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ECB LTRO Won’t Stop Contagion.

  • Written by Syndicated Publisher 307 Comments307 Comments Comments
    December 29, 2011

    Bond action in the Eurozone has modestly picked up (yields steady or falling) since the ECB’s 3-Year LTRO program – Long Term Refinance Operation. However, European banks still do not trust each other, not even for overnight lending.
    Instead, banks park all available funds with the ECB, as noted by the Wall Street Journal in Deposits at ECB Hit Record High.

    Use of the European Central Bank’s overnight deposit facility hit the second all-time high in a row Tuesday as euro area banks increased the amount of cash they park at the central bank’s safe haven, ECB data showed Wednesday.

    Banks parked €452.034 billion ($589.72 billion) at the ECB, up from €411.813 billion the previous day. The high level reflects prevailing distrust among banks which prefer using the ECB’s facility rather than lending to each other.

    The increase in deposits follows the ECB’s first-ever three-year liquidity tender last week in which it allocated nearly half a trillion euros to more than 500 banks.

    The ECB also said banks borrowed €6.225 billion via its overnight lending facility, up from €6.131 billion the previous day. When markets are functioning properly, banks use the facility to the tune of a few hundred million euros overnight.

    The “first-ever three-year liquidity tender” offer cited by the Wall Street Journal is the 3-year LTRO that I mentioned at the top.

    ECB’s LTRO Won’t Stop Collateral Contagion

    Gordon Long put out an outstanding report on his website on why theECB’s LTRO Won’t Stop Collateral Contagion. I picked up the link from Zero Hedge. Following are a few snips:

    Here is the stark reality of what forced the ECB to offer unprecedented three year loans at absurd rates and most alarmingly, the acceptance of collateral that no other financial institutions will accept. The ECB has sacrificed its balance sheet in yet another EU “kick at the can”.

    1. COLLATERAL CONTAGION: There is a cascading Collateral Contagion crisis in which secured lending, based on sound assets, has replaced unsecured lending based on future expected cash flows.

    2. WHOLESALE LENDING: Wholesale bank lending, which is a unique cornerstone of European banking, has completely frozen since the failure of Dexia and US Money Market Funds will no longer risk short term capital having learned their lesson in 2008.

    3. BANK RUNS: Bank Runs are quietly and insidiously occurring throughout the peripheral EU countries as corporate and private depositors seek safe havens for their cash holdings.


    There are approximately $55T of banking assets in the EU. This compares to only $13T in the US. Bank Assets in the EU are 4 times as large as the US.

    In the US, debt held by the bank is smaller because retail deposits are a primary source of funds. EU banks use wholesale lending and, as a consequence, the debt held by banks is closer to 80% versus less than 20% by US banks.

    Wholesale bank lending in the EU approximates $30T versus only $3T in the US, a 10 X differential.

    Wholesale lending is fundamentally borrowing from money market funds and other very short term, unsecured instruments. The banks borrow short and lend long. It all works until short term money gets scarce or expensive. Both have occurred in the EU and this recently placed DEXIA into bankruptcy, forcing them to be taken over by the Belgium and French governments. The unsecured bond market fundamentally closed in the EU in Q3 2011, as fears mounted that an EU solution was not forthcoming.

    Assuming $30T of loans is spread over three years, EU banks have a requirement for $800B / Month of rollover financing for wholesale lending outstanding.

    Where is this money going to come from? No one is waiting around to find out as there will be cascading counterparty failures soon surfacing. Banking money in Europe is fleeing to custodial and official accounts of the ECB, the US Federal Reserve and any other central Bank willing to accept their cash.

    Excerpts do not do the article full justice. It’s well worth a read in entirety.

    Mike “Mish” Shedlock

    Images: Flickr (licence attribution)

    About The Author

    Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.  Visit Sitka Pacific’s Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

    You are currently viewing my global economics blog which typically has commentary every day of the week. I am also a contributing “professor” on Minyanville, a community site focused on economic and financial education.  Every Thursday I do a podcast on HoweStreet and on an ad hoc basis contribute to many other sites.

    When not writing about stocks or the economy I spend a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com.