Former hedge fund manager Warren Mosler is skeptical that the long-term loans from the European Central Bank will do very much for the banking system.
From his website:
So what does locking in their funds via LTRO [the ECB's long-term refinancing operation] do for most banks? Not much. Helps keep interest rate risk off the table, but they’ve always had other ways of doing that. It takes away some liquidity risk, but not much, as the banks haven’t been euro liquidity constrained. And banks still have the same constraints due to capital and associated risks.
To its credit, the ECB has been pretty good on the liquidity front all along. I’d give it an A grade for liquidity vs the Federal Reserve where I’d give a D grade for liquidity. Back in 2008 the ECB was quick to provide unlimited euro liquidity to its member banks, while the Fed dragged its feet for months before expanding its programs sufficiently to ensure its member banks dollar liquidity. And the FDIC did the unthinkable, closing [Washington Mutual] for liquidity rather than for capital and asset reasons.
But while liquidity is a necessary condition for banking and the economy under current institutional arrangements, and while aggregate demand would further retreat if the [central bank] failed to support bank liquidity, liquidity provision per se doesn’t add to aggregate demand.
What’s needed to restore output and employment is an increase in net spending, either public or private. And that choice is more political than economic. Public-sector spending can be increased by simply budgeting and spending. Private sector spending can be supported by cutting taxes to enhance income and/or somehow providing for the expansion of private sector debt.
What Mosler’s missing here, I’d argue, is the monetary effect of discounted sovereign debt . Since he sometimes reads this site, I’ll explain once again exactly what I mean by this.
When assets are considered risk-free by bankers and regulators, they operate as money inside of the banking system. You can use a money-good bond in almost any way you can use actual money. They can be used to meet regulatory reserve and capital requirements. They can collateralize all types of loans and repo deals.
But when risk-free become a risky asset, a huge monetary event takes place. The discount applied to the bonds is exactly as if the banks had suddenly seen that much cash vanish. It’s actually even worse than that because the assets don’t have to drop to zero before they lose almost all of their money-like qualities.
Regulations double down on this effect, since banks have to post new capital reserves against the very assets they once counted as capital reserves. It punches a huge hole in their balance sheets.
By easing the collateral requirements for the loans it is making, the ECB is effectively re-monetizing bank assets. These assets are once again as good as cash — albeit at discounted values since the ECB insists on not “overpaying” for the assets it lends against. This also provides an intrinsic liquidity bump to the value of the assets.
In short, this is a very, very big monetary event.
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