Slow Uptake of TLTRO Funding

It seems European banks are not all that eager to take up more central bank credit. The ECB has begun to offer its dirigiste “targeted long term refinancing operations” at a spread of 10 basis points above the repo reference rate. Since the repo rate was lowered from 0.15% to 0.05% at the last ECB council meeting in early September, this type of funding has become even cheaper. However, when banks obtain funding by posting collateral with the ECB, this automatically creates additional bank reserves – and those bear a penalty rate of 20 basis points these days. We continue to be mystified by the introduction of the penalty interest rate on bank reserves. We have no idea what it is supposed to achieve and in fact we suspect that it actually achieves the opposite of what the ECB ostensibly wants.

One of the goals is to weaken the euro, which is quite a hare-brained idea, as a weaker euro will affect consumer purchasing power across the euro zone negatively. Note that the euro area just posted another strong increase in its trade surplus. So even those who believe that a positive balance of trade is in any way indicative of an economy’s health (which is nonsense to begin with), will have to admit that the euro zone’s export sector hardly appears to be in need of an extra boost.

As to the TLTRO funding, this is extra-cheap long term bank refinancing tied to certain conditions – banks must use these funds to extend private sector credit (exclusive of mortgages). In the event they use the funds for other purposes like e.g. more carry trades in government debt, they merely need to repay the TLTRO funds two years earlier, in 2016 instead of 2018. Since there is very little private sector credit demand, it should perhaps not be too surprising that the first round elicited very little demand. Reuters reports:


“The European Central Bank saw far less demand than expected on Thursday for its new four-year loans to banks, raising doubts about a stimulus package it hopes will stave off deflation and revive the euro zone economy.

The launch of the scheme, a central plank of the ECB’s efforts to coax reluctant banks to lend, saw the euro zone’s central bank hand out 82.6 billion euros of 400 billion euros ($515.16 billion) on offer to 255 banks. That was well below the 133 billion euros forecast by a Reuters poll of 20 money market traders. Banks will get a second chance on Dec. 11 to apply for the cash, granted at ultra-low interest rates on condition they lend it on to businesses, when the poll predicted take-up of 200 billion euros.

Berenberg Bank chief economist Holger Schmieding called the low demand “a disappointing result for the ECB” that cast doubt on the bank’s hopes of injecting 400 billion euros into the economy through this scheme. “Simply offering more liquidity at more generous terms to banks awash in cash will not make a huge difference to the outlook for growth and inflation,” he said.

But ECB Executive Board member Peter Praet warned against reading too much into the first result, stressing that it was part of a broader policy package that “will have a sizeable impact” on the ECB’s balance sheet. He added that expectations for the first round had always been lower than for the second offering in December.

“Markets have understood that the June and September measures should be seen as a combination aiming at addressing credit impairment,” Praet told Reuters in an interview, adding the measures could only be assessed once fully implemented. Praet also reiterated the ECB’s readiness to do more should it become necessary.


(emphasis added)


Force-feeding more money from thin air into the banking system is of course not going to “help the economy” one bit. It will only distort prices further, and lead to wasting of scarce capital which will be misallocated as a result. So Mr. Praet’s “the ECB is ready to do more” assertion should probably be seen as more of a threat than a promise.


1-Euro area lons to non- financial corporations+y-y changeEuro area: loans to non-financial corporations (total, in red) and the y/y change rate (blue line). Banks are already awash in liquidity, but corporations are in no mood to increase their borrowings – click to enlarge.


QE Threat Revisited

Naturally, Reuters also mentions the threat of outright “QE”, Fed & BoJ style, as well as noting that many banks in Europe continue to be in abysmal shape, in spite of having made a lot of money on account of a massive government bond carry trade sponsored by the ECB since 2011-2012. This has occurred on the back of savers, who get paid practically nothing on their savings anymore.


“Previous rounds of cheap ECB loans for banks and borrowing costs close to zero have done little to boost lending to companies, with much of the money instead spent on government bonds. Critics fear a similar fate for the new scheme.

