Villain of the past week, the ECB – which forced IMF bailout-programme country, Ireland to pay €1.25bn to unsecured, unguaranteed bondholders at a defunct bank – really is taking the biscuit for distorting, and in some cases, damaging intervention in the economies and societies of Europe. In Ireland, we have experienced the ECB sit on its hands in the early 2000s as core European banks lent colossal sums of money to Irish banks which was then poured into property, causing a bubble which has now burst with disastrous consequences set to last generations. And the Irish nation has found itself paying back inter-bank lending, partly from a foolish bank guarantee and partly under duress from the ECB. And we have an ECB which doggedly sticks to its primary remit of price stability (keeping inflation in check) when the obvious need for the EuroZone as a whole is to print euros and let inflation rise beyond the 2% ECB target.
But consider the latest wheeze on the part of the ECB – the so-called “Longer Term Refinancing Operation” or LTRO in December 2011. This saw €489bn lent by the ECB to banks operating in the EuroZone, the ECB loans were for three years and at the main ECB lending rate which is currently 1%. The banks placed collateral with the ECB as security, but it is widely acknowledged that the ECB lowered the quality of collateral accepted. The LTRO operation was undertaken as part of the ECB’s remit in support of monetary policy. Monetary policy is where a Government or central bank seeks to support an economy through interest rates and money supply.
We saw during the week that Irish banks have used the LTRO funding to buy Irish government bonds paying 5.15% per annum. Which is pretty good business for the banks – they borrow at 1% and get paid 5.15% on their borrowings. Not only that, but sitting on Irish government bonds for three years is far easier – and cheaper – than lending to pesky households and businesses. After all some of those households and businesses may not repay loans, others may get into difficulty and each represents a small connection and there is great cost in administering such loans. Nicer to kick back and wait for Irish government bonds to mature!
It gets better. In February 2012, the ECB will undertake another LTRO operation and Irish banks may be able to pledge the newly acquired Irish govt bonds as collateral. So they get more funds at 1% and can then buy even more government bonds that pay 5%-plus. Isn’t it great to be a bank! Prior to the December 2011 LTRO, the previous longest LTRO was for 1 year and was issued in 2009. There has been a 6-month LTRO also but generally LTROs are for three months.
Unlike other businesses or industry, banks can get access to this cheap 3-year money from the ECB. By comparison, spare a thought for poor old Michael O’Leary (pictured above, left) who is run ragged as the CEO of Ryanair trying to build the world’s biggest airline. Michael, the schmuck, labours away at providing a real service to consumers, and trying to make a profit on his enterprise. How peeved must he feel when he looks over at other businesses – banks – who simply get lent 3-year money at 1% which they then “invest” in 5%+ yielding investments? God knows what he thinks about the uneven playing field between banks and his own business when trying to attract equity investment. You can only speculate if Michael stays awake at night, sore at the fact that he can’t use the assets in his own balance sheet to get 1% 3-year money from the ECB and then stick that in Irish government bonds. The poor eejit!
On the other hand, if you happen to be say, the CEO of Anglo – or IBRC as it is now called – Mike Aynsley, (pictured above, right) and just happen to have a bank licence or are a bank shareholder, then the ECB largesse is like manna from heaven. Pity that the funding is not demonstrably going into the real economy – households and businesses. And isn’t this what monetary policy should support? And if so, isn’t the ECB queering that as well?
The ECB was asked to comment on any consideration it had paid to competition issues before devising its 3-year LTRO operation in December 2011. Ryanair’s spokesman, Stephen McNamara was asked whether Michael O’Leary felt like a right eejit for slaving away on a proper business whilst banks have been given a licence to print profits and whether Ryanair might consider legal action on competition grounds. Neither has yet commented.
NAMA Wine Lake 
The ECB is “distorting competition” to help European banks rebuild their balance sheets, or at least to prevent them from collapsing. It’s already too late for Irish banks but you could see that as a back-door bail-out, especially for Spanish and Italian banks; and on top of that it helps countries not to default by creating demand for their bonds and thereby lowering their interest rates. It’s killing two birds with one stone!
