European Central Bank unlimited loan facility - apres le deluge, encore un deluge

And so, in December 2011 the expected deluge of money from the European Central Bank arrived. Loans at a fixed rate of 1% for 3 years, to stave off, more likely only postpone, the dénouement of the Euro crisis. But, as is often the case with the weather, the deluge of money didn’t fall where it would have done the most good.

The ECB showed a bit of Christmas spirit, and offered unlimited funding for 3 years at a fixed 1% interest rate. A few days later, nearly €500 billion had been borrowed. Who were the borrowers of this cheap money? Where did the money come from? Are we all saved?

In reverse order:

Question:             Did this wall of cash relieve nations imposing draconian cuts on their citizenry? Nations that were haemorrhaging money paying up to 18% interest on their borrowings from the banks?

Answer:             No. This loan facility was not open to national governments. This makes no difference to the loan burdens on governments. In fact, it extends the burden as it prolongs the time before the lending banks demand their money back, leading to some countries defaulting.

Question:            Where did all this lending money come from? Is this a resurgence of confidence, with investors around the world at last putting their hands in the pockets of their hanfus, kimonos, and saris?

Answer:            No. The ECB has the power to ‘create’ money. Britons of a certain age would remember, from their nursery days, the dreaded collywobbles. The ECB’s collies are vibrating like a phone on silent mode – the ring tone having been switched off, as the groans of the dispossessed and the unemployed is rather off putting. The graph shows how the ECB created money since the banking crisis started in 2007.

Question:            So, where did the deluge of freshly created money fall? 


Answer:              Once again, this is a bailout of the banks. Banks borrow money from investors and depositors which they then lend out to borrowers including countries like Greece. Much of the money banks borrow is for a fixed term – they have to pay it back at a specified date. Under normal circumstances, they just borrow more to replace what they repay. In current circumstances nobody in their right mind is lending banks money. At which point the banks could have to start writing off bad loans, and potentially go bust.

Which is where the ECB comes in with its €500 billion. The ECB lends the money to the banks at 1%, and the banks lend it to governments at anything up to 18%. As the ECB is a creation of European governments, the banks effectively borrow from governments to lend back to the governments, pocketing the profits.

This €500 billion is considerably more than the entire Greek debt burden, which was €360 billion in September this year. But simply handing the money to the Greeks at 1% interest, a small fraction of the interest they pay the banks, would be morally hazardous. A clear invitation to them to continue behaving profligately, smashing their crockery instead of washing it up and saving it for their next meal.

You might think the banks are taking a big risk lending to the likes of Greece. Earlier this year the banks were shoved towards taking a 50% write-off of Greek debt. For the more risk-averse, the EU provides another rock-solid route to taking a profit. The European Investment Bank and the European Financial Stability Facility are big borrowers, and are owned by the same people who own the ECB - the Eurozone member states.

Plus  ça change, as they say in the Eurozone – the deluge once again falls into the pockets of the bankers. Three year loans means the profits earned by the banks by this ‘carry trade’ will be safely in the pockets of the bankers over the next couple of bonus seasons. No moral hazard there then!