The problem began back in June 2009 when a number of other bankers around the world decided that certain large European banks were notoriously overleveraged, insolvent, and not creditworthy. They refused to lend them money. The ECB saw this as an emergency situation, and stepped in. It provided so-called “liquidity”, regardless of solvency or the likelihood of repayment, and handed out unlimited long term “repo” loans for a period of 12 months. A little over ½ trillion dollars worth of these loans were due to mature, at the same time, on July 1, 2010.
By the end of June 2010, financial markets became extremely worried about this impending liquidity event. The euro was being pummeled by speculators, and worries were no longer limited to the possibility of a collapse of private banks, but had expanded to worries about a collapse of the sovereign debt market. Investors were carefully anticipating ECB’s refunding data and wanted to examine it in close detail when released. It was widely anticipated, rightly or wrongly, that this data would provide a window into the health of Europe’s banking industry.
The questions were many. How many of the euro-banks that were cut off from financial markets were still insolvent in 2010? How many would be forced to arrive, once again, hat in hand, to the ECB’s loan windows, and seek the charity of the taxpayers of the European Union, through the medium of central banking? How many would need yet a second bailout due to their inability to obtain funds on the open market?
The ECB board was no doubt fully aware of the importance placed upon the refinancing numbers. On the day when the closest attention was being focused, on June 30, 2010, the ECB proudly reported that only 171 banks had requested a mere 131.9 billion euros. This was much lower than the total of 442 billion euros worth of loans that were coming due. It was also much lower than the 250 billion worth of euro refinancing that financial markets generally believed euro-banks would request. The message, of course, was that the euro-banks were actually solvent, and that the eurozone was in better shape than we believed. That was false.
When the numbers were released, there was a wave of relief. European markets and the euro were supported, at least somewhat, for the day. The message, as is often the case when dealing with central bankers, now appears to be one of manipulation. A day after announcing the alleged tiny demand for refinancing, on the morning of July 1, 2010 the ECB announced that yet another 78 banks had asked for another 111.2 billion in 6 day repo loans. This brings the total amount of refinancing to 242.3 billion euros, which is VERY close to what was originally expected. Obviously, the whole amount is not in the form of 3 month extensions, but there is nothing to stop 6 day loans from being endlessly renewable. I have no doubt that endless renewals will become the order of the day.
The intense demand for cash does not appear to be over. Given that the ECB is the “lender of last resort” in the eurozone, more money will be handed out…perhaps even to the tune of eventually refinancing the entire 442 billion euros. The key effort seems to be avoiding public perception of that fact by breaking the refinancing into separate installments, and announcing them on days when less attention was being focused on the issue.
No bank wants to borrow from the ECB at the official 1% rate if they have a hope of borrowing from other banks at the euro Libor rate, which is now floating somewhere around 0.75% for the same 3 month loan term. So, it appears that, on July 1st, a number of banks who had been hopeful about finding open market loans couldn't find them and turned back to the ECB.
Meanwhile, in spite of the extra 111.2 billion euros, euro Libor rates increased substantially. As of the morning of July 1, 2010 (this morning), even AFTER the tendering of two rounds of ECB “funny-money” to insolvent euro-banks, Libor for euro loans still rose 20 basis points to the highest level in 10 months, at 0.787%.[i] This tends to indicate a burning need for euro refinancing, and that euro-banks are trying, but failing, to obtain funds in the open market.
I reach the following conclusion by means of logic and reason. Many banks, including, obviously, the ECB, do not want the public to know about the insolvency of the European banking system. Instead of taking new loans at the ECB repo window, right away, they are trying to bid, or have been asked to bid first, on whatever free market loans are available. If they cannot get refinanced elsewhere, the ECB will refinance them.
Whether or not some of the euro-banks have paid back the $200 billion difference or whether we will see yet more 6 day loans, 12 day loans, 3 month loans, or new 1 year loans, remains to be seen. As previously noted, whether the loans are for alleged 1 day or 1 year terms, nothing stops them from being endlessly renewed.
On top of all this, the ECB continues to monetize debt from weaker European nations. Europe has a long history of hyperinflation and therefore the ECB originally claimed that that it would not engage in the same type of money printing that the U.S. Federal Reserve, Bank of England and Bank of Japan have engaged in.
The ECB promised that all asset purchases would be “sterilized” by the issuance of an equal and opposite amount of ECB reserve deposits. This was supposed to lock up the cash, preventing the money supply (and inflation) from exploding while, at the same time, reducing the cost of financing for the weaker European states. Unfortunately, the ECB has now been caught in a trap.
The ECB failed to sterilize its bond purchases in the most recent week, as banks had no appetite to put their liquidity at the ECB term deposit facility. It was the first time since the start of the Securities Market Programme that the ECB didn’t succeed to sterilize the entire amount of purchases. [ii]
That tends to indicate that the European banks (even the solvent ones) either don't have enough funds to buy term deposits at the ECB, or are getting much higher rates, in the open market, than euro Libor would imply.
“Sterilization” of ECB’s monetary diarrhea, by the sale of term deposits at the ECB, is a critical point. Without sterilization, the German faction is violently opposed. The Weimar hyperinflation is seared into the consciousness of most German economists.
In order to avoid the euro treaty, which forbids monetization of sovereign debt by the ECB, individual national central banks have been buying debt for their own accounts. The Bundesbank of Germany is the only large European central bank that can buy such debt, in large quantity, without severe repercussions. The monetization program is doomed without Germany on board. So, unless the ECB can convince banks to put money back into reserve deposits at the ECB, the program will end, and yields that the weaker members of the eurozone will be forced to pay will soar.
The low number of banks, and low amount of refinancing announced on June 30, 2010, is a case of misinformation. It was certainly not in the interest of the ECB, or the insolvent banks of the eurozone, to focus the attention of market participants upon bank insolvency at a time when careful focus was already being applied. Better to obfuscate, misinform, and delay.
The implication is that the ECB wants people to believe that Europe is more solvent than it actually is. Unfortunately, the truth has an unpleasant habit of popping up, at very inopportune times, haunting those who lie.