I really do believe it benefits the rest of the economy as surely we are all better off if Ireland, Italy etc don’t default. I don’t know how much this is helping French banks and thereby helping to prevent French taxpayers from having to bail them out but based on the market reaction (strong increase in the share prices of French banks and lower interest rates on French government debt) it looks like it’s very effective.
So basically I’m not sure why you’re complaining about a policy that looks very effective at preventing a depression in Europe!
Bloomberg is reporting this regarding French banks,no numbers available,decent attempt at preventing a credit crunch,without it there may be no European banks for O’Leary,but its not quantitative easing which is NWL’s point,no spillover into the real economy.
“French banks BNP Paribas (BNP) SA, Societe Generale (GLE) SA, Credit Agricole SA and BPCE SA all borrowed from the ECB though declined to say how much, Morgan Stanley said. Spokespeople for the banks declined to comment. Royal Bank of Scotland Group Plc, the U.K.’s largest government-owned lender, took 5 billion pounds ($7.8 billion), according to the analysts. An RBS spokesman declined to comment.”
http://www.bloomberg.com/news/2012-01-23/european-banks-may-deepen-their-dependence-on-unlimited-central-bank-loans.html
The wily Michael might consider converting to Ryanair Bankcorp to take advantage of all this. Or how about a loan of €1 million for every man woman & child in the country at !% to invest in government bonds….€45,0000 per annum profit each would help lower our debts pretty quick! What have banks got that we don’t?…. Have to figure that one out. It can’t be their honesty or charm…
@WSTT, €45,000 profit on a €1m loan? Oh no, in February you will be able to take the Irish govt bonds and pledge these as collateral against another €1m loan which you can then “invest” in Irish govt bonds, so the €1m loan actually nets you €90,000 and that assumes the ECB doesn’t run more 3-yr LTROs after February.
@Narg, fair points. But strictly having regard to commercial competition, where a bank is one business and an airline is another business, the LTRO and Govt bond purchase, is a distortion of commercial competition. And because banks are creaming off the LTRO and not letting it trickle into the real economy, monetary policy objectives are also being perverted.
Here is Summers on LTRO,Ackermann from Deutche was on earlier.
http://video.cnbc.com/gallery/?video=3000069827
@ Narg
This shenanigan of helping the banks “rebuild their balance sheets” by effectively printing money without a license reeks of moral hazard. A term you may wish to become familiar with that has much longer term negative consequences than letting the banks fail outright.
@NWL. WOW! The mind boggles. Do that a couple of times and the banks won’t know what to do with their cash. One thing that they will not do, of course, is to lend it into the domestic economy.
“the banks won’t know what to do with their cash”
Its going to vanish up their own ars*s.
Just thought that I’d share this 15-minute clip of Michael O’Leary’s address at a recent EU Innovation Conference http://youtu.be/p4HYSsrlcq8
It is the first time he has spoken at an EU event, aside from EU-sponsored court cases against RyanAir !
This is hitting the wires over here,implications for Ireland !
“(Reuters) – Germany is pushing for Greece to relinquish control over its budget policy to European institutions as part of discussions over a second rescue package, a European source told Reuters on Friday.”
http://www.reuters.com/article/2012/01/27/us-eurozone-greece-germany-idUSTRE80Q1ZF20120127
As Nassim Taleb commented, we’re not living in capitalism or socalism anymore but in some weird mix.
Personally, I think we are living in a kleptocracy.
@BF thank you,thoroughly enjoyed the link,excellent.
The Reuters exclusive is very well covered by zerohedge,the comments are great.Not,trying to usurp NWL,but call me curious,why did irish economists schedule,actually a very interesting conf. today,but so was Davos!
http://www.zerohedge.com/
@nwl
I agree that there is a new tone, a quiver of emotion, a swerve in the rhetoric on this site, not just among posters, but from the NWL machine itself.
Good.
