Any attempt to wade through the media reports and political quotes on the Euro crisis would have left you more befuddled than ever. As I wrote Will Someone Please Inform British Prime Minister Cameron, the terminology used, and media reporting, was almost unintelligible for any senior banker. Let alone the general populace.
And when the various EU governments had a final crisis meeting in November, I all but gave up.
My favourite self exposing quip was President Sarkozy suggesting that banks could borrow from the European Central Bank (“ECB”) at 1% and lend to Euro governments at 6%. Like he had just invented the wheel. I mean that’s what banks do for goodness sake. Maybe he had only just realised it?
In my blog I diagnosed the Euro problem as “This is a global sovereign and systemic liquidity crisis. Underlined individually because each word has a specific meaning in finance.”
First up, Mario Draghi, the new President of the ECB made an announcement of a major bail out for the banks on 8 December; due to commence on 22 December. He didn’t call it that, but that is what it was as I will explain later. He at least understands the issues. And he did confirm my diagnosis as this being a liquidity problem; without the correct diagnosis, you cannot fix it. He said:
“In its continued efforts to support the liquidity situation of euro area banks, and following the coordinated central bank action on 30 November 2011 to provide liquidity to the global financial system, the Governing Council today also decided to adopt further non-standard measures. These measures should ensure enhanced access of the banking sector to liquidity and facilitate the functioning of the euro area money market.”
His speech in full is here, and for anybody interested in the facts as opposed to what has been reported, it is well worth a read. The actual ECB press release is probably too complex for non bankers, but it is here.
But what does it all mean? Well the only media report that I read that made sense and was accurate was by Floyd Norris of the New York Times. And I would highly recommend it. He wrote ”It would do only what central banks normally do. It would lend to banks. It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.”
And I agree with his conclusions. This action has pretty much finalised (wrong word), stabilised the Euro crisis as it has become known; for a period.
Mr Norris did make one error however; he referred to this as “normal”. It is not normal practice. Banks should not be bailed out for liquidity purposes. The raison d’être of the entire financial regulatory system is to ensure that there is not a liquidity problem. Ever. From risk management, through to all the capital and liquidity ratio hurdles banks are meant to maintain.
And there is another issue. Bloomberg has battled with the Fed Reserve to obtain full disclosure on how much that central bank used to liquefy its banking system (including off-shore banks – European). During 2007-2009 crisis, at its peak it lent a total of US$1.5 trillion to 407 banks. That is an average of US$3.7b per bank. Although the calculations are more complex than this simple averaging and the full article should be read.
The ECB’s offer is for unlimited funding up to a maximum of 3 years maturity. And on the day it commenced it gave 523 banks a total of US$640 billion. Or a simple average of US$1.2 billion each. Not a lot frankly, but its scale as in the number of banks who tapped the borrowing is frightening.
But the bad news is this. Despite bailing out the banks, and the mini boom (or dead cat bounce as it is called) the Fed’s response did not save the economy. It went on to use Quantitative Easing – dancing up and down the yield curve on a further two occasions during 2010 and 2011; and still people are only talking of a green shoot economic recovery. Hardly encouraging for Europe.
What is most extraordinary about the Euro bailout though is that it did not happen before it reached the critical stage. I mean, it is not as though they were re-inventing the wheel. It has been done recently, by the Fed Reserve. That is in recent memory exactly the same bailouts occurred. In fact, the solution is so obvious in banking terms, it beggars belief.
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