BUSINESS OPINION:There is a danger that the ECB will eventually have to start printing money
HOW ABOUT this for an investment proposition? Somebody comes along and says they will lend you money at 1 per cent interest so you can go and buy another investment that returns 4 per cent a year?
Sounds to good to be true? It is – unless you happen to be a eurozone bank, that is. If you are one you can now borrow pretty much limitless sums money from the ECB at about 1 per cent and use it to buy Irish and other eurozone government bonds paying up to 4 per cent.
The actual mechanism is a bit more complex – the banks have to buy the bonds first and then use them as collateral for loans from the ECB – but the net effect is the same. A 3 per cent annual return for doing little more than making a few phone calls – it sounds dangerously like the sort of madness that got us into this mess to begin with and the the National Treasury Management Agency (NTMA), the Government, the ECB and the banks themselves understandably are rather coy about it all.
The justification for offering what is essentially a free lunch for the banks is that firstly it allows them access to money at a time when they cannot get it anywhere else due to the freezing up of the credit markets. The second – and more problematic – argument is that by allowing them to make profit as well, you are helping them rebuild their shattered balance sheets, thus reducing the need for them to seek cash from their respective governments.
It is hard to argue against the first point as it is entirely in keeping with the role of the ECB as the lender of last resort to the eurozone banking system.
The ability of banks to use Government bonds as collateral for ECB loans is a very necessary part of the plan to fix the credit markets. Banks have always been able to do this, but until the credit crunch struck, the loans had to be repaid within a week or two and really only a last resort for banks facing temporary liquidity problems.
Since the collapse of Lehman Brothers though, the ECB has extended the length of time that it will lend money via these refinancing operations, lending more and more money for three months and then six months.
Early last month it announced it would conduct 12-month refinancing operations.
The second point is a little more contentious as the idea that banks should in effect be given money for nothing rather runs contrary to the public mood.
When you pair the ECB 12- month refinancing facility with some of the bonds currently being sold by Ireland and other states, you have a very attractive money- making opportunity. This, one suspects, is the main reason why nobody is very keen to highlight the refinancing arrangements and its consequences for debt issuance.
However, as with so much in the current climate, this has had some unforeseen consequences.
One has been to create concerns about why the Irish banks are such enthusiastic buyers of Government debt at the moment. The presumption is that they are being strong-armed into it by the Government as a quid pro quo for the taxpayer coming to their rescue.
If this really was the only reason the banks were buying Government bonds, it would be very worrying, as it would amount to little more than robbing Peter to pay Paul.
The NTMA chief executive went to some pains in a letter to this paper last week to address the issue by pointing out that the agency sells its bonds via intermediaries and has no control and no direct knowledge of who ends up owning them. The logic following on from this is that the NTMA is not in a position to oblige the Irish banks to buy Irish bonds.
It’s a plausible argument, but not really robust enough to withstand attack from conspiracy theorists and other cynics. However, once you understand the more venial commercial rationale for banks bailing into Government bonds, the whole thing starts to make a bit more sense. They are buying because – among other reasons – the ECB is in effect providing a subvention.
From the ECB point of view, the subvention presumably makes sense for several reasons; it provides liquidity, it bolsters the banks and it eases eurozone debt markets. Win, win win? Almost.
There does however remain an elephant in the room and it is the question of where exactly the ECB is getting the money to keep the whole thing going.
If it is coming out of existing bank reserves – and presumably it is, given that ECB has yet to embrace quantitative easing with the same enthusiasm as the Federal Reserve and the Bank of England – then the inflationary dangers are limited. But if, as some postulate, the ECB is – or eventually will be – printing money, then the whole thing starts to look a bit more dangerous.
jmcmanus@irishtimes.ie