To those who disagree, since when were families, distress and fairness not part of the equation? NWL is just being thorough.
@BF, Thanks Brian. I even bought the book!
The purpose of the LTRO is recapitalize the banks by stealth, by giving them an easy win.
It may not trickle down to the real economy any time soon but it reduces the need for sovereigns to come up with actual cash to recapitalize the banks.
Just had another thought – this money can’t go into the real economy, even if banks wanted to.
When you make a loan it needs to be backed by a certain amount of capital, which corresponds to its riskiness and which is increasing these days thanks to Basel III. The average European bank currently doesn’t have enough capital as the regulatory minimum is being increased, so banks can borrow as much as they want, if their capital base doesn’t increase as well, they cannot increase lending.
Government bonds, on the other hand, are considered as good as cash: under Basel II and III, you don’t need to set capital aside to invest in government bonds.
So this is not a mistake: the ECB knew full well where the money would go. LTRO money was designed to be ploughed back in government bonds, or at least to just replace other forms of funding as the interbank market is frozen.
As to commercial competition, I still don’t get that part – how is a bank in competition with an airline? How can AIB threaten to reduce Ryanair’s market share or cause it to reduce its profit margins? As I see it it’s exactly the other way around: if the banks can borrow at a cheaper rate and if the country isn’t in danger of collapsing then Ryanair is operating in a safer environment and should in turn be able to borrow at a cheaper rate (isn’t that why stock prices have been increasing all over the place over the last few weeks, especially for the weakest companies?)
As for moral hazard, Basel III is taking care of that – forcing banks to hold a lot more capital mechanically reduces return on equity and therefore profitability, which has a direct impact on whether activities are profitable and on bonuses. That’s why banks are firing staff all over the place, and bonuses just can’t remain high if the return on equity is 5% instead of 25%.
@Narg “As to commercial competition, I still don’t get that part – how is a bank in competition with an airline?”
A bank is a business. Okay we own AIB, EBS, Anglo, INBS and ILP. But Bank of Ireland is only 15% owned by the Govt, and there are other banks operating here with a normal shareholder base. And at some point, the state owned banks will be sold off.
Banks, as businesses, try to attract capital or as termed in the above blogpost “equity investment”. And other businesses eg airlines also try to attract capital. And if you are a potential shareholder in a bank or an airline, then both compete for your investment. Now if one, the bank, is allowed print profit but the other, the airline, has to build a proper business then as a rational investor, you would tend to favour the bank. And in that way, banks compete with airlines, and are competing unfairly because of the action of the ECB.
Or to look at it another way, last November you might have bought shares in Ryanair or in Bank of Ireland. Ryanair’s shares are doing okay on the back of enterprise by that company providing a real service to consumers. Banks were given an almighty profitability boost by the ECB lending at 1% so that banks could lend to the Government at 5.15%. Sure, a company can be affected by Acts of God, but the ECB providing 1% funding for three years doesn’t fall under that heading.
I get you now.
Well see it this way: Ryanair is trading at 2.56x book value, Bank of Ireland is trading at 0.09x book value. It seems to me that it is much more expensive for Bank of Ireland to raise capital than for Ryanair. If you think in terms of price-to-earnings you get the same result.
And market forces and Basel III will both take care of that issue: by getting interest rates on government bonds to come down, the profitability of the transaction goes down; and under Basel III there will soon be a hard limit on leverage (meaning not risk-weighted so you can’t take advantage of the fact that government bonds have a risk weight of 0), which puts a limit on how many assets you can have relative to capital and it will prevent banks from doing this kind of transaction over and over again. I think that this leverage ratio will be put in place in three years and as the LTRO lasts three years the banks will basically only have one shot at it. I guess the ECB’s plan is to pray that EU politicians will have sorted the mess in the meanwhile.
@Narg, I make what is a simple point, that if one business is provided funding at 1% – a rate not available to other businesses – using collateral which is not exactly gilt edged and is able to immediately lend that to a Govt at 5.15%, thereby making a 4.15% profit which might be repeated depending on how many LTROs the ECB conducts, then that favours that business over another business.
