October 2, 2012
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This post by Zero Hedge gives a subjctive interpretation of the current rush of covered bonds by Europeans banks, some of them soon approaching the limits for such issuance. Many banks retain large portion of the new bonds themeselves; which raises the interesting question if you can own your own debt!
The post goes on to argue that central banks are painting themeselve into a corner, where lack of collateral and requirement of collateralized lending (from CBs to banks) will finally meet.
If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time.
At that point the system will collapse or central bank will be force to relax collateral requirements, ref. Tuckers discussion of this problem under the heading of “central banks’ time inceonsistency problem”, for a discussin of this dillemma see my Levy WP here on The Collateral Squeeze, p. 17
Alternatively (and better), central banks should let failing banks go into resolution and stop the collateral chasing. Better to start on this process before it becomes too late.
My old friend Peter Stella and IMF colleague M. Singh has a new VOX post based on their IMF WP Money and Collateral. They argue that we should not fear inflation due to excess reserves, since the money multiplier is not working anyway. The shadow banking system is now creating much of the credit, but also need support in the crisis from central bank liquidity support. But since the shadow banking system is based on repo financing in government paper, central banks should support the system by doing QE in other undervalued papers, like asset based securities.
Whereas I liked their IMF WP, this post needs some discussing. First of all, the money multiplier is long dead anyway. For a good discussion of whether excess reserves will create inflation, this see blog post by McAndrews of NY Fed. Second, they correctly note the huge size of financial market assets relative to very little reserves, but do no discuss further the advisability of operating a financial system of private credit with so little official backing.
As I have noted earlier in my Levy WP “Shadow banking and the limits to central bank liquidity support” there is probably a limit to how far central banks should accommodate the endogenous expansion of shadow credit. Unless credit creation is somehow constrained, central banks cannot simply go on to support private liquidity markets with endlessly new QEs.
If you are interested in the FT’s view on the issue, Isabelle Kaminska of Alphaville devotes two long posts to their paper.
April 24, 2012
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Todays hearing in the Senate Banking committee on the MF Global bankruptcy were supposed to deal with how we can avoid a similar debacle in the future. Much of the action was still on where the money went and how this could happen. Not so much new information during a short two hour session, but obvious that the relevant rules (1.25 &30) could be used in a quite flexible way as a result of previous strong lobbying by Goldman Sachs (for rule making proposal to straighten up this loophole, see here, and for the objections from MF global, see here). Unbelievable that CFTC let them continue with investing client money in European debt and in-house repos! Gensler, chairman of CFTC and former colleague of Corzine at GS obviously has a problem with this case (he has left it to his commissioner Sommers to handle the case on the Hil)
This post from January capture the angry (and probably correct) mood among the MF Global clients, when it comes to lack of fair treatment. And nobody should believe that the money just “vaporized”. They were stolen twice!
April 11, 2012
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A new IMF WP by Singh and Stella has already attracted a lot of comments on FT Alphaville and Zero Hedge blogs. They note that thee is a shortage of safe capital instruments out there, and suggest that Governments should issue more Treasuries to accommodate the shadow asking systems demand for safe and liquid assets over and beyond what they can get inguaranteed bank deposit accounts. However, you can as well argue atshe size of he shadow banking should be reduced, for further arguments see my WP on shadow banks and the limits to central bank liquidity support http://www.levyinstitute.org/publications/?doctype=13.
April 4, 2012
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Global liquidity provision is highly pro-cyclical. The recent financial crisis has resulted in a
flight to safety. Severe strains in key funding markets have led central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask how elastic the supply of central bank currency should
I address this question in a new Working Paper from Levy Institute: Shadow banking and the limits of central bank liquidity support. The paper review the recent expansion in central bank liquidity support, including their collateral polices, and then suggests that central banks should not unconditionally supply liquidity to a banking system that is growing uncontrolled. Stricter controls are required unless central banks again will have to underwrite dysfunctional markets.
