Why ECB's LTRO Won't Stop Collateral Contagion | Zero Hedge
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.
4. SHADOW BANKING SYSTEM: The European Shadow Banking System off balance sheet and unreported leverage structures, such as SIV (Structured Investment Vehicles) is collapsing due to non performing loans which must finally be rolled nearly 3 years since the financial crisis began.
5. GLOBAL INVESTORS PULLING SOVEREIGN EU INVESTMENTS: Net outflows from the euro-zone’s financial account reached ?32.1 billion in October alone, on an unadjusted basis. The drop reflects the sale by foreign investors of ?53.3 billion in euro-zone debt instruments and ?6.6 billion in equities.
6. INTERBANK LENDING: Prior to LTRO, overnight interbank lending was impaired as LIBOR, LIBOR-OIS and TED spread yields were going almost straight up on a percentage change basis.
7. INVERTED YIELD CURVES: Prior to LTRO, yield curves in the EU peripheral countries were either inverted or nearing inversion prior to LTRO.
8. US DOLLAR SWAPS: A shortage of US dollar denominated loans forced the US federal Reserve and other global central banks to intervene and offer what is turning out to be unlimited US dollar SWAPs for minimal interest rates and unprecedented, extended durations, not previously considered.
9. SOVEREIGN BOND MARKET: The EU Sovereign Bond Market is being avoided by almost all Global financial institutions. The only participant are Central Banks desperate to buy more time until confidence is restored.
10. GERMAN BUND SCARE: You cannot have a currency without a risk free bond. The German Bund had become a proxy for this, but recently even the Bund has come under pressure as selling escalated in a flight from Europe.
11. YEN CARRY TRADE: The YEN Carry Trade which has been a major financing source for the EU, even prior to its inception, is being forced to unwind due to a significantly weakening Euro and the threat of a serious drop.
12. BASEL BOX: The Tier 1 Core Capital requirements have forced many banks to actually shrink lending to meet requirements. A significant withdrawal from lending in Central and Eastern Europe and many Emerging countries is now clearly seen as a direct result.
13. CREDIT DOWNGRADE ONSLAUGHT: S&P placed the long-term sovereign-debt ratings of 15 euro-zone nations, including struggling Italy and Spain, on negative watch. That typically means there is at least a 50% chance of a downgrade within 90 days. France is likely to soon lose its coveted AAA rating, which will impact the European Financial Stability Fund (EFSF) borrowing costs.
The list is even longer, but it will need to suffice for this shorter article.
The above issues suggest, minimally, an immediate ?4-8 Trillion EU problem.
The EU has no ability to solve this problem short of simply printing Euros, which unlike the US Federal Reserve, Bank of England and Bank of Japan, the ECB presently (I stress presently) refuses to do.
Why The LTRO Is Not A "Risk On" Catalyst | Zero Hedge
So just over a month in, what does the LTRO really mean for Europe (especially as we approach the next 3 Year LTRO issuance on February 29)? Here is Brockhouse's explanation.
Via Bloomberg:
The 3-yr LTRO is not a catalyst for a risk-on rally as the central bank is substituting itself for funding sources that have “dried up"
"This is a key difference that implies that the current collateral shortage will continue"
Collateral shortage negative for velocity of collateral, velocity of money, “not exactly a catalyst for a rally"
Not all LTRO funding is “parked” in short-term peripheral debt as ECB overnight lending touched record EU528b Jan. 17
"The stigma associated with borrowing from the ECB is visibly gone, but the stigma associated with holding peripheral debt remains present"
Post-LTRO, developments in peripheral sovereign bond markets are driven more by solvency factors than liquidity factors
"The desire to de-risk European bank balance sheets will continue to prevail and the need for higher capital requirements will continue to constrain leverage"
And that's the main difference between the European "easing" and that of the Fed: in Europe the ECB's balance sheet is merely filling the leverage void created by the recent mauling of European banks and the fact that nearly ?500 billion is still parked with the ECB: hardly an indicator of confidence in the system. In the US, QE1 and QE2, were not only substantial, they provided incremental liquidity into the system, which then spilled over into risk assets.The question the becomes: what happens to the capital lent out at the next LTRO? Unfortunately, as the bulk of it will go to prop up European bank capital in anticipation of a Greek, and potentially Portuguese - its 10 year just hit a new record, default (controlled or otherwise), it is more than likely that while the market may front run it once again, the final outcome will be even more frozen cash which does nothing to actually benefit from the carry trade, or to pump risk assets.