Market reaction was muted. The euro fell briefly, but rebounded later, while German bond yields nudged down and European shares climbed as bets on possible large-scale asset purchases gained traction.

Traders said the low take-up raised expectations the ECB may eventually take more radical monetary stimulus measures, such as printing money to buy securities – quantitative easing, or QE – although there is strong resistance in Germany to such a move.

Some banks were reluctant to participate in Thursday’s round, possibly for fear that it could single them out as struggling just weeks before the results of an ECB-led asset quality review (AQR) and stress tests. “The European financial sector continues to be weak,” said Karel Lannoo of Brussels think tank the Centre for European Policy Studies. “There may be a stigma because the markets are waiting for the AQR in a few weeks.”


(emphasis added)


2-Euro Area, total loans to household, + y-ychangeEuro area lending to households and non-profits serving households, total, with annual change rate (blue line). Flat to lower since 2011 – click to enlarge.


Even though the ECB has already found ways to skirt the law with its SMP (the securities market purchase program in the course of which it bought the bonds of Ireland, Greece and Portugal to manipulate their prices and yields, to no avail as it turned out), “QE” as it is practiced in the US and Japan is explicitly prohibited by the central bank’s statutes.

It says there black on white that the ECB and the national central banks of the euro system may not buy any debt securities issued by a government or a government body. Here is the relevant passage, paragraph 21, section 1:


“21.1. In accordance with Article 123 of the Treaty on the Functioning of the European Union, overdrafts or any other type of credit facility with the ECB or with the national central banks in favor of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.


(emphasis added)

What is it about the term “prohibited” that people don’t seem to understand? It is no coincidence that the ECB is once again seeking to employ indirect methods via the commercial banking system, with its recent plant to monetize ABS and covered bonds. This is of course also “QE”, as these will be outright purchases. Compared to the size of the EU’s government bond markets, these markets are however fairly small, and as we recently pointed out, in the covered bond space the mere announcement has already massively distorted prices and yields, in the face of a relative dearth of supply in this segment.

Of course, banks may now make efforts to increase their ABS and covered bond securitizations. However, it no longer pays as well to play the government bond carry trade, so the benefits that can still accrue to banks from gorging on EU government debt are much smaller than they once were. Moreover, the associated risks have not become smaller – they have increased further.


Jack Lew Wants EU to Spend and Print More

In this context, consider also recent comments by US treasury secretary Jack Lew and the German reaction to them:


U.S. Treasury Secretary Jack Lew on Friday called on the euro zone and Japan to do more to spur growth as the global economy continues to disappoint, highlighting what is sure to be a bone of contention as Group of 20 ministers gather in Australia. While lauding the strength of the U.S. economy, Lew said more work was needed to achieve faster and more balanced economic growth and to boost demand.


Speaking during a stopover in Hong Kong, German Finance Minister Wolfgang Schauble said his country’s economy was robust and that it was important for Europe to stick with the tough path of fiscal reform.

“We are in the global economy and in Europe in a situation, in which we seem to have too much liquidity and too much public debt,” Schauble told reporters. “That means the room to stimulate growth from the demand side and the monetary-policy side is – with regional differences – small‎,” the German minister said.

Berlin has been under intense pressure to allow the euro zone to ease back on fiscal austerity and to stimulate its economy through more government spending or tax cuts.

U.S. and other G20 officials have previously flagged concerns about Europe’s tepid economic growth and want Germany to do more to help its neighbors by spending and importing more. The OECD slashed its growth forecasts for major developed economies on Monday, urging Europe to do more to ward off the risk of deflation.


(emphasis added)

How can “Germany import more”? There exists no disembodied entity behind an arbitrary national border that engages in trade. Only individuals trade with each other, and national borders only figure in these transactions insofar as they may represent obstacles due to state-imposed restrictions on trade in the form of tariffs and such.

“Germany” cannot act. Only German individuals can act, and as we have previously pointed out, there is surely nothing wrong with the world eager to buy German products on account of their quality. Again, it is not clear to us what is expected. Are the Germans supposed to lower the quality of their products? Moreover, the surplus Germany achieves in trade is not lost to the world – it returns in the form of German investment abroad. So if Germans in the aggregate were to import more relative to what they export, their capital exports would shrink accordingly.

