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Are the clouds of the European Debt Crisis that has so shrouded U.S. and global stock markets at long last beginning to dissipate?
There are signs that the fears of sovereign-debt defaults across the Southern European nations such as Italy and Spain are starting to lift. U.S. stocks have risen smartly in recent weeks. Such cagey macro-economic investors as the redoubtable George Soros in recent months is said to have bought a third or so of the damaged $6.4 billion European debt position that drove MF Global into bankruptcy liquidation.
But, perhaps most important, European officials seem, after months of dithering, to finally be coming to grips with the crisis in the euro zone. A plan came the week before Christmas when the European Central Bank granted some $630 billion in three-year loans to banks across the European Union and likewise loosened collateral requirements on a subsequent round of liquidity facilities dubbed the Long Term Repo Operation.
Despite widespread skepticism over the efficacy of the measure, the LTRO seems to be a far more powerful signal to the markets than many suspect. It signals a willingness by the ECB to print euros and provide liquidity to the European banking system in any quantity desired. And it stands at least an even chance to head off the contagion, triggered by Greece's debt woes, that has threatened the solvency of euro-zone countries as diverse as Portugal and Ireland in addition to Italy and Portugal. In a world in which a liquidity crisis can quickly morph into contagion, the LTRO could prove crucial.
This facility could help solve a number of seemingly intractable problems. By being able to borrow unlimited amounts of money at the current ECB interest rate of 1.0%, European banks will have access to cheap money to replace fleeing deposits, costly bond funding and a frozen interbank lending market. The ECB hopes, of course, that the funds will be used to buy the high-yielding, sovereign debt of the likes of Spain and Italy for collateral and bring down their punishing and untenable debt funding costs.
The spreads on such a "carry" transaction (dubbed the Sarko trade in honor of French President Nicolas Sarkozy) are large, up to five percentage points on long-dated paper. But one probably won't find banks in the northern tier of Europe playing this game. They've been sedulously unloading the debt of their confreres to the south for many months. But the major banks in the beleaguered nations will no doubt step to the plate to help finance their native lands. They already have huge loan exposure to their national governments, consumers and businesses, and in the event of any sovereign-debt default, the banks would be dead meat anyway. It's thus no surprise that the Italian banks were among the heaviest subscribers to the latest LTRO program.
Of course, this operation involves the ECB printing money with abandon and constitutes quantitative easing through the back door. By having banks buy sovereign debt to put up as collateral, the ECB is able to technically maintain its theological mandate of not financing national governments directly. But should the borrowing banks go bust, all the ECB will have is the selfsame sovereign debt. In a sense, the LTRO will make the ECB a hostage to any untoward dissolution of the euro zone followed by debt defaults or national currency devaluations.
AN ACQUAINTANCE OF OURS with close connections to European bankers claims that as result of the LTRO, investors are gaining confidence in the commitment of the ECB to preserve the euro zone at all costs. And if the LTRO doesn't deliver sufficient monetary stability, a full-scale quantitative easing program of direct sovereign debt purchases will follow, he insists. That was the successful policy progression the Fed adopted after the collapse of Lehman Brothers in the fall of 2008 to head off that baleful credit crisis.
The Germans and other sound-money proponents remain inalterably opposed to the ECB running the monetary printing presses at full tilt. But at least German politicians can take some solace in the fact that taxpayers don't have to foot the bill directly. Part of the problems with the programs that have been offered up to date is that they would have involved taxpayer money.
Would ECB euro printing result in ruinous inflation as some critics contend? That certainly hasn't been the experience of the U.S. to date. Likewise, massive ECB easing seems called for in light of the austerity budgets and concomitant recessionary conditions in much of Southern Europe.
So the euro zone seems to be buying itself time to tackle its systemic problems of insufficient fiscal and monetary integration. And that's unambiguously good news for the U.S. stock market.
E-mail: editors@barrons.com
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