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A Bridge, but Leading Where?

Ponzi at the European Central Bank.

Feb 13, 2012, Vol. 17, No. 21 • By ANDREW STUTTAFORD
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Purity has no place in a crisis. The 2008 TARP bailout was a clumsy, ugly, and rather shameful creation, but by signaling that Uncle Sam was in the room (with his printing press not far behind), it headed off the final descent into a panic that would have brought the banks, and, with them, the economy, and, with that, who knows what else, tumbling down. Three years later, another four-lettered program has been launched, this time in Europe, but once again designed to calm fears that were threatening to metastasize into catastrophe.

Photo of Draghi

It was no coincidence that the European Central Bank (ECB) launched its first LTRO (long-term refinancing operation) on December 8, the first day of a two-day Brussels summit in which the EU’s leaders planned to show that they were really, really in control of a currency union on the edge of chaos. The central bank’s billions were intended to sugar the bitter pills that the Brussels summiteers were bound to prescribe​—​and did. The eventual, uh, “Treaty on Stability, Coordination and Governance in the Economic and Monetary Union” that was hacked out of those talks (and a second summit last week) combines the big-heartedness of Scrooge with the vision of Magoo and the credibility of Madoff. Its significance lies more in what it won’t do than what it will. Few were impressed.

The LTRO, by contrast, got off to a tremendous start. In the months prior to the new program’s debut the central bank had been criticized (not always fairly) for not doing enough to support the eurozone’s stumblebum banks. Its rescues were too ad hoc, too brief, and too grudging. Not any more: Just in time for Christmas, the ECB repackaged itself as Santa, offering out longer-term (three year) funding at highly attractive rates and, as an added bonus, not being too fussy about how it was collateralized.

The combination of one generous lender and many anxious takers produced a spectacular result. From across the eurozone, 523 banks borrowed a total of 489 billion euros ($641 billion), a far larger haul than financial markets had anticipated. This was a measure both of the easy terms being offered and the difficult straits in which so many European banks had found themselves. -Lehman’s unquiet ghost was on the move. Trust in the banks was eroding, as was trust between them. Interbank lending was slowing, crimping the banks’ ability and willingness to lend money out into the “real” economy. 

By December, credit to the eurozone’s businesses and consumer clients was falling at a rate that conjured up memories of the nightmare of 2008. With the currency union’s extended ordeal driving Europe into recession, the last thing anybody needed was credit crunch part deux to make matters even worse. Yet that is what the continent was getting. And the deeper the recession, the harder it would be for the PIIGS (Portugal, Italy, Ireland, Greece, Spain) to escape their budgetary hell, and, crucially, for their lenders’ faith in them to return. And so the vicious circle turns.

Initially, the market was unsure how to respond to the LTRO. Was the program’s size a reason for celebration or concern? But then sentiment changed for the better. Italy completed a number of successful bond auctions. Yields on French and Spanish government debt fell​—​while those of Germany’s safe haven bunds rose. The Rodney Dangerfield euro even made up some lost ground against the dollar. And this was despite the flow of dreary news that just would not go away. The impasse over the “voluntary” restructuring of Greek debt continued, Portugal slid closer, again, into bailout territory, there was a further round of ratings agencies downgrades (this time from Fitch), and hideous fresh reminders of the plight of the eurozone’s periphery continued to slouch into view. In late January statistics were released showing that Spain’s unemployment rate had hit 22.8 percent in the last quarter of 2011. For the under-25s the rate is nearly 50 percent.

But for now the glass was half full. The old TARP trick had worked again. The European Central Bank had not only supplied the banks with nearly 500 billion euros ($650 billion) in badly needed liquidity, but it had also signaled that it was there on the ramparts alongside them. The cash was important, the boost to confidence no less so, and the message will be rammed home with an LTRO 2.0 scheduled to take place later this month. Another gusher? Maybe. The standard guess is that this second round will amount to 350 billion euros or so, but some have speculated that the total could swell to as much as 1 trillion euros.

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