This week has seen a new stage in the battle between the European Central Bank and the economic malaise which is affecting much of the Euro area. One factor in this has been that it announced this on Friday.
The ECB announces that the Eurosystem starts covered bond purchases on Monday 20/10.
Covered bonds that are eligible for monetary policy operations in line with section 6.2.1 of Annex I to Guideline ECB/2011/14 ….. and are issued by credit institutions incorporated in the euro area, shall be eligible for outright purchase under the CBPP3. Multi-cédulas that are eligible for monetary policy operations in line with section 6.2.1 of Annex I to Guideline ECB/2011/14 and are issued by special purpose vehicles incorporated in the euro area shall be eligible for outright purchase under the CBPP3.
I have taken out a little of the detail there but left in the bit about special purpose vehicles qualifying as that is the sort of thing that can return to haunt a central bank. But the crucial point is that the ECB began to purchase covered bonds again this week. The operations have been observed by market traders. According to Bloomberg it did this on Monday.
The ECB bought short-dated French notes from Societe Generale SA and BNP Paribas SA as well as Spanish securities.
Yesterday it did this.
The European Central Bank bought Italian covered bonds …………Debt issued by Intesa Sanpaolo Spa (ISP) was included in the purchases,
I think most readers will be clear why Italian and French debt was chosen although it is less clear why the debt of the supposedly recovering Spanish economy was chosen. I suspect that the mortgage related problems of the Spanish banks are far from over.
What will it achieve?
According to the ECB it will be all-singing and all-dancing when combined with its existing measures.
the CBPP3 will further enhance the transmission of monetary policy, facilitate credit provision to the euro area economy, generate positive spill-overs to other markets and, as a result, ease the ECB’s monetary policy stance, and contribute to a return of inflation rates to levels closer to 2%.
Does it also supply apple pie and ice cream?
What is a covered bond anyway?
Here is the definition from the Financial Times.
A bond backed by assets such as mortgage loans (covered mortgage bond). Covered bonds are backed by pools of mortgages that remain on the issuer’s balance sheet, as opposed to mortgage-backed securities such as collateralised mortgage obligations (CMOs), where the assets are taken off the balance sheet.
What does this mean?
We see that there are two very familiar themes to this particular operation. The first is that apparently the way to rescue the real economy is always via another bank bailout or subsidy. The second is that most of these moves involve the housing market and finance on it. If we stay with the concept of an implicit bailout for the banking sector we see the depth of their troubles I think as bailout follows bailout. The theme here is along the lines of Agent Smith in the film the Matrix Revolutions as he cries “More,More” as he replicates and clones himself throughout the system. Indeed Agent Smith has another line in that film which reminds me of the modern banking sector.
This is my world! My world!
What has so far been missing in the Euro area has been any real transmission of the ECB’s policies to the economies of the weaker nations. It has got stuck in the banking system in these places and has never emerged. After all the traditional measure for firing up the engines of the various housing markets (or stopping price falls) has been to reduce mortgage rates by cutting official interest-rates, except with a headline rate at -0.2% we can see that this has been tried. There have been various extraordinary measures too such as LTROs and now TLTROs as the ECB has gone acronym crazy but what has been missing is any real sign of economic recovery.
Even worse the banks started to give some of the money back earlier this year and at times this has approached a flood. Along this road the balance sheet of the ECB which reached a peak of 3 trillion Euros has shrunk to just over 2 trillion. Last Friday saw yet another example of this.
Accordingly, on 22 October 2014 EUR 3317.70 million will be repaid in the tender 20110149 by 4 counterparties and EUR 2504.50 million in the tender 20120034 by 6 counterparties.
Thus another 5.8 billion Euros departed the balance sheet of the ECB in what has become a regular Friday drumbeat. This poses a darker problem than you might think as it looks as though the banks feel that they have enough liquidity and do not want anymore however cheap it appears. The prospect of them lending more in such an environment do not look optimistic as we see something of a reverse for this type of extraordinary monetary policy. They no longer seem especially keen to borrow such funds and put the cash into sovereign bonds which I suppose is a side-effect of the lower level of bond yields available these days.
Is there an element of deja vu here?
Actually you could say deja vu squared as the ECB has had two goes at this before and the clue is to be found in the 3 of CBPP3. This has been missed by much of the media which has announced that this is the ECB’s first effort at Quantitative Easing. There were Covered Bonds Purchase Programmes in both 2009 and 2011 and the ECB still has some 45 billion Euros of bonds from those purchases.
Here of course we hit a problem, if the past purchases were such a success how did we get to this position? Why did the ECB start and then stop it twice? The truth is plain that the purchases did not seem to be ing having either the required or the hoped for effect so they were quietly binned. As they had little publicity anyway this was not that hard to do.
Accordingly I note that the ECB is back not because it really believes that such purchases will work but because it is a large enough market for it to look like it is doing something substantial. Here monetary policy morphs into a form of public relations.
What about Asset Backed Securities?
As 2014 progressed we saw Mario Draghi offer ever more impassioned pleas for the ABS market to grow. But the truth is that the amount available to buy may only be of the order of 15 billion Euros.
What about Corporate Bond purchases?
This subject roared into life only yesterday as rumours that the ECB would announce purchases at its December meeting spread like wildfire. Those who recall that November comes before December might have already been wondering what happened to it?
One plus of entering this market is that it is a large one and the ECB would be able to expand its balance sheet substantially by buying some of it.
Having pointed out that bankers have become like Agent Smith in our economy it is even more true of central bankers. If we recall that 2014 was supposed to be the year of recovery it is a way especially troubling to see the ECB both planning new measures and reheating old ones. The supposed end product of boosting small and medium-sized businesses always seems to morph into a subsidy for the banking-sector in reality. Yet the cry goes up again and again “More! More!”. One day there will have to be a valuation of the paper,bonds and markets they have got involved with and I expect there to be “surprise” shortfalls.
Perhaps the one way this may impact the euro area economy is via a lower exchange rate and the value of the Euro has fallen. But in a way this is just exporting the problems of the Euro area to other countries as we mull the competitive devaluations of the 1920s.
Meanwhile rumours spread that 11 Euro area banks have failed the latest stress test.