After the smoke had cleared from ECB’s announcement to cut the deposit rate another 10 BASIS POINTS to NEGATIVE FORTY, the central bank ADDED MORE MONEY TO THE SYSTEM VIA AN INCREASE IN QE TO EIGHTY BILLION EUROS A MONTH. The press called this a BAZOOKA but I THINK IT IS A WATER PISTOL. The most significant piece of the press release on monetary policy decisions was item six, “A NEW SERIES OF FOUR TARGETED LONGER-TERM REFINANCING OPERATIONS (TLTRO 2), EACH WITH A MATURITY OF FOUR YEARS, WILL BE LAUNCHED, STARTING IN JUNE 2016. BORROWING CONDITIONS IN THESE OPERATIONS CAN BE AS LOW AS THE INTEREST RATE ON THE DEPOSIT FACILITY.”
So the ECB is going to pay banks MAYBE 40 basis points to take money and lend it out to borrowers—-the previous TLTRO plan led to European banks borrowing from the ECB and purchasing huge amounts of government debt. (Think of Italian banks buying Italian government bonds.) The domestic banks in each nation can buy their government’s debt and under the CURRENT BANK OF INTERNATIONAL SETTLEMENTS (BIS) RULES government debt is given a zero-weighted risk so sovereign debt does not require holding reserves to offset the liability of lending to the government. DRAGHI IS TRYING TO BAIL OUT THE BANKS THROUGH THE BACK DOOR. As I wrote yesterday, the NON-PERFORMING LOANS ON THE BOOKS OF ITALIAN BANKS ARE CONSERVATIVELY ESTIMATED AT 16%. Do you really think that the battered Italian banks are in a hurry to make more loans to zombie firms or will they take the zero-priced money and load up on Italian 10-year notes that yield 150 basis points?
DRAGHI IS TRYING TO LOAD UP THE ECB WITH DEBT THAT WILL BE SECURED WITH THE GERMAN CREDIT CARD. YET, DRAGHI DID NOT CHOOSE HIS NUCLEAR OPTION, WHICH WOULD HAVE BEEN TO BURY THE ECB’S CAPITAL KEY AND THUS CAUSE THE BUNDESBANK TO RUSH TO THE GERMAN CONSTITUTIONAL COURT AND GET A WRIT TO DECLARE THE LISBON TREATY NULL AND VOID. President Draghi was too fearful of Weidmann making the front pages of every German newspaper. The logic of increased QE is senseless as long as the capital keys are in place because there just isn’t enough quality assets to purchase based on the legal ratios of the capital key.
I know others will say that the ECB is stepping up to purchase INVESTMENT GRADE CORPORATE BONDS but that will not be enough to meet the increased 80 billion a month QE because the European corporate bond market is not that big and very few banks will want to give up quality assets for ECB funds to invest in new loans of a questionable nature. The MARKET HEARS WHAT IT WANTS TO HEAR AND DISREGARDS THE REST. Now it is important to hear what the BIS has to say about Draghi’s efforts to take on risk without the adequate safeguards. Be vigilant for this weekend’s German elections.
***Challenging Draghi for financial mendacity award was referenced in a Bloomberg article by Matthew Brockett, “Wheeler’s Communication Criticized After RBNZ Policy “U-TURN.” The opening line says so much about the fabric of today’s financial world: “New Zealand central bank Governor Graeme Wheeler faced criticism from economists Thursday after delivering an interest-rate cut that took most of them by surprise.” Economists were caught off-guard because they failed to pay attention to many of the signals that the market had provided. Three cheers to Governor Wheeler for making the financial literati actually earn their living through sweat. Good on you, mate!