Why the ECB refuses to be a Lender of Last Resort

Paul De Grauwe

The euro has a matter of weeks to save itself, with several institutions now preparing for its collapse. Given this, why does the ECB still refuse to bail out Europe’s heavily indebted countries? This column provides an explanation. It says that the ECB may well be behaving rationally but adds that such behaviour is also foolish – and dangerous.

Seven reasons why the European banking system is again teetering on the edge of the abyss

The European financial system is again in trouble.

Dexia, the Franco-Belgian bank, has just received a government guarantee. European Union finance ministers are again cobbling together late night rescue plans in an effort to prevent the financial crisis from worsening.

So what is going wrong with Europe's banks?  In no particular order, there are seven reasons why European banks continue to struggle:

A genuine exit strategy from the crisis

In 2010, the global economy enjoyed steady if unremarkable growth. By the third quarter of 2011, it teetered on the edge of recession. The post-crisis recovery lasted barely 2 years. Moreover, in many advanced economies, growth proved insufficient to ensure that GDP reached its pre-crisis level.

How did things get so bad so quickly? The answer lies in the public sector balance sheets of advanced economies.

When banking sector difficulties turned into an economic downturn, tax revenues took a hit, while expenditures on unemployment benefits rose. In some countries, the revenue decline was exacerbated by a long-standing dependence on asset prices and financial bubbles as sources of taxes.

Politicians believed that they could buy their way out of recession. With revenues already weakening due to the economic downturn, governments tried to stimulate activity by cutting taxes and increasing expenditures, pushing fiscal deficits up to levels not seen since the Second World War. With rising deficits came rising debt levels, which were already extremely high in many socialist leaning European countries.

High frequency trade is child's play

What? Seven out of ten equity trades are done by computers?

Ten things you should know about US foreclosures

Ten horrible facts about the terrible condition of the US housing market and the phenomenal rate of home foreclosures.

We owe it all to UK banks

Today, the Office of National Statistics reported November trade data. The mainstream media were not tripping over each other to report the latest export and import numbers. The latest numbers were, truth be told, quite unremarkable.

London Property Market is burning up

(click on the graphic for a larger version)

This graphic presents a different way at looking at London property prices.  Dark red represents rapidly growing prices, dark blue represents rapidly falling prices.  The shades in between represents different degrees of price change (remember red means up, blue means down).

UK house prices to fall another 13 percent

It has been a while since we saw such a cheery forecast for the UK property market.

Aug. 24 (Bloomberg) -- U.K. house prices will plunge another 12.7 percent before bottoming out, according to bond investors surveyed by Royal Bank of Scotland Group Plc.

Britain’s homes, which have already fallen 15 percent since October 2007, have further to fall, said 86.4 percent of respondents to RBS’s poll of mortgage-backed debt investors. The U.K.’s biggest bank controlled by the government distributed the result of the survey in an e-mail to clients on Aug. 21.

“General opinion was that U.K. housing has another down leg to take,” RBS said in the note.

RBS’s survey contradicts evidence U.K. real estate is starting to recover as the economy emerges from the worst recession in decades. House prices rose for a third month in July, according to Nationwide Building Society, while the Royal Institution of Chartered Surveyors said Aug. 6 that prices will increase this year, reversing an earlier prediction of a drop of as much as 15 percent.

At last some sanity...

The government needs to reverse this foolish VAT cut as soon as possible

From the Guardian....

The Treasury dashed hopes of an extension to the government's VAT holiday tonight after the latest figures for public borrowing revealed a collapse in tax revenues and prompted City forecasts of a £200bn deficit for the whole financial year.

With the City taken aback by the rapid deterioration in the state's finances, aides to the chancellor, Alistair Darling, stressed that the Treasury could not afford the £12bn cost of the VAT cut for a second year and the tax would return to 17.5% from January 1.

The US government ends car scrappage scheme

The US car scrappage scheme has been overwhelmed with applicants. The scale of demand has forced the administration to stop the scheme on Monday, as it became clear that the $3 billion allocated to pay for the cash giveaway may not be enough.

