The EU banking system is in big trouble. That’s why European Central Bank (ECB) head Jean-Claude Trichet continues to purchase government bonds and provide "unlimited funds" for underwater banks. It’s an effort to prevent a financial system meltdown that could wipe out bondholders and plunge the economy back into recession.
"We have the best track record on price stability over 11 1/2 years in Europe and among the legacy currencies,” Trichet recently boasted. “What we have done and what we do with the same purpose is to help restore an appropriate functioning of the monetary-policy transmission mechanism.”
Nonsense. EU banks and other financial institutions are presently holding more than 2 trillion euros of public and private debt from Greece, Spain and Portugal. All three countries are in deep distress and face sharp downgrades on their sovereign debt. The potential losses put large parts of the EU banking system at risk. Trichet knows this, which is why he continues to support the teetering system with "unlimited funds". It has nothing to do with restoring the "functioning of the monetary-policy transmission mechanism". That’s deliberately misleading. It is a straightforward bailout of the banks.
Imagine that you are deeply in debt, but the bank offers to lend you as much money as you need to keep you from bankruptcy. To help maintain appearances, the bank agrees to accept the worthless junk you’ve collected in your attic in exchange for multi-million dollar loans. Does the bank’s participation in this charade mean that you are not really broke after all? Does it increase the value of the garbage collateral you’ve exchanged for cash?
The ECB is providing billions of euros per week to maintain the illusion that the market is wrong about the true value of the bonds. But the market is not wrong, the ECB is wrong. The value of Greek bonds (for example) has dropped precipitously. They are worth less, which means the banks need to take a haircut and write down the losses. More liquidity merely hides the problem.
This is from Reuters:
"Despite the open-arms approach, outstanding ECB lending has fallen more than a third since the start of July to 592 billion euros…. Liquidity remains abundant though. Over 120 billion euros was deposited back at the ECB overnight, the latest figures show."
So, overnight deposits are increasing because the wholesale funding market is on the fritz, while–at the same time–the ECB has had to lend more than half a trillion euros to stabilize the under-capitalized banking system. This is progress? It’s a farce.
Interbank lending has been falling, but bond yields in the distressed countries continue to rise. That means there’s more trouble ahead. It also means Trichet’s plan is not working. Time for another bailout.
Trichet has kept the ECB’s benchmark lending rate at rock bottom (1 per cent) for 17 months, depriving savers of desperately needed interest income. The policy is designed to increase the yield-curve so the banks can make more money. The low interest rates are not passed on to workers or households (who still pay 18 per cent on their credit cards), but to banks that borrow money at nearly-zero rates. It’s another giveaway. The policy curtails spending and depresses demand. When savers slash spending, GDP shrinks, and the economy goes into recession. The real economy is being savaged to help the banks pull themselves out of the red.
Trichet has recently joined the Austerians in calling for more belt tightening. Here’s a quote:
"With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: “stimulate”, “activate”, “spend”! … there is little doubt that the need to implement a credible medium-term fiscal consolidation strategy is valid for all countries now."
Sure, austerity for workers and welfare for the banks. If Trichet is really worried about fiscal deterioration, he should stop diverting capital into broken institutions. He should force the banks to seek funding in the markets and stop using the ECB as a crutch. That’s how the system is supposed to work.
This is from Calculated Risk:
"Was there much sovereign stress in the European bank stress tests?
No…The haircuts are applied to the trading book portfolios only, as no default assumption was considered, which would be required to apply haircuts to the held to maturity sovereign debt in the banking book.” (Calculated Risk)
The stress tests were a fraud. The sovereign debt (bonds) have already slipped in value, but the losses remain concealed behind a wall of ECB liquidity. This is a very nontransparent and corrupt system.
MIKE WHITNEY lives in Washington state. He can be reached at [email protected]