Evercore Pan Asset

It was a generous Christmas present to the European banks. The ECB made almost half a trillion euros available for up to three years at a very low interest rate. Over 500 European banks took up the offer. The markets rose immediately on the news, thinking that maybe this at last was the wall of money they have been craving to put Euro problems behind them. Second thoughts settled in very quickly.
 
Some of the money was rolling over previous facilities. The money is needed partly because the inter-bank money markets have dried up. Banks do not trust each other. The ECB has become the prime source of funds for banks that need to borrow. The money is also needed by some banks that face the necessity of refinancing their bonds over the next year or so. Some of the weaker banks are worried they will not be able to renew their borrowings at a realistic rate, so why not take the cheap money on offer to tide them over three years?  

It is, however, good news that the immediate spectre of failing banks has been lifted. Markets have been worried that weak banks may crash. With this amount of money available for up to three years, it buys weak banks more time to sort out their balance sheet problems, and helps them make a profit.
 
Some in the markets have speculated that this cash can be used now by the banks to buy up sovereign bonds. After all, if a bank is borrowing from the ECB at 1%, it would apparently make a good margin if it lent that money on to the Italian government at 6% or the Spanish government at 5%. Could this be, they asked, a back door way of overcoming German resistance to a larger bond buying programme from the ECB?
 
I do not think that is too likely. Whilst the running yields point to a profitable trade, the last thing weak banks need now is to lose more money on weaker sovereign debts. There is no guarantee that Italian or Spanish bonds will stabilise or go up in price from here. The ECB money does not solve the large budget and debt refinancing problems in the weaker countries. The banks have more immediate needs for the borrowing, and may choose to spend the money on safer assets, or to finance assets they already own where other financing is being withdrawn.
 
Meanwhile, attention increasingly turns to the balance sheet of the Euro system itself. Before this latest mega loan the Euro system’s balance sheet had reached 2.4 trillion Euros, on a base capital of just Euro 81 billion. Central banks do in difficult times balloon their own balance sheets. After all, they are backed by the taxing power of the country that sponsors them, and by the ability to print currency to pay bills. Normal rules of bank gearing need not apply to them. The issue with the ECB is slightly different. The question is who stands behind the ECB? We have to assume that the full taxing powers of the Euro zone are at its disposal, and the member states would put more capital in should need arise. We also have to assume that German and other reluctance to print more money will be overcome if that becomes a necessity.
 
It is still important that the ECB keeps an eye on its risks, as well as its duty to keep the banking system solvent and liquid. The ECB needs to avoid ending up with too many loans to weak banks and too many bonds issued by overstretched sovereigns. Let us hope they are demanding good quality collateral for the former, and keep an eye on the balance of their portfolio for the latter. In the UK the Bank of England enjoys a Treasury guarantee for its holdings of UK government stock.
 
It was good to see the better news on US jobs and activity coming through as we had hoped. There will be decent growth in the emerging world next year, and should be some growth in the US. As long as the ECB carries on staving off a worse crisis amongst European banks, we could make some progress.
 
A Happy Christmas to all our readers.