Thursday, December 29, 2011



This morning’s (i.e., Thursday, 12/29’s) Wall Street Journal featured a page C1 article outlining two concerns regarding the European Central Bank’s (“ECB’s”) collateralized lending to European banks. The headline concern is that the banks, and especially the smaller banks, may run out of collateral for such loans and thus spark a liquidity difficulty. (As loyal readers know, I prefer the term “difficulty” to the hideously overused “crisis,” but I digress.) A second concern is that the increasing reliance of European banks on secured lending degrades the quality of the banks’ unsecured debt, which also could lead to liquidity, and possibly solvency, problems.

Perhaps there is nothing especially insightful or unique about this observation, but, at least to yours truly, a larger concern with the ECB’s collateralized lending to European banks seems to be a macro concern. Naturally, the ECB takes European sovereign debt as collateral for its loans. Perhaps not so naturally, the ECB takes the sovereign debt of any European country, including, according to the aforementioned article, debt “…from financially weak countries such as Greece and Ireland”. The ECB continues to take such collateral despite the ECB’s heretofore “limited” direct purchases of sovereign debt and its protestations that it will not bail out spendthrift European governments, at least not until it gets some kind of eurozone wide fiscal rectitude pact as a fig leaf for engaging in such wholesale monetizing of bad debt. Such willingness to take sovereign debt as collateral leads one to question the difference between directly bailing out European governments and taking their paper as collateral for loans to banks. It would seem that, under such a rubric, banks can buy all the European sovereign debt they want, even from the PIIGS, and then present such debt to the ECB as collateral. Not only is the ECB creating the money to lend to European governments, regardless of the latters’ fiscal conditions, but if the fiscal situations in the PIIGS improve, the banks make a sizable profit and, if the situations don’t improve, the banks can simply default on their collateralized loans and stick the ECB with the consequences. If this isn’t a bailout of profligate European banks and sovereigns, perhaps we ought to revisit the definition of bailout.

An opinion piece in yesterday’s (i.e., Wednesday, 12/28’s) Journal by Gerald O’Driscoll contended that the Fed’s dollar swap arrangement with the ECB amounts to a Fed bailout of the European banks and sovereigns, and it’s hard to disagree with Mr. O’Driscoll’s argument. However, the ECB’s willing to take any European sovereign credit as collateral seems to be an even more naked bailout of profligate eurozone countries. It’s a good thing this operation doesn’t include the Fed…yet.

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