Quelle Surprise! Banks May Be Gaming ECB Liquidity Facility

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The ECB has uncovered gambling in Casablanca. The central bank is shocked to learn that banks appear to be originating crappy assets solely for the purpose of dumping them in a liquidity facility intended to help them through a rough patch, not to provide an ongoing subsidy.

Regulators should know better. Indulgent parents generally wind up with spoiled kids who posses a sense of entitlement and react particularly badly when restrictions are imposed. In this case, the ECB took it as a point of pride that it accepted a broader range of collateral than other central banks, but its liberalmindedness appears to be working against it. Financial firms are first and foremost loyal to their own wallets. Any program that can be used to generate profit or other competitive advantage can and will be exploited.

From the Financial Times:

The European Central Bank yesterday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank…..

Mr Mersch said the type of collateral now being accepted was: “A matter of high concern.”….

Investment bankers who work in securitisation say that their main business is structuring bonds that are eligible for ECB liquidity operations. Some analysts have concerns about whether the bonds being created will ever be saleable if markets recover.

“There is moral hazard . . . and we are not in the business of taking over the market,” Mr Mersch said. “That means there must be an exit strategy.”

This shows the danger of the idea of the central bank as market maker of the last resort. It’s too easy for it to become market maker of the only resort.

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10 comments

  1. tom a taxpayer

    That’s those naughty foreign bankers. At least we can sleep at night knowing that our Wall Street bankers would never think of pawning fake Rolexs and Gucci bags as collateral to the Fed.

  2. a

    “”That means there must be an exit strategy.”

    The exit strategy of the banks is clear: stuff the ECB with the losses.

  3. Richard Kline

    The central banks have taken the insolvent banks as partners. The insolvent banks have taken the central banks as suckers. Right now, the insolvent banks are in the money.

    The one thing no one wants to take is responsibility for the true scale of the losses in the financialy system which all this massive shifting of assets at the top of the financial system is designed to conceal but cannot mitigate. It’s musical chairs played minus the chairs to the tune of ‘Col. Bogey,’ and when as as the marchers fall out from dehydration they will be shot by vulture capitalists. . . . I’ve got a great sunrise on my lefthand, and a bowl of popcorn on my right hand, and good view from where I’m sitting: Let’s get on with the show.

  4. Anonymous

    Uh oh… sounds like the tuba player is getting tired and the music might stop… better find an empty chair.

    Central banks providing ongoing subsidies? Whocoodanode?!?!?!

    Honestly, where do they find central bank leaders so stupid? Have they been inbreeding for thousands of years?

  5. Anonymous

    Gee, do you think the Fed cash is being pumped into the commodities markets ?

    The whole idea of the CB taking in fraudulent, illiquid securities is rediculous in the first place.

  6. Peripheral Visionary

    There is an exit strategy: it’s not called a “swap” for nothing. All of these alphabet-soup facilities have a built-in expiration, all the central banks need to do is not renew them. It won’t be popular, but it certainly will be possible.

  7. Maria Dos Santos

    I’m a European taxpayer,with a stake in the ECB.Iceland and American banks are stuffing the ECB,as are others.But what really irks,is the propping up of really awful companies in Germany and England via the purchase and hiding of truly dreadful paper.But this propping is being carried out on the “right”people and their companies.This political nepotism has a large democratic deficit attached,M.Trichet should be slashing the cord.

  8. Francois

    There would be a relatively easy way to get out of this predicament…provided the ECB has the political kahunas to do so. (that qualifies as a big if)

    Have a crack team of their analysts examine latest collateral dump on them, identify the worst offender and shut off the spigot.

    At the same time, make sure it becomes clear to all other parties involved that yes! this is in retaliation for trying to mess with us. And yes! thou shall be the next on our shit list if you even dare to think we are not serious about that.

    Of course, we can think of thousands of reasons why this is not doable, none of them valid IMO. bankers need to understand they are just service providers to the economy, nothing else. If they can’t provide the services, or won’t abide by this principle, why should they receive any favorable treatment anyway?

    But that’s just me.

  9. Tom

    I would bet that Mr Mirsch is correct in terms of the overall credit quality of deals that are being specifically structured for ECB repo – I wouldn’t want to own the first loss. However, everyone seems to forget / ignore that the ECB does not own the first loss: apart from the subordinate tranches, the deals are subject to haircuts based on credit quality. And further, would he prefer to have a (e.g.) Spanish banking crisis on his hands? I can only imagine the bloodbath we would see if funding lines were withdrawn – the only ones wishing for that scenario are hedge funds with net short positions. The bigger problem IMO, is the ECBs ability to control the access to it’s facility. Northern Rock could have accessed the ECB facility if they had bothered to fill in the paperwork at their Dublin office, and as a UK tax payer (and investor in Granite), I would have welcomed ECB support for them ;).

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