Although Mr. Lew didn’t spell out what measures he expects to be taken, he obviously believes euro area governments should emulate US policies. There are three things that governments and government agencies could do: spend more (increase their deficits and public debts even further), print more money (let the ECB ignore the legal restrictions on full-scale “QE”), or engage in economic reform, by rolling back regulations and lowering taxes.

Only the latter possibility has any hope of enhancing prosperity, but it is the path least likely to be taken, unless governments are under extreme duress that leaves them no other choice. For instance, Spain has probably instituted the most far-reaching economic reforms, simply because the government and Spain’s banking system had become insolvent when the last bubble aided and abetted by the ECB burst. While these reforms are laudable, they are certainly not going far enough. The recent sharp decline in government bond yields meanwhile has lessened the pressure on governments to continue with the implementation of reforms.

It is of course not incorrect that another phase of illusory bubble-prosperity could probably be ignited by an increase in monetary pumping and government spending, but neither of them can actually increase wealth. Every cent the government spends is a cent the private sector can no longer spend or invest. Inflating the money supply won’t create a single iota of real capital. All that can be achieved is an inflationary illusion, making the underlying structural situation even worse.

Below you can see the massive liquidation of unsound debt that has occurred in Spain. It is noteworthy that in spite of credit expansion going into reverse in Spain, the country’s economy is now doing better than that of many others in the euro area. The same is incidentally the case in Ireland.


3-NFC loans, Italy, SpainLoans to non-financial corporations in Italy (blue line) and Spain (red line). In Spain, the collapse of the housing bubble has had a particularly large effect, as many billions in unsound investment and the unsound debt supporting them had to be liquidated. It is interesting in this context though that Spain’s economy is nowadays acknowledged to be one of the better performing in the euro area – click to enlarge.


We believe Mr. Schäuble’s assessment to be correct, but would add that so-called “austerity” is a myth anyway. Government spending in the euro area overall has continued to grow. There have been de minimis declines in nominal government spending (excluding debt service costs) in countries like Italy and Spain, but their gross fiscal debt has continued to grow, since one cannot exclude debt service costs in the real world.

These costs are the unfortunate result of wasteful deficit spending in the past and cannot be wished away. Italy may currently enjoy a “primary surplus”, but its actual deficit still amounts to 3% of GDP and its public debt-berg keeps growing accordingly. Moreover, economic reform has been haphazard and timid, with the greatest zeal thus far shown in raising taxes and hunting down tax evaders, at the price of curbing economic freedom and intimidating the population (we have discussed some of this in greater detail in the past). As e.g. Italy’s tax payer association remarked with regard to Mr. Monti’s reforms at the time: “Monti’s reform has consisted of introducing new taxes and nothing else”.

As a result of all this, the risks to playing the government bond carry trade have clearly increased as well – in spite of the ECB’s “everything it takes” promise.



4-Italy-government-debt-to-gdpItaly’s government debt to GDP ratio. It is currently estimated that it will grow to between 140-145% over the coming year – click to enlarge.



Given the backdrop of the ECB’s asset quality review, the lackluster results of the first TLTRO round may not yet tell the story, but if the second round in December once again fails to attract much interest, the central bank is likely to take even more interventionist steps. After all, it allegedly needs to ward off the non-threat of “deflation”. The prospect that consumers may have to pay less instead of more for goods and services is regarded as an unmitigated calamity by modern-day central bankers.

It continues to be widely held by the world’s bien pensants that the best way forward consists of emulating the Fed and recreating the bubble conditions that have come to grief in 2008. Memories are evidently very short – when the Fed did the same after the Nasdaq bubble expired, its actions were also seen as beneficial until the bust revealed that the bubble prosperity of the period 2002-2007 was a complete illusion that destroyed untold amounts of wealth. But just you wait: this time, it will of course be different …


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8 Responses to “ECB TLTRO Fails to Attract Much Interest – QE Threat Lingers”

  • No6:

    The banks love free money, but they have virtually if not actually colluded to make this QE-lite fail so as to bring on the Big Kahuna QE max.

