By Mike Whitney
ECB president Mario Draghi’s new lending facility–the Long-Term Refinancing Operation–has helped to pull the financial system back from the brink of another Lehman-type catastrophe, but it doesn’t address the fundamental problems that created the crisis. (Account imbalances, capital flows) What the LTRO does is allow EU banks to exchange dodgy collateral for “limitless” 3-year loans at a rate of 1 per cent. The borrowed money–nearly one-half trillion euros–perpetuates the illusion that the banks are solvent, mainly because the vast pool of loser assets that were on the banks’ books have been transferred to the ECB’s balance sheet. (The Fed conducted a similar operation (QE1) when it purchased $1.25 trillion in mortgage-backed securities from US banks in 2009.) So, now the EU banking system is awash in liquidity and the rates that banks pay to borrow from each other have fallen dramatically. So, everything is hunky dory, right?
Wrong. Even though interbank lending rates have dropped to a 10-month low (on Monday), the banks are still parking the money they borrowed at the ECB. Last Friday, overnight deposits at the ECB hit a record high of 528 billion euros, which is 39 billion MORE than the 489 billion then the banks borrowed via the LTRO. How crazy is that? That means that the money is not being lent to consumers and businesses as Draghi had predicted, but is being hoarded by the banks so they can roll over their debts and continue deleveraging to meet the new capital requirements of 9 per cent.
This is smoke-and-mirrors fakery at its worst. After all, Draghi is just over-paying for assets that have plunged in value. What good does that do? Think of what the reaction would be if the Fed initiated a similar program to counter the effects of the housing
bubble. Let’s say, Fed chairman Bernanke launched a facility that would cough up the difference in equity for every homeowner who lost money on their mortgage from 2006-on. Do you think that would reduce the number of distressed homes and foreclosures?
Sure, it would. But the “little people” don’t get perks like that. They’re expected to take it on the chin. All the giveaways go to the big money guys. That’s what the LTRO is all about. The ECB is doling out tons of cheap money to its friends on collateral that it KNOWS is not worth the value of the money it is lending. So, it’s basically a subsidy. (re: ripoff) And, the ECB is trying to conceal what it’s doing by saying that the bank funding market isn’t working right. Or as Mr. Draghi put it, [worries over government bond markets] “have led to severe disturbances in the normal functioning of financial markets.”
Have you ever heard such idiocy?
When the banksters inflate a gigantic credit bubble that blows up and wipes out $8 trillion in homeowner equity, no one ever utters a word about “the market not working right”, because it’s just you and me who come up losers. But whenever the bankers are on the hook, out come the excuses.
“Oh, no, this can’t be happening,” they moan. “The market must not be functioning right.” But, that’s nonsense. There’s nothing wrong with the market, after all, we’re just talking about buyers and sellers, not some intricate mechanism that requires specialists with clipboards and white jackets. The problem is, that no one’s buying the crap that the banks are selling because that crap has lost considerable value in the last year. That’s all there is to it.
Here’s how the system works: The banks don’t make their money on Joe Blow and his pittance of a deposit every week when he gets his paycheck. All that’s changed. The way the banks fund themselves now is they get big slugs of money from funds that need a place to park their loot short-term while they figure out how to invest it. So, the banks issue short-term loans for the money and post collateral they have on their books. The repo market–which is what we’re talking about–is just one big, unregulated pawn shop.
The problem that inevitably arises, is that the people with the big money (fund managers) get more and more skittish about trading with the banks when they see there’s some question about the true value of the banks’ collateral. So the banks are forced to pony up more collateral to get the same amount of money. This is the equivalent of a haircut, which means the banks lose more money on every transaction. At the same time it becomes more difficult for the banks to raise money by issuing stock or selling bonds. Why? Because by now, everyone knows that the banks are sitting on a huge stinkpile of financial dross that no one would touch with a ten foot pole.
But does that mean the market’s not working right?
No, in fact, the market is working perfectly. Investors are just doing what investors always do. They’re separating the wheat from the chaff, nothing more. It’s Draghi who is distorting the market by pumping hundreds of billions of euros into a bond bubble that burst long ago. Have you looked at Greece lately?