Apparently, the scheme was "overwhelming and overnight success". Forgive my skepticism, but it is hard to see how a scheme designed to give $4,500 away to every car buyer could fail.

However, what happens next? The surge in demand will fade away, leaving car manufacturers pretty much where they started. The US taxpayer will be left with the bill for paying for the ridiculous scheme.

From the FT....

The US cash-for-clunkers car scrappage scheme has become a victim of its own success, with the government announcing on Thursday that the incentives will come to an end on Monday evening, just a month after they were introduced.

The decision was taken to ensure that payments under the scheme do not exceed the $3bn allocated by Congress. A senior administration official described the scheme as “an overwhelming and overnight success – so much so that we need to wind this programme down”.

By Thursday, the transportation department had recorded 457,000 transactions, worth $1.9bn in rebates.The official said that “the over-riding objective [in ending the programme] was to be conservative and to provide an adequate window for a soft landing”.

The taxpayer put money in, and the bankers take it out

I think I am going to become a communist.

While taxpayers were pumping in uncountable billions into the US financial system, bankers took out multi-million dollar bonuses. How on earth could that be justified? If it wasn't for taxpayers, these banks would have been forced into bankruptcy.

At least in the US there is sufficient transparency to ensure that taxpayers know they have been ripped off. How many UK bankers in loss making banks received multi-million pound bonuses, generously financed by UK taxpayers?

From the Financial Times.

Citigroup and Merrill Lynch, which together lost $55bn in 2008, paid bonuses of more than $1m to a total of 1,400 employees, according to a New York state report on Thursday on bonus payments by banks propped up with taxpayer funds.

The study, compiled by Andrew Cuomo, New York attorney-general, showed that JPMorgan Chase and Goldman Sachs, which both finished in the black last year, paid the most million-dollar bonuses - 1,626 and 953, respectively.

However, the totals at a profitable bank like Goldman were nearly matched by two of the year’s biggest losers on Wall Street. Citi, which suffered a $27.7bn loss, paid million-dollar bonuses to 738 employees. Merrill, which lost $27.6bn, paid 696 bonuses of $1m or more.

Lets roll those loaded dice

There is something deeply disturbing about this chart. It shows that mortgage approvals have picked up over the last four months. While lending activity hasn't yet reached the levels seen during the bubble, there is no doubt that banks are returning to the housing market.

This chart is disturbing because mortgage lending is the only credit market that has seen a pick up in activity. Credit to the corporate sector is contracting. Firms are, on a net basis, actually paying loans back. Things aren't much better for consumers. Interest rate spreads on credit cards have actually increased, and consumer credit growth is close to zero.

So why are banks ready to return to the housing market and at the same time abandon other credit activities? Well, I have my answer. This is a classic case of moral hazard.

Regardless of what the government said in public, the recent bailout had only one objective in mind - put a floor under house prices. The liquidity support and the guarantees were all aimed at stabilizing the housing market. In effect, the government offered to insure banks and their property speculating clientele. The message from Brown and Darling is clear - "we will support house prices no matter how much it will cost".

Banks have picked up on this commitment. Bankers understand all too clearly that the government didn't offer any real support to corporate or consumer lending. Only property matters. Therefore, it is rational for banks to return to mortgage lending while at the same time, cut back on other credit activities.

With this huge de facto insurance contract in their back pocket, banks are cranking up another housing bubble, and it is happening with the financial support of the taxpayer. Moreover, as recent RICS data suggests, there is army of potential house buyers out there ready to dive in and speculate again on property prices.

It is the rational response. After all, we have a government that is ready to guarantee that no one will lose if they speculate on housing. If there are any losses, the government will ensure that the hapless taxpayer will pick up the bill.

US real estate lending growing at 6.4 percent

There are many occasions when I wonder just how serious was this credit crunch. Here is a good example - US real estate lending by banks.

This chart tracks the annual change in real estate lending. Currently, it is running at about 6.4 percent. Moreover, at no time did it ever actually decline. As such, it was always possible for US borrowers with good credit ratings to get new mortgages.

