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"Like tying two drowning people together" [ClearOnMoney]
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Commentary

"Like tying two drowning people together"

30 Mar 2012 by Jim Fickett.

A pithy and amusing analysis of the European Central Bank's rescue efforts:

The ECB’s “longer-term refinancing operation” has sparked a big rally in global equities and has lowered borrowing costs for Italy and Spain, viewed as the countries whose fortunes will determine whether the crisis in the 17-nation single currency area intensifies again. …

But there is a dark side to the LTRO. Critics are increasingly concerned that by helping to save banks and governments now, the ECB may unwittingly be sowing the seeds for the next escalation of the crisis. …

“Financial markets have certainly been impressed. But this isn’t really solving anything and in some respects it is actually worsening the intricate and nepotistic relationship between banks and sovereigns,” says George Magnus, senior adviser to UBS, the Swiss bank. He describes claims by some European politicians that the crisis is over as “myopic”.

… the sheer cheapness of the funds has prompted banks to go on another credit-fuelled binge, similar to what preceded the global financial crisis but this time snapping up the debt of their own governments.

Their bond buying has brought bond yields down for the likes of Italy and Spain but it has also caused the fates of banks and countries to become even more inextricably linked. “There is a risk it’s like tying two drowning people together in the hope they will float,” says Benedict James of Linklaters, the law firm. …

Spanish banks, for example, increased their holdings of Madrid’s state bonds by 29 per cent in December and January combined, the last two months for which data are available, to reach €230bn. Italian banks boosted their domestic purchases by 13 per cent over the same period to €280bn. …

If yields continue upwards, some analysts worry that banks may have been pushed into buying the bonds at exactly the wrong time. “You are encouraging banks to buy at potentially the peak. Banks are going to have to mark to market and post more collateral if bond prices decline meaningfully,” says Graham Secker, equity strategist at Morgan Stanley. He describes Spanish and Italian banks’ approach as in some respects “the proverbial all-in at poker”.