Wednesday, February 29, 2012

ECB's bazooka has not stopped money collapse in Greece, Italy, Portugal and Spain

In his column, Ambrose Evans-Pritchard discusses the ECB's Long Term Refinancing Operation and notes that it has not stopped the collapse of M1 deposits in Greece, Italy, Portugal and Spain.

Readers know that the collapse in deposits in these countries is related to the run on the banks going on in these countries.

Specifically, there is a run on the banks going on because not only are there questions about the solvency of the banks, but there are also questions about the ability of the sovereign to make good on its bank deposit guarantee.

As for deposit growth in the North, particularly Germany, this is not surprising because the deposits have to go somewhere.  The alternative is a mattress.

So the Draghi Bazooka II will be just under €530bn: Goldilocks, if you like that kind of liquidity. Not too high, not too low. Instant thoughts: 
This is about €330bn of new money once you strip out roll-overs of shorter maturities. The last one in December was a net €200bn, so it is a nice shot in the arm for French, Italian, and Spanish banks, and their sovereigns. 
They can borrow at 1pc for three years to buy Club Med bonds at over 5pc, the Sarko "carry trade". It is certainly a game-changer for the South, heading off the near-certain disaster that was unfolding before Mario Draghi took over the European Central Bank.
While it will boost the income of the Club Med banks, it is not clear that it will restore them to solvency.

As this blog has said repeatedly, it is time to adopt the Swedish model under which Wall Street/the Banks rescue Main Street.  Banks need to recognize all their losses and provide ultra transparency to prove it.

Combining this with the Draghi Bazooka then puts the banks on the path to restoring their book capital and providing the funds the local economies need to grow.
But be careful. It is in essence a Martingale play, a doubling up of a very risky strategy. Prof Charles Wyplosz from Geneva University said the ECB is taking a trillion-euro bet. 
The weakest banks in the weakest countries are gobbling up ever more sovereign debt, concentrating systemic risk. If it all goes wrong, the ECB itself will be in grave trouble with ever expanding junk collateral. 
The ECB action is leading to structural subordination of all other creditors, degrading the bonds of weaker banks – some of which will soon be reduced to junk status. The Draghi LTRO reduces the likelihood of defaults, but increases the losses should it happen.
As previously discussed, the unsecured debt and interbank lending markets are frozen.  As a result, the ECB funds are replacing the unsecured debt and interbank loans as they mature.

Should these markets remain frozen, subordination is a moot point as they will no longer have any exposure in the banking system.
It is double-edged, and whether it ultimately works will depend on the monetary transmission channels. The data from January showed that the eurozone’s broad M3 money supply has recovered slightly, but narrow M1 is flat and lending to business is still deep in the doldrums. 
It is not yet enough to save the South. 
What few economists picked up – because there are almost no monetarists left – was the monetary break-down by country. Simon Ward from Henderson Global said the collapse of real M1 deposits is continuing at terrifying speeds in Europe’s arc of depression. The vortex is actually getting worse
The six-month fall was 12.9pc in Greece, 9.2pc in Ireland, 9pc in Portugal, 8pc in Italy, and 1.5pc in Spain (there are special technical reasons for the Spain’s better profile). On an annual basis these rates would be twice as high. These are 1931-1932 rates of decline. Indeed they are worse than the worst year of the Great Depression. 
Meanwhile, real M1 deposits are recovering in the North. The gap is widening again.

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