The paper also provides input to the ongoing Krugman – Keen discussion on banking. See especially section 6 on excessive global credit and section 7 on A new view of banking.
February 16, 2012
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As a followup on my post on the client funds after MF global on Tuesday, this new post from Zero Hedge today gives more detail. Somewhat tedious, but also very important, and of much relevant to the ongoing redesign of bankruptcy law and resolution regimes for financial institutions in general.
Until the Congress rectifies the current bankruptcy laws and allows trustees to claw back payments made to secured lenders and other counterparties, there is no reason for any rational personal to allow a broker dealer to hold securities in custody. All of this business will go to the big banks, who will be just as happy to see the smaller dealers thrown into the meat grinder.
The uber-privileged position of derivatives in the 2005 Bankruptcy law was supposed to secure the payment system and therefor financial stability. In fact the crisis and this MF Global bankruptcy has shown that customers and markets are worse off as a result, and pressure are building for change:
Now why, you may be wondering, did the lobbyists from the big banks push Congress to expand the safe harbor for secured parties in the bankruptcy code? As one former Bush II Treasury official told me last night: “The canard the banks used to get 546 amended was that overriding the trustee’s normal avoidance powers was said to be necessary to limit systemic risk and ensure access to credit. God forbid the banks be required to do some due diligence. As the bailouts showed, the systemic risk was in fact enhanced by the changes to the bankruptcy code and the illusion of superior claims to collateral, thus increasing leverage.”
February 13, 2012
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Willem Buiter (LSE, now at Citigroup) was a fierce critic of ECB’s collateral policy back in the mid-2000. He claimed that the collateral policy did not differentiate between the underlying credit risk, and therefore papered over the convergence problems in the periphery countries. See his 2005 paper with Anne Sibert (Birbeck) on “How the Eurosystem’s Treatment of Collateral in its Open Market Operations Weakens Fiscal Discipline in the Eurozone
ECB Chief Economist Ottmar Issing responded in a speech the same year, and stated that:
Let me take the occasion to briefly comment on an idea that seems to gain more and more support. It has been recently argued that the ECB should use its collateral policy as a sanction to exert fiscal discipline on those euro area member states that breach the 3 % limit. One possibility would be for the ECB to impose haircuts on the bonds issued by those governments that fail to comply with the Pact, thereby making those bonds less attractive for counterparties to hold and use as collateral in the ECB’s regular operations.
Although superficially appealing, this suggestion would be misguided. First of all, such a measure would exceed the mandate of ECB’s collateral policy, which is to manage risk in monetary policy operations. Assigning additional roles to collateral policy would deflect it from its primary and crucial purpose.
Second, such a proposal ignores the differentiation already applied by the ECB in valuing collateral. All financial assets offered as collateral, including government bonds, are valued daily at market prices. In its collateral policy, the ECB therefore relies on the judgement of the market to distinguish among government bonds and, implicitly, the fiscal behaviour of member states. Moreover, the ECB sets credit standards for the eligibility of assets as collateral and is bound by the Treaty not to distinguish between government and private issuers in the implementation of these standards.
It is interesting to read his response today, with all the ongoing problems in the sovereign debt markets still unresolved. Buiter’s argument was that the ECB collateral policy was circular, as the market valuation reflected the ECB position that everybody was equal. Thus, the market for sovereign bond converged towards the common low denominator of the German Bunds, enabling periphery countries to borrow at low cost and delay the required real convergence. But that is all history now.
February 10, 2012
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FT Alphaville gives further details today on the regional variations in collateral requirements for the upcoming LTRO . As noted by Draghi yesterday, ECB will apply a hefty haircut of 2/3 on all pledged collateral. But national central banks have discretion within the new collateral rules to accept local assets depending on circumstances. Generally, the new guidelines imply that NCB’s will accept assets with ratings down to BB- instead of previously BBB-. But there are variations between NCBs as noted in this report, e.g. CB of Spain will accept mortgages, while the Irish CB will not.
The Germans think the ECB is giving away “easy money”. That can be debated, with such a heavy haircut.