The transaction has already happened. The LTRO took place in December 2011, the purchase of Irish government bonds took place on 25th January 2012.
On a separate point which might also give us cause for concern. The ECB is lending to banks at 1%, the banks are lending to Govt at 5.15%. Except when we say “Govt” we mean the people, whose taxes will be used to pay the interest on the loans from the banks to the Govt. Why is the ECB not lending directly to governments at 1%? Because apparently its rules prevent it from so doing. But here we again have the people enriching banks by paying the banks 5.15% for money which only cost them 1%.
And this “rebuilding banks balance sheets” malarkey. The people are not called upon to subsidise Ryanir to rebuild its balance sheet (not that it needs rebuilding because it is a decently managed business)
@ NWL Ryanair and all other airlines obtain a huge subsidy by use of double dip structure on aircraft leasing. Effectively the aircraft are bought by an aircraft leasing company in one country (In Ryanair’s case I think it is Cyprus) and the leasing company charges capital allowances against the leasing income. The airline then claims capital allowances on the same aircraft against its profits, in this case Ireland.
As I am sure you are aware, the North Docks of Dublin are the main centre of aircraft leasing worldwide, based on this little scam. However the amount of tax lost worldwide annually because of this tax subsidy to airlines puts the refinancing of the banks in the shade.
Also by using EU Social Insurance rules drawn up in another time, Ryanair manages to avoiding paying Social Insurance in the countries in which it employs crews because all of its aircraft are registered in Ireland! The place of employment for crew is deemed to be where the aircraft is registered. Guess which country has the lowest rate of Social Insurance?
@ Niall
With all due respect, I think you miss the point entirely. The tax avoidance game you describe is in no way comparable to what the banks are doing. The difference? The banks have NO RISK in their little maneuver. Airlines go bust everyday, like SpainAir just yesterday. They even pulled the passengers off flights ready for departure. No bank is going to go bust selling a one Euro note for a fiver.
@ Narg
To suggest that the bankers are succumbing to moral hazard by firing their employees is beyond ludicrous.
Sorry, should be Spanair, former Catalan flagship.
@Niall, How about turning poacher? We’ll set up NWL Aircraft Leasing Corp. and make a fortune. How do we do it?
This is Europe doing a Japan – ZIRP and Zombies.
What could possibly go wrong?
Can you clarify this a wee bit for someone who is not an accountant or economist but reads your blog a lot…
The Irish government got bailed out by ECB and gave the money to the banks (I know this is simplistic) and the people of Ireland are paying between 5 and 8 % roughly for that. That puts the government in a tricky position financially so the banks borrow money off the ECB at 1% and loan it to the goverment at 5%. But don’t we own half of those banks and why can’t we borrow that money off the banks at 1.5% or better still 1%. I don’t get it… We’re borrowing off ourselves and charging ourselves interest???
@The Fuzz, “We’re borrowing off ourselves and charging ourselves interest???” I’d like to be able to academically and sensibly explain where you’re wrong. But I can’t.
The ECB can’t loan directly to governments, that’s a condition of its existence. Although the European Central Bank is a member of the Troika, it doesn’t fund the bailout which in the EU comes from the EFSF and EFSM. The ECB is part of the administration of the EFSF.
The ECB can loan directly to banks. In Ireland we own Anglo/INBS (or IBRC as the merged entity is now called) and we own 99% of AIB/EBS. We own 15% of Bank of Ireland. And we don’t own any part of KBC, ACC, Rabobank, Ulster Bank and a few others that have smaller operations.
So it would be fair to say “We, the people of Ireland, are borrowing from a banking sector which we mostly own and we are paying interest at 5.15% to those banks who are getting the money to lend to us at 1%”
Not only that but the ECB is distorting commercial competition in member states and is perverting the aims of monetary policy which are, when it comes to money supply, tighten or expand the amount of money going into the real economy of households and businesses.
Who is tackling the ECB on these matters?