European Central Bank

Europe vs US — Will QE on the QT by the ECB Save the Year?

In the US for most of 2011, the words of Pogo the Possum have prevailed in our political economy:  “We have met the enemy and it is us.”  This reality was most evident in the gridlock in Congress over budgets, debt and taxes that endured for almost all of this past year, culminating in the recent momentary stalemate  over the extension of the payroll tax cut into 2012. We get the Congress we deserve. And despite the frequent media commentary that cites a national desire for compromise and deal-making between the parties, the politicians with their ears closest to the ground hear a firm insistence on intransigent from their most loyal supporters (and campaign funders). Fortunately,  our situation can be changed for the better by a shift  in public sentiment that in turn changes political will — and this in fact happened on Christmas night at Speaker Boehner’s House. For once, the polls showed the pols that voters were backing-off their love affair with “lines in the sand”, and we got a deal.

Europe, on the other hand, remains tangled in its own underwear: in particular, the German strict construction of the European Union treaties to the effect that the European Central Bank can never act as a “lender of last resort” to its sovereign states, even to prevent a financial panic and  the collapse of the Euro currency. (German authorities seem to be most fond of enforcing the rules they themselves are the first to break: originally, by violating the Euro limits on national debt; and now, by their own political interference in ECB decisions, which they separately argue should be “independent” from such influence  –at least from other governments.) In effect, if the German position is not merely a negotiating posture to force recalcitrant Mediterraneans to get their budget acts in good German order — as many market participants seem to hope — the Euro currency is essentially a suicide pact!

All this could come to a head as soon as the first quarter of 2012 when Italy and Spain are forced to refund billions of maturing debt. At prevailing pricing trends, they cannot afford to do so without bankrupting their budgets. They need a financial  backstop to effectively put a lid on their sovereign debts’ interest rates by massive and timely market intervention — exactly what the Germans say the ECB cannot do.

Among Europe’s financial eminences, only the semi-disgraced Dominique Strauss-Kahn  seems to understand just how serious the situation is, but he is effectively without political force.

As we approach year-end, however, the ECB has attempted an elegant  hook-slide around  Germanic obstinacy by extending to three years its virtually unlimited lending facility to EU banking institutions at a rock-bottom short term rate that normally applies only to very short term borrowings. This yield curve tinkering –let’s call it QE on the QT  by the ECB — enables these banks to hold on to their existing holdings of Eurozone sovereign debt purportedly to maturity, thus deferring further write-downs impairing their capital or  the dumping of such bonds on a highly nervous market. It also invites the banks to buy into the refunding rollovers due. $500 billion of this offer was taken up by Europe’s banks, and another opportunity will be in place by February to continue  shoring-up the banking sector, which in turn helps the sovereign sector (which would have to bail out failing  banks to prevent Lehman-lke economic collapses int their economies).

The main fly in the ointment as we end 2011 remains the rating agencies’ posture toward Euro sovereign credits. These agencies collectively failed to downgrade the  US mortgage debt instruments that brought on our own financial meltdown in 2007 and the Great Recession that followed. They now seek to display their new-found backbone by following up Standard and Poor’s questionable downgrade of  US  credit on political grounds with threats of downgrading Europe’s safest credits, including France and Germany.

Ironically, a quick-trigger downgrade in Europe in early 2012 could have the same effect as the slow trigger in the US of 20005-07 — a massive collapse of global confidence this time in Europe’s financial structure, and a potential global depression along with it. If we are lucky, the agencies will notice the subtlety of “Super Mario” Draghi at the ECB — he may be the first Italian politician to outwit the Germans. As the US begins to sense its own economic recovery (look for a great jobs number on at the end of January’s first week), we can only hope this is the case.

Better Fed Than Dead

Terry Connelly is dean emeritus of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.


Traders ares speculating that the fed is bound to disappoint the markets on wednesday as there is really nothing much they can do tohelp the economy grwo any more, and nothing much that they can agree on in any event. I think they are wrong, on both counts.


As to the second matter first — Ben Bernanke’s background is not in the corporate world, where a Board of Directors, like the Fed’s Open Market Committee at least in structure and mission, is expected to be unanimous or nothing at all. Instead, the Chairman’s background is steeped in academic strcuture. Like any dean of a strong minded faculty (including myself, although I have lived in the other world of business, too), he knows that no faculty is likely to be unanimous about anything, and it does not bother him particularly even he has two or three public dissenters to Fed policy. And he gets great marks from his colleagues for courtesy and openness. Most faculties prefer to debate more than decide, anyway, because down deep they have mutual respect for their diverse opinions, no matter have pointed their disagreements. Ben will do a deal with majority support and not hold out for the “perfection’ of unanimity. You don’t have a specially-extended  two-day meeting and then do nothing; unless you want to contribute to market carnage.


And what ‘s to be done? Lengthening the maturity of the Fed’s balance sheet (the so-called “twist’) was sexier  when it was really just a teenage dance move, but it would help hold down longer-term interest rates that are the base for mortgages and consumer loans. Lowering the interest rate it pays banks to keep their excess reserves on deposit with the Fed will also help at the margin to push them to lend, finally. (This step should be staged to prevent a huge washover of deposits into money market funds and risking their valuation.) Both these moves would be welcomed by the financial markets, especially in terms of reducing the current obsession with every choreographed move in the Greek default process, as the “troika” of EU. ECB and IMF negotiators string bailout approval VERY PREDICTABLY BUT ALSO INEVITABLY  to the last minute so as to hold in check the negative public  opinion in Germany about spending more money on the Greeks. (They cannot afford to be scene as anything other than the strictest of lenders, so they drag things out to create that impression while the markets forget that it was just last week that Merkel and Sarkozy said the deal would get done! Traders can be downright stupid at times.)

And, by the way, don’t let this loose talk that we’d all be better off just to let Greece default right now (rather than waiting until 2013 when the lead countries of the European Community get their banks in shape to sustain losses in a managed default) get the better of your memory. That’s what folks said about “letting Lehman fail” before the great mistake (predicted in this blog) that triggered the Great Recession. Moral: don’t listen to the drumbeat on CNBC, ever!