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.