Destination Oblivion" strategy, of ranting on about issues the electorate either didn't care about or even didn't approve of, was later followed by the Conservatives over the issue of Europe leading to the spectacularly unsuccessful campaign to "Save the pound" of current foreign secretary, William Hague.
"In the early 1990s, the Fed deliberately engineered an upward-sloping yield curve to allow US banks to rebuild their balance sheets after the savings & loan crisis..."
Which led to the Y2K bubble. Then the bank engineered the housing bubble to bail banks out of the deleveraging Y2K bubble. Printing to bail banks out, rather than because it is appropriate for the economy, is just asking for trouble.
The banks are in so much trouble today because the bubbles they printed misallocated capital into unproductive Minsky. Minsky projects produce nothing useful that can be used to repay loans, so each printed bailout produces a greater future disaster. Capital is wasted on bubbles, so the median standard of living continues to go down. That is, voters can buy less per hour worked than if no printing had taken place.
Many nations in the past have printed disastrous future economies. Printing for the supposedly noble goal of "bailing out banks" does not change the fact that too much printing leads to future disaster. Printing removes accurate supply/demand information from prices, so the free market cannot figure out what to produce. We wind up with millions of empty McMansions instead of useful goods.
I think you've got it in one. It's all part of the 'extend and pretend' routine on the banks. Neither Pres. Sarkozy nor Chancellor Merkel wish to reveal to their voters the extremely dodgy state of thier banks - or the costs that a proper recap would impose.
Menawhile keep the pressure on the PIIGS with this 'fiscal pact' so that, in addition to some fiscal rectitude, they might be forced to come up with the structural reforms that might go some way to satisfy bond market participants.
Not so fast. What happens to the leverage of the banks which engage in this activity? Sure, the profits are lucrative, but there is no way to assign the risk-weighted factor of 0 to PIGS bond holdings even under Basel II. And Basel III will hit the overleveraged institutions even harder.
This behaviour is not a consequence of democratic government. The phenomenon of adverse selection under franchised monopoly government creates the incentives for political agents to behave thus.
"That's how they do, these days, and everywhere. All democratic government nowadays is by slight of hand. I expect lateness, extra complication and a certain degree of lying from elected officials but I still think transparency is possible. It's just a backwards hunger strike."
Excellent point. One of two seems to have happened: we are living in a cowardly age or people who dare say things the way they see them can't get elected in the modern circus and hot air of elections, and on both sides of the Atlantic perhaps.
Two comments All nations accept that there should be transfer of capital from richer to poorer areas. The Eurozone is obviously not a nation however the principle still applies that the richest areas should transfer capital to support poorer areas. The consequences of large imbalances will always become unsustainable.
Most of the Eurozone would benefit from a devaluation of the Euro, the main exception is Germany. Rather than discussing whether Greece, Italy, Portugal, Spain, Ireland should leave the common currency perhaps the discussion should shift to whether Germany should leave the Eurozone to allow the others to devalue their joint currency and for the ECB to become lender of last resort.
that or its government money laundering.
me want in plz, i r open bankofforsize. we serve 100% of all governments that give us free money.
" Good job on highlighting the taxpayer-financed yield arbitrage custom made for the banks to make money - both now and historically - injustice on a grand scale. "
Nothing stops you or any other indignant from being a beneficiary of this yield curve "arbitrage" yourself. Swap, bond and repo markets are not restricted to banks. You can even take curve positions on online trading platforms with very small capital. It's easy money, go for it.
"The taxpayer stands behind both, of course, but this kind of deal is designed to create an implicit commitment on the part of taxpayers without making the costs explicit to voters."
Oh, I think we out here are getting a clear idea. This is what we get when the political, media and comercial system uncritically accepts honeyed blandishments from confidence men in finance.
Wouldnt one say that the bank is being smart? It is a smart move by the government, we give you money but by bong market. By doing this they are increasing their securities and expected return. However the banks liabilities increase, obviously the bank wont or shouldnt take the risk because the governments are not stable. Look at Greece, lets say a bank bought government bonds; when would the bank get its returns? Or will it ever get it returns? So as a bank, they would think twice investing on government bonds. No banks wants to go down as the Lehman brothers.
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
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