13/11/2014: ECB Boldly Going Where It Doesn't Want to Go

ECB is falling way behind its own target for liquidity injections into the economy. Frankfurt has managed to shrink, not expand, its balance sheet last week, down EUR22.3 billion to EUR2.030 trillion which is roughly EUR970 billion short of the target.

Remember, ECB has set the target of expanding its balance sheet to EUR3 trillion at the last Governing Council meeting (although the target is 'soft') to bring it in line with 2012 average.

Here's the dynamic of the ECB balance sheet, courtesy of @Schuldensuehner

1/1/2012: Groundhog Year 2012 - part 2

And on with another summary of 2011. One side of the euro area economy had a boom year in 2011, unlike the rest of us. The boom, of course, was of a very dubious nature, but it is set to continue through 2012. That side was the ECB balance sheet.

Check out the following charts to spot the 'up year' for ECB's 'assets':

But what about ECB's capacity to carry these? Well, of course, ECB doesn't really function like a regular bank, but were it, with capital and reserves finishing 2012 at €81.481bn against total assets of €2,733.2 billion, ECB's leverage currently stands at 3,354%, which is well above 2000-2004 average of 1,372% and 2005-2008 average of 2,180% and 2009 level of 2,609% and 2010 level of leverage of 2,565%.

And, of course, more financial wizardry to come in 2012, folks. So brace yourselves for another 'up-and-up they go' year at ECB.

26/12/2011: LTRO will not solve Euro banks' problem

As the annus horribilis concludes for the terminally ill, but refused (by the ECB & EU & the respective Governments) death, Euro area banks, the key note of that Mahlerian (the 5^th symphony-styled) Trauermarsch is the LTRO allocation of cheap 3 year €489 billion worth of ECB credit (at 1%) to the European banks. And, thus, the theme for 2012, the second movement in the opus magnum of the Euro destruction, is the looming recapitalization deadline for the said zombies – the end of June.

Alas, the hope that seems to sweep the markets to boost, albeit moderately, Euro area banks valuations – the hope that having the mother of all carry trades can help these banks recover their margins just in time to use ‘organic’ recapitalization path through mid 2012 – is seemingly out of reach.

Firstly, I put ‘organic’ in the inverted commas, since the margins rebuilding on the back of ECB-created artificial liquidity boost is about as organic as performing a puppet show with a corpse is ‘live-like’.

Secondly, the carry trade I am talking about - for those readers of this blog who are unfamiliar with finance – is the artificial exercise of taking cheap loans in one country/currency and carrying funds into purchase of assets in another country/currency. Of course, with nothing but loss making (or near-loss making) assets in the markets of the Euro zone, any banks who borrowed funds in the LTRO will be either buying Government paper (yielding on average, say, 3.0 percent margin on borrowings gives Euro area banks pre-tax uplift of just €7.3 billion in 6 months time (and no, there are no capital gains realizable, since buying today and selling into mid-2012 will leave this paper, at best, capital gains neutral). Thus, to make even a dent in the capital demand, the banks will be needing assets yielding more than double the junkier Euro area sovereign yields, which means carry trade, and all associated currency and asset risks.

Of course, Euro area banks can try to magnify their returns via ECB-offered leveraged carry trades. But unless ECB offers more LTRO-styled longer term operations, doing so at 3mo or even 11mo liquidity supply windows would be simply mad. 

So, having borrowed through LTRO, Euro area banks will purchase Government bonds which then can be used as a collateral for further ECB borrowing. So let us assume that the banks will be buying liquid debt, e.g. Spanish or Italian. The margin earned by banks is ca 2.6-3.5% per annum after they cover the cost of LTRO borrowing. Note, this carry trade will turn loss-making for the bank if the sovereign bonds yields fall below 1% cost of ECB LTRO funds. In my view, this is highly unlikely.

So the whole operation can provide some €14.6 billion annually to the banks in terms of profits earned. And this is pretty much the unleveraged maximum. Nice one, but through June 2012 hardly enough to support banks recaps. Even if EBA deadline is shifted to December 2012, profits from LTRO are nowhere near the required funds to cover recapitalizations. Recall that under 9% Core Tier 1 scenario, euro area banks require something to the tune of €119 billion in fresh capital.

The downside from this conclusion is that the Euro area banks will require, post LTRO either a warrant to die (the preferred option, assuming the death warrant involves orderly shutdown of the insolvent banks) or a public bailout of immense proportion. Given the EU hit some serious trouble coming up with €200 billion for loans to IMF, good luck with that latter option.

Economics 14/12/10: ECB/CBofI Ponzi schemes

Last week's ECB figures show that the Irish banks have managed to rake up €136bn worth of borrowing from Frankfurt as of November 26th. This is an increase of €6bn on end-October figures. Mysteriously little? Not really - Irish banks have also borrowed some €45bn from the Central Bank of Ireland - a rise of €10bn on October.

The reason for such a dramatic increase in borrowing from the CBofI instead of ECB is two-fold:

1. ECB is becoming increasingly reluctant to lend to the Irish banks, and
2. Irish banks have run out of suitable collateral to pawn at the ECB discount window.

Which, in turn, means 2 things.

Firstly, Irish banks demand for borrowing is not abating despite Nama and other measures undertaken by the Government. Injecting quasi-Governmental paper into banks balancesheets has meant that the banks face immediate loss without any real means for covering it (remember, they can't really count on selling Nama bonds in the market without incurring an extremely steep discount on the value of these notes). Swapping nearly worthless paper for almost totally worthless loans is not doing the job and the entire banking system simply sinks deeper into debt.

Secondly, Irish banks have now uploaded some €45 billion worth of useless paper (that even ECB is unwilling to accept) into the Central Bank of Ireland. How much of this paper is loss-generative and are we, the taxpayers, on the hook for these losses, should the whole pyramid scheme go belly up?

Oh, and in case you wonder - ECB's equity funds are €5.8bn. It's lending side is over €200bn (it was €139bn total - banks lending & sovereign bonds inclusive - as of the end of December 2009), so as a bank, ECB's 2009 leverage was 24 times. Now, it is closer to 35 times. Lehman Bros territory, folks.