February 9, 2012
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Lots of interesting tidbits here from ECB chief Draghi’s press conference today. My favorite quote:
The new Fiscal Compact is a major political event. For the first time governments are giving up some of their sovereignty and are ready to put this into their primary legislation. This is a sign that the Euro is strong. It is a first timid step to fiscal union. This will not be a transfer union! All countries should stand on their own without continued subsidies from the others
But, what is the point of being together if you have to mange alone??
I have included my notes below. There are some new info about the LTRO coming up end of month. See also recent Zero Hedge post for more on the weakening collateral position and what it say about the banking sector in Europe.
- ECB has more optimistic outlook than IMF for Europe, especially for Germany
- Don’t see substantial downside, but rather stabilization of economy at a low level
- But lots of uncertainty!
- EU (consolidated) is in much better fiscal shape than the US and Japan
- Inflation expectations are well anchored and remain low
- ECB is very concerned about the current credit crunch, especially to SME (account for 80 % of EU employment)
- Normally large banks would take money from ECB and distribute locally, but with interbank market not working, we have to enable them to get it directly from us
- Therefore the ECB has relaxed the eligibility criteria for LTRO collateral to enable smaller bank direct access
- This will expose the ECB to more risk, but the risk is very, very well managed
- Loans will be over-collateralized by a lot (haircut of 2/3)
- The first LTRO was used by many banks to refinance their own debt; also many are facing higher capital requirements
- We expect more will be used for lending (and purchasing government bonds) in the next LTRO
- What they use LTRO for will be their own business decision (we cannot force them to lend)
- But we are looking very closely at what is happening (with lending) and will review our policy options in 6 month time
- Size of next LTRO will be substantial and (probably) at around same level as the first one
- LTROs are non-standard (extraordinary) monetary policy operations that should not be continued when we get back to normal (funding markets)
- LTRO is not an alternative to a rate cut. LTRO is addressing quantity constraints and liquidity deficiencies. Interest rate changes would address pricing conditions, subject to normal functioning financial markets. Markets are not functioning now, therefore LTRO.
- Difficult for us to say how large next operation will be. There is no stigma attached to LTRO borrowing! There has been some press reports that it is undignified to borrow from the new facility; such “manhood” statements are not correct. Actually many much better banks (than the one quoted) have taken funds under LTRO1. Since this crisis originated as a sovereign crisis, many banks in better placed countries will not need the money. They should thank their countries for being well managed.
- TARGET2 imbalances are inherent in a monetary union. Some are in surplus while others are in deficit. These imbalances are usually not high under normal conditions. Since the interbank markets are not working now, some countries have accumulated balances and others have seen negative balances grow. However, this does not represent any more risk; it is part of the normal functioning of the ECB.
- Greece should focus on reform, not refinancing
- ECB will not take haircut; not our intention to violate monetary financing prohibition
- European Financial Stability Facility (EFSF) is a Government institution, i.e. if we make a loss on a transfer of Greek debt to EFSF, it will be monetary financing (of Governments)
- Another matter if ECB transfer part of its profits to EFSF (i.e. Governments); that is not monetary financing
- The new Fiscal Compact is a major political event. For the first time governments are giving up some of their sovereignty and are ready to put this into their primary legislation. This is a sign that the Euro is strong. It is a first timid step to fiscal union. This will not be a transfer union! All countries should stand on their own without continued subsidies from the others
- Q: Do you have a plan B for Greece? D: We never have plan Bs (we will work this out, but cannot say more until after the EU Council meeting tonight)
- Whatever is decided of haircuts for Greece (Private Sector Initiative) should not lead to precedent for other countries (including Ireland)
- Ireland should be commended for the bold and courageous measures that are being taken
January 25, 2012
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As central banks immobilizes more and more collateral through their liquidity support operations, banks are scrambling to find new ways to repo; where will it end?
US plan sponsors look to alternative repo – Finadium | securities lending latest news | securitieslendingtimes.com.