Trader Talk

ECB's New Lending Program: What to Do With the Money?

The main topic of discussion this morning was Mario Draghi's interview in the Financial Times, where he warned that any country trying to leave the euro zone would still face austerity measures and would be "in a much weaker position." He reiterated no increase in the current bond buying program, and no printing money.

However, the new European Central Bank (ECB)longer-term lending program comes into effect on Wednesday, whereby the ECB can provide loans of up to three years to banks. In theory, unlimited loans at 1 percent with — get this — VERY loose collateral requirements and a flexible repayment plan — are a no brainer: Take the money and then buy sovereign debt at 5 percent. But it's not that simple, because there are two contradictory forces at work: 1) the pressure to buy sovereign debt to stabilize them; and 2) tougher regulatory requirements that encourage raising capital and deleveraging.

Bottom line: It's not clear that banks that are already up to their eyeballs in European debt are going to be big buyers of sovereign debt. So what would they do with all this money they’re being offered by the ECB? Well, banks have a lot of their own debt that is maturing: 800 billion euros ($1.04 trillion) in term wholesale maturities come due in 2012, according to RBS.

Why wouldn't they retire their own debt first? Wouldn't that stabilize the banking system, so then the ECB doesn't have to come to their rescue? And wouldn't that stabilize the sovereigns as well? That makes sense, not buying sovereigns.

Still, it's difficult to explain strength in Italian and Spanish debt without this carry trade. Somebody's buying sovereign debt.

Draghi will be testifying in front of the European Parliament today.


1. The death of North Korean leader Kim Jong il has put pressure on Asian stocks. Korea's Kospi Index was down more than 3 percent; Taiwan's stock market was down over 2 percent to a two-year low.

2. Another chip maker cuts forecasts: This time Xilinx cuts its fourth-quarter forecasts, joining Texas Instruments, Altera, and others.

3. Schnitzer Steel Industries lowers guidance for its first quarter earnings, citing weaker-than-anticipated global market conditions for recycled metals. Schnitzer slid 6 percent in pre-market trading after lowering its expected earnings per share range to 18 cents to 25 cents a share versus analysts’ estimates of 55 cents a share.

4. The Italian Senate should approve Italy's austerity package this week, after the lower house of the Italian Parliament approved it on Friday. The 33 billion euro ($43 billion) package cuts costs and raises taxes.

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