Quantitative easing - what next?

Edmund Conway of the Telegraph today.....

As Charlie Bean, deputy governor of the Bank, has said repeatedly on his tour of the UK to explain the unusual monetary medicine, it may take as many as nine months to show its full effects. But so far the results have hardly been encouraging. The fact is that the vast majority of this money is being funnelled into banks' reserves – the cash they keep with the Bank of England – and is not finding its way out again.

According to data from the British Bankers' Association, the level of reserves held by major banks rose to £110bn in June, compared with £27bn before quantitative easing began. Indeed, a full 3pc of total banks' assets are now sitting in reserves – a proportion not seen since comparable records began in 1987.

What is alarming is that something very similar happened in Japan, when it experimented with quantitative easing. The Bank of Japan poured cash into the system but it was merely soaked up by the zombified banks, where those who managed them were too scared of losses, under-capitalisation and the threat of collapse to do anything other than put it under the figurative mattress.

We were warned

"Growing domestic and international debt has created the conditions for global and financial crises".

Bank for International Settlements, 2005

US housing starts increase

True, you need a microscope to see it, but US housing starts increased in June.

Hands up anyone who thinks this looks like a sustainable recovery? What, no hands?

Goldman Sachs are Scum

Tell us what you think about Goldman.....

Another crazy US banking chart.

Have US banks made sufficient loss provisioning to cover their loans? This chart tells us that they haven't.

First, a warning, this is a difficult chart to explain and understand. However, it is well worth the effort to see what it is telling us about the US banking system.

So here goes....

The US Federal Financial Institutions Examination Council assesses whether banks make sufficient allowances for losses. In the bank supervisory reporting system, this number is called the "allowance for loan and lease losses" or the ALLL.

In order to make this assessment, the FFIEC looks at each bank and divides the ALLL by non-performing loans. If the ratio is greater than one, then the bank has things covered. If it is less than one, the bank has insufficient provisioning.

Here it gets a little more complicated. There are big banks and there are little ones. This chart takes account of that rather obvious fact. It separates those banks that have a ratio greater than one from the under-provisioning banks. It then takes the sum of all assets held in those good banks and divides it by the total assets of the banking system.

So what is this chart telling us? Currently, only 19 percent of assets are held in banks that have a ratio greater than one. In other words, the US banking system as a whole has insufficient allowance for losses.

This is why US banks are scrambling to increase their loss provisioning. In turn, provisioning is costly, and this is going to keep the US banking system severely depressed for a long time to come.

I choose freedom

When you look at long term credit data, you begin to understand the revolution in personal finance that took place in the last thirty or so years.

Back in the early 1960s, private credit was less than 16 percent of GDP. By 2007, it was over 170 percent. It is an historically unprecedented increase in personal indebtedness. GDP measurs our national income, which ultimately determines our capacity to repay debt. So this data tells us that our debt burden, which expressed in terms of income, has increased ten-fold.

To put it mildly, the data sems to suggest that we have become a nation of debt serfs. The vast majority of households, it would appear, are totally beholden to the bankers.

But not me. I proudly declare that I have no debts. The relevant number is zero. You won't find me in that chart. I have no credit card debt and no mortgage. Overdrafts are banned in the Cook household. Everything we have belongs to us. We deal in cash, and not credit.

I don't know about the rest of you but I choose freedom over serfdom.

Green shoots?

From the American Bankers Association:

A record wave of job losses is being cited as a major factor in a record rate of consumer delinquencies in the first quarter of 2009, according to the American Bankers Association’s Consumer Credit Delinquency Bulletin.

More than two million Americans lost their jobs in the first three months of the year with more than 6 million jobs lost since the recession began. The composite ratio, which tracks delinquencies in eight closed-end installment loan categories, rose to 3.23 percent of all accounts (seasonally adjusted) compared to 3.22 percent of all accounts in the previous quarter.

The delinquent balances on those accounts also rose from 3.16 percent to 3.35 percent of total balances due (not seasonally adjusted). The ABA report defines a delinquency as a late payment that is 30 days or more overdue.