A Preliminary Assessment

ECB governing council member Vítor Manuel Ribeiro Constâncio yesterday mentioned en passant that:


„It never crossed our minds to solve the EU sovereign debt crisis with LTROs. They were designed to ease funding pressures, not increasing credit supply.“


Indeed, this is what it was actually about: helping capital-impaired banks that saw their funding sources dry up faster than a waterhole in Botswana in the summer get some funding they could otherwise no longer get. The fact that the banks promptly turned around to play the carry trade in euro area sovereign bonds was merely incidental. It actually sounds as though Constancio himself was slightly surprised by this development.

What clearly has not happened is an increase in credit extended to the private sector.  This is not terribly surprising, as those who are creditworthy feel no need to borrow  and those who have a need to borrow are not creditworthy. In fact, over the past quarter inflationary lending by euro area banks has contracted at a 19.2% annualized rate.

Euro area-wide true money supply meanwhile has contracted at a 7.2% annualized rate in February, which has lowered the quarterly annualized growth rate of the true money supply to a mere 0.2% – only one tenth of the already meager 2.1% year-on-year growth rate.

In short, against our expectation that the LTRO would have an effect similar to that observed in 2009, euro area money supply growth has in fact completely failed to respond so far. However, it has to be noted that the effect of the second LTRO in late February is not yet visible in the most recent data, so this may yet change.

However, the effects observed to date mean of course that the reason cited officially by the ECB at the time the LTROs were instituted as to why this was being done has been revealed as spurious – and not  only because Mr. Constancio basically admitted to that just now.

Recall that the ECB said that these measures were necessary to 'help the flow of credit to businesses and households'. However, credit to the private sector has shrunk anyway.

As the International Financing Review reports:


“Banks cut lending to euro zone companies in February while those in Spain and Italy stocked up on government bonds, suggesting the flood of cash that the European Central Bank has pumped out has yet to bolster flagging businesses in the wider economy.

The monthly flow of loans to non-financial firms fell by 3 billion euros ($4 billion) after rising by just 1 billion euros in January. The flow of loans to households was unchanged.

Euro zone M3 money supply – a more general measure of cash in the economy – grew at an annual 2.8 percent in February, accelerating from 2.5 percent in January. A Reuters poll had pointed to a reading of 2.4 percent.

The lending figures, released on Wednesday, were a blow to the ECB’s efforts with its 3-year funding operations – or LTROs – to unclog the banking system and encourage an increase in lending to companies, which have been starved of investment funds.

Global Insight economist Howard Archer said the drop in lending to firms and flat lending to households “fuels concern that the 489 euro billion loaned to European banks by the ECB in a three-year unlimited tender in December has not – so far at least – fed through to boost lending to the private sector.”

The ECB flooded the financial system with 489 billion euros of cheap three-year funds in the first of the twin operations late last year, adding another 530 billion euros at the second operation on Feb. 29. The February lending data would not have shown the impact of the second big loan handout, Archer said.

“We no longer expect the ECB to cut interest rates further, although we actually believe that there is a decent case for the ECB to do so given the ongoing very real possibility that the euro zone will suffer gross domestic product contraction in both the first and the second quarters of this year.”

ECB President Mario Draghi is under pressure from a German-led group of ECB policymakers pushing for the bank to prepare an exit less than a month after it completed the second of the twin LTROs, which dousing the euro zone crisis at least temporarily.”


(emphasis added)



Euro area money supply aggregates and ECB credit, via Michael Pollaro. So far no acceleration in money supply growth is in evidence – click for better resolution.



The IFR report continues:


“Draghi stressed on Monday the 3-year loans were aimed at preventing a credit crunch, not supporting sovereign debt markets.

However, the ECB figures showed that Spanish as well as Italian banks increased their monthly net purchases of government bonds in February.

The new data, which captured the period just before ECB’s record second injection of 3-year cash, showed Italian banks increased their holdings of securities issued by euro zone governments by a record 23 billion euros, taking their total holdings to 301.6 billion euros.

Spanish banks increased their holdings of securities issued by euro zone governments by a hefty 15.7 billion euros. While the rise was smaller than January’s record 23 billion, it left total sovereign holdings at a record 245.8 billion euros.”


(emphasis added)

So we can conclude: the LTROs achieved precisely what they were allegedly 'not aimed at'.


Tower of Babel Spotted

Meanwhile, Bundesbank chief Jens Weidmann continues to snipe at the ECB as well as at the latest plans to increase the funding for the EFSF/ESM. This time he didn't do it from his redoubt across the street from the ECB, but on occasion of a speech he delivered in London. Employing vivid imagery involving the Tower of Babel and 'walls of money', he said:


“Just like the “Tower of Babel,” the “Wall of Money” will never reach heaven,” Weidmann said in a speech at Chatham House in London today. “If we continue to make it higher and higher, we will, in fact, run into more worldly constraints,” which might include setting “incentives that lead to new problems in the future.”

Euro-area finance ministers are likely to bolster Europe’s firewall to between 700 billion euros ($934 billion) and 940 billion euros at a meeting in Copenhagen on March 30. German Chancellor Angela Merkel yesterday gave her first indication that she is prepared to allow an increase in the debt-crisis firewall as Portugal and Spain show “fragility.”

“All the money we put on the table will not buy us a lasting solution to the crisis,” Weidmann said, citing Bank of England Governor Mervyn King’s view on the matter that it merely buys time.”


He said the risks that fiscal austerity will prevent countries returning to growth are “being exaggerated,” and “in any case, there is little alternative.”

Weidmann rejected any calls for the ECB to “temporarily ease the pressure” and do more to support the euro-area economy.