  • pigeon:

    I think the idea is not to say that no deflation will occur but that it should not be viewed as dangerous. Spending less for commodities allows for spending more on other things or investing.
    The Euro system has a major flaw – there is a central bank setting one uniform price of money for all the member nations with no possibility for the economies to adjust via their exchange rates. This fosters current account distortions to a massive extent, the main capital exporter being Germany.
    A common currency in itself can indeed be as progress as long as it is sound money. That’s not true for the Euro and hence what was einvisioned to bring the unity of Europe a big leap forward can easily end up as throwing it backwards decades.

  • Mark Humphrey:

    One quick note: since everything the governments are doing guarantees wealth destruction, many firms become gradually impoverished. Not because the world is coming to an end, but because the wealth destruction proceeds at a faster pace than private production can overcome.

    In the next downturn, firms and banks will be weaker and more vulnerable than in 2000 and 2008. This raises the risk that a weakened productive sector will roll over into a major banking panic. When banking panics outrun the response of central banks, money gets destroyed and actual monetary deflation gathers force.

    So the question comes up: To what extent does the issuance of excess reserves by the central banks and the accumulation of excess reserves by commercial banks reduce the risk of “accidental” deflation by “covering” deposits with “excess” reserves?

    That seems important and worth investing. Thanks again for your always excellent analysis and writing.

    • zerobs:

      Your post made me think of recent relocations, or lack thereof, of companies for corporate tax reasons. In particular I was thinking of Walgreens who decided against moving their company HQ to Europe. While many shareholders were pressing the idea, I think they decided against it in part because whatever tax rate advantage they may have today, it could all vanish tomorrow – if not via corporate tax (and VAT) rate increases then certainly via ECB inflation.

  • Mark Humphrey:

    Thanks for another excellent article.

    One reason that lending to businesses in the Euro area and the USA continues to lag could be the narrowed loan spreads reflecting bargain basement rates. Government bonds can be safely carried, borrowing short and going out a few years on the yield curve. There is no recognized default risk.

    However, loans to businesses carry considerable default risk that can easily exceed today’s impoverished spreads. Businesses are often reluctant to pay a high enough loan rate to induce banks to lend to them, because of capital consumption.

    As capital gets consumed, due to money pumping, taxation and spending, firms and individuals become poorer in real terms. This gradual impoverishment forces time preferences higher, which lead to a shift in relative prices. The demand and pricing for higher order capital goods slumps, compared to demand and pricing for consumer goods.

    Most firms make and service products for other businesses, not for final consumers. As time preferences are forced higher, business prospects among firms that make producer goods languish. They may report some profits, but in real terms–after adjusting for accounting distortions–they’re marginally profitable in the midst of “recovery”, or accumulating losses.

    Managers of these firms know or sense that they can’t afford to borrow much in their precarious circumstances, despite the need to replace depreciating capital goods. So lending to business sags and lending to capital destroying governments flourishes.

  • jimmyjames:

    What is it about the term “prohibited” that people don’t seem to understand? It is no coincidence that the ECB is once again seeking to employ indirect methods via the commercial banking system, with its recent plant to monetize ABS and covered bonds.


    Another new phrase soon to be coined by the EU ..

    “If it gets serious enough .. you have to break the law”

  • HitTheFan:

    The non-threat of deflation?
    Worth having a look at some commodity prices methinks, deflation lurks, it is very close.
    Why is that a threat to the ECB?
    It’s not really, other than the EZ is still adjusting under massive debts.
    It saddens me that writers here cannot see the Euro is a huge leap forward, due to its separation from the nation state.
    Maybe only time will show them, that, and the asset the ECB directs its QE towards.
    Then you’ll get it. But not before it would seem.

    • zerobs:

      Separation from the nation state? Is this some sort of joke? The only thing worse than a nation-state is a council of unelected bureaucrats, which is what the Euro is. Then again, we all know who else had a great leap forward.

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