Here’s where an analogy might help: Let’s say you need $500 to make your car payment. So you decide to rummage through your basement to find something you can sell on Craig’s List that will fetch you that amount. And, in the process, you dig up an old Foosball table with 3 legs that’s badly stained from your Oktoberfest party a few years back and post it on CL for $500. Then you sit back, pop a cold one, and wait for the calls to start pouring in.
Only the phone never rings, so you have to call the car dealership that’s been hassling you about your delinquent payment and tell them that “Sorry, man, it’s not my fault. The market isn’t functioning right!”
How much slack do you think the car dealer’s going to cut you?
The fact that no one wants your Foosball table is not a sign that the market is not working. The same rule applies to the banks’ garbage bonds. No one wants them because they’re garbage; there’s nothing more to it than that. Besides, there’s always a price for financial assets; (even garbage) it’s just a question of how much people are willing to pay. In this case, the offers for the sovereign bonds are so low that many of the EU banks would go belly-up if the sold them and reported the losses. That’s why they’re counting on Draghi to bail them out. And bail them out he has. But what should have happened is the banks should have had their debts restructured so eurozone taxpayers are not forced to pump trillions more into this new regime of zombie institutions that will henceforward be deemed too big to fail.
But Draghi’s gigantic reflation operation is just one of many problems with the LTRO. Another issue is the fact that the banks stockpile of collateral is steadily dwindling, which will make it harder for the ECB to lend to these struggling banks in February when phase 2 (estimated at 400 billion euros) is launched.
But how could that be? That would mean that the banks have neither money nor decent collateral, which means that modern banking is just a big shell game.
Indeed, it is a shell game. You see, the banks have been borrowing heaping sums of money on the same collateral over and over again. It’s called rehypothecation and, in most cases, it’s perfectly legal. A problem arises, however, during deleveraging cycles when the number of financial assets in the vault don’t match the number on the books. And then…? As the Financial Times blog site FT.Alphaville notes: ” …banks could still quite easily run out of collateral and thus fail in this environment (Dexia!).” (“Death sanitised through credit”, FT Alphaville)
This casts doubt on the effectiveness of the upcoming phase 2 of the LTRO. After all, there are limits to the kind of junk that even the ECB can accept for loans.
There are other problems with the LTRO too, like the fact that it stands the system on its head by replacing the state with the banks. How does it do that?
By providing the banks with implicit guarantees on their debt while government bonds have lost blanket ECB backing, thus, reducing government debt to the level of a junk bond. The reason this has happened is because the Draghi has signalled to the market that the ECB WILL act as lender of last resort for the banks, but not for the member states. So, bond yields on government debt have soared while the yields on bank debt have plunged. Naturally, this has put pressure on state budgets while their deficits continue to explode.
Ask yourself this: What kind of goofy world do we live in where privately-owned, for-profit businesses (like banks) can borrow money cheaper than the state? The state employs tens of thousands of workers, provides for welfare programs, policing, education, unemployment, health and human services, security, etc and operates in the greater interests of the public, and yet–under Draghi’s regime– reckless, unscrupulous bankers can tap into the central banks limitless resources at a better rate. Explain that to me?
Of course, this is what happens when nations give up the power to print their own currency. They lose the ability to control their own destiny. That creates an opening for financial elites to creep in and grab the levers of political-economic control, which is what they’ve done. Big finance has taken over Europe and is doing exactly what big finance does wherever it goes, that is, it’s systematically dismantling the institutions that provide healthcare, retirement, and job security to millions of ordinary working people while reducing the population to mellenia of grinding, abject poverty.
Isn’t that the gameplan? Isn’t that what the unctuous Italian Maestro really has in mind?
One last thing: The LTRO has no transmission mechanism. In other words, there’s no way to convey the liquidity that’s building in the banking system to the real economy. It’s just stuck there like the trillion-plus dollar reserves in the US banking system.
So Draghi’s lavish $600 billion giveaway won’t be invested in residential construction or building new factories or developing new drugs or creating more energy-efficient vehicles. In fact, it won’t be allocated to any kind of productive society-building activity at all. Instead, it’s going to be used the same way that US banks used the $700 billion from the TARP or the $1.25 trillion from the first round of QE; by turbo-charging risk assets and sending stocks into the stratosphere for a year or so. And that’s going to make Draghi’s shady investor buddies very happy, because they’ll be raking in record profits off equities while the rest of Europe languishes in a protracted mini-Depression.