(emphasis added)

For a modern-day central banker, Weidmann is as always refreshingly frank and truthful. Of course, the 'wall of money' may well 'reach heaven', namely the part of it that's colloquially known as 'money heaven'. This is where money goes when it is lost.

Buying time has so far invariably turned out to be a big mistake. All that has been achieved was the digging of even bigger holes. Weidmann knows it, and so do many others of course. Alas, he is one of the very few officials actually saying it out loud.


A False Sense of Security

Meanwhile, the rest of the eurocracy once again feels safe:


“European leaders signaled rising confidence that their region’s crisis is near an end, while Federal Reserve Chairman Ben S. Bernanke warned that a U.S. recovery isn’t assured.

The euro area’s woes are “almost over” after a slow initial response by policy makers, Italian Prime Minister Mario Monti said in Tokyo today. German Chancellor Angela Merkel said yesterday that the crisis is ebbing and her country’s borrowing costs will probably rise as its status as a haven wanes.


Bernanke’s comments contrasted with a series of declarations by Monti during a visit to Japan, with the Italian leader saying a solution to Greece’s challenges is almost accomplished, Spain is employing discipline and Italian actions have helped stop deterioration in Europe’s woes.

Monti predicted a continued rally in Italian bonds. The country sold 3.82 billion euros ($5 billion) of zero-coupon and inflation-linked securities yesterday as borrowing costs fell to a four-month low.


Conclusions to Europe’s turmoil have been called prematurely before. In March 2010, former European Commission President Romano Prodi said the worst of Greece’s financial crisis was over and other European nations wouldn’t follow in its path. Since then, Portugal and Ireland needed bailouts.

“The euro zone has gone through a huge crisis,” Monti said in a speech today. “I believe that this crisis is now almost over.”


German Finance Minister Wolfgang Schaeuble said yesterday that he sees no scenario under which the current euro-area rescue fund, the European Financial Stability Facility, will have to issue new bailouts in the next three months. Schaeuble and Merkel spoke to lawmakers from their Christian Democratic Union, according to officials who spoke on condition of anonymity because the briefing was private.


(emphasis added)

No scenario “under which the European Financial Stability Facility, will have to issue new bailouts in the next three months”?

Really? No such scenario is thinkable? We beg to differ. Spain looks more than ripe as it were, and as noted in our earlier missive, Greece could easily soon waylay the euro area again.

In the context of the recent euphoria over the 'saved banks' in the euro area, one should perhaps ponder this long term chart of the Eurostoxx banks index as well as our proprietary euro-land bank CDS index:



Eurostoxx banks, long term. The recent bounce is barely visible on this longer term chart – click for better resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – it seems to have bottomed – click for better resolution.



The fact that the Fed's William Dudley thinks that the 'Fed has done enough to protect the US from Europe' isn't exactly comforting either, considering the forecasting prowess of this august institution and its most prominent members.


More Bad News From Spain's Banks

Monday's takeover of Civica Bank by Caixa Bank in Spain once again drew attention to the parlous state of the country's banking system.

As the WSJ reports:


“Domestic leader Caixa Bank's €1 billion ($1.3 billion) takeover of listed minnow Banca Civica on Monday is the latest in a series of deals this year designed to restore confidence in the sector. But while these transactions are a step forward, big challenges remain—and may be getting harder.


But look closely at Caixa Bank's takeover of Banca Civica, and the scale of Spain's challenge becomes clear. At the end of 2011, Banca Civica had a book value of €2.8 billion. Caixa Bank is writing this down to zero. The €1 billion purchase price represents only Banca Civica's share of an estimated €1.8 billion of synergies. That seems generous given that the deal will knock €2.8 billion off CaixaBank's capital, reducing its core Tier 1 ratio to 10.4% from 12.5% at the end of December.

Yet Banca Civica is supposed to be one of the cleaner savings banks, having taken €2 billion of provisions to cover bad loans before it listed last year.

Worrisomely, these new write downs are €2 billion more than was required under the government overhaul plan. That will fuel concerns that sector provisions still aren't sufficiently realistic to create incentives for banks to unload properties. Indeed, the stock of unsold properties—already at one million—is growing as banks continue to complete unfinished developments.

These doubts over capital adequacy are toxic because the Spanish banking system's funding structure is broken: The sector's loan to deposit ratio is an eye-watering 145%. Faced with the closure of wholesale markets, Spanish banks have been forced to rely on European Central Bank facilities, with usage equivalent to 15% of GDP. Some banks are already tapping the ECB for more than 10% of their loan books, the level at which UBS reckons investors may no longer regard them as a normal private-sector enterprises. Meanwhile, Spanish banks have been using ECB cash to buy government debt at a time when Madrid faces questions over its own solvency”


Below is a chart showing the performance of Caixa and Bankia versus the Eurostoxx bank index:



Via the WSJ: Spain's Caixa Bank and Bankia: vastly underperforming the euro-stoxx bank index since the beginning of the year – click for better resolution.




Needless to say, we believe the fat lady has yet to truly sing in Spain.


Addendum: China Pulling the Rug From Under the Aussie?

Readers may want to check out this article in the WSJ on how China's slowdown may be bad news for Australia's currency. We happen to agree.


Addendum 2: UK Recovery Weaker than After Great Depression

We also want to draw readers' attention to another interesting article that was posted at the Bond Vigilantes blog,  which discusses the dismal pace of the economic recovery in the UK thus far – apparently it compares unfavorably with the recovery following the Great Depression.




Charts by: M. Pollaro, Bigcharts, WSJ, Bloomberg



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