LTRO and Sovereign Debt

Paul De Grauwe argues that the LTRO operation is a poor substitute for direct ECB intervention in the sovereign debt market in this FT article.

25 replies on “LTRO and Sovereign Debt”

Excellent article. It points to the crucial question that has yet to be made explicit during the whole eurozone crisis:

Should monetary forces determine national fiscal policies?

If not, what is the role of the ECB. If yes, then the ECB has become a vehicle to advance the interests of private market actors and not European citizens.

Coincidentally, Charlie Fell has an equally good article in today’s IT which will help round off the one-sided view that Paul De Grauwe takes of the causes of the crisis. He is confusing the symptoms with the disease.


“Policymakers consistently argued that intra-regional trade imbalances were not relevant in a monetary union, but this belief proved to be embarrassingly wide of the mark once the Great Recession prompted a dramatic reassessment of risk premiums. Previously, the periphery had depended upon the willingness of member states with current account surpluses to fund their external deficits at reasonable rates of interest. Once the financial crisis struck, this source of capital evaporated and the buyers’ strike left the troubled countries with little option but to seek official assistance to fill the gap”.

China has just reported the biggest monthly trade deficit in years; €24 billion! This suggests that the real world is beginning to intrude and the imbalances at a global level may be beginning to correct themselves. The same process has to be facilitated within the EU (and by means other than the protectionist slogan embraced by Sarkozy of a ‘Buy Europe Act’ campaign).

Can’t help but remark on the sorry irony of Irish banks taking up so little LTRO because the nation has already paid to stress test and recapitalise our banks properly.

If LTRO was available in mid-2010 would we have even needed a bailout (our debt:GDP wouldn’t have changed much, mind) and would the ECB have been able to threaten Minister Lenihan if the banks back then had been bulked up on 3-year money?

Seems like the cavalry has arrived too late for us.

Indeed. Despite the eerily accurate prophecy (h/t Mr. Bond) he seems to have things the wrong way around. Some bond market participants took fright when they saw that some governments didn’t have the fiscal space to bail out their banks – and nobody seemed to know what bailing out was required. And other bond market participants took advantage of the mayhem – and created more – to nake shedloads of money. The ECB could have hosed these bastards and cleaned up a limited mess afterwards, but wasn’t allowed to by anally retentive right-wing political forces.

And so we are where we are and the mess just expands making it much more costly to clean up.

@ Jagdip

Honohan and Lenihan both pleaded for a LTRO back in Q4 2010. It took Draghi to bring it to life.

Excellent article from a wise man Paul de Grauwe the John Paulson chair in European political economy at the London School of Economics.

John Corcoran
M.Sc.Economics London School of Economics

I agree that Paul de Grauwe is a sound man whose writing has always been consistent and relevant. I was not aware he had moved from Leuven to LSE – Belgium’s loss in London’s gain.

I like that article. Mostly because I agree with it.

@ B_Eoin_B,

I’d give the credit to Spain and Italy rather than Draghi. Thanks for the link to the 1998 article; I’ve already emailed the link to a couple of people.

@ Ahura

i read an interesting article yesterday, though i cant for the life of me remember where it was printed (i might have been surfing twitter), but it essentially suggested that while Italy had agreed to do the tough work on reforms etc and so was deserving of ECB support, the LTROs had enabled Spain to skip fixing its banks or deficit and kick the problem down the road. So the sometimes “bad cop” fears from German/ECB officials about not being willing to grant support before reforms or austerity was agreed to, is now being bourne out by the Spanish government.

What we see, folks, is the breakup of a very dodgy credit union due to the fact the euro is still not politically feasible. “What is politically impossible today may, in the end, be accepted when it becomes obvious that direct intervention is the only way to save the eurozone.”

As IT article quoted by DOCM above states “Previously, the periphery had depended upon the willingness of member states with current account surpluses to fund their external deficits at reasonable rates of interest.”

Members of the credit union squandered away their savings/borrowings. Direct intervention mentioned in FT will come at a huge political cost contrary to the original democratic ethos of the EU itself. Democracy is not in harmony with the venus fly traps prepared for recalcitrant EMU. It would appear to the astute that EU is being consumed by the banks. Direct political intervention if it comes will surely be followed by more substantial forms of intervention to deal with the ensuing difficulties this will impose. It would be ironic at that time to see an Arab Spring arise out of the ashes of the euro project. Currently, it does appear, to all intents and purposes, the euro is a failed project awaiting the scuppering as things go from bad to worse eg as evidenced by growing bond spreads in Spain and its refusal to obey the dictats of compliance. But breaking up of the currently braking up of the titanic euro would appear to be all but assured…

I’m sure a lot of the LTRO was used to fill the holes of shadow banking exposure to derivative losses hidden away since 2008 and under the ‘stress testing’ radar. Lots would have been used to return to the casino of financial markets and the unregulated arm of investment banking. Lots would have been spent speculating on the currency, forex markets; more would even have been spent hedging on the purchase of US TBonds.As we know, lots would have been used to refinance debt including loss exposure to Greece. Very little, if any, would have reached business development. Hoovering up finance for banks and the financial sector instead of culling this sector means the euro is kaput; but not before financial services can extract as much from it as they can in the service of an unregulated FIRE paradigm that created the problem in the first place.

@ Bond, Eoin Bond
I’m afraid that the Spain thing just illustrates one law for the big and one for the small.
Italy will become the real poster boy for austerity and will be supported whatever way it can.
Ireland will be consigned to decade long stagnation because 4 million don’t actually matter. All the signals from Europe are that we don’t matter. We are a nuisance for them. We are too smal, too peripheral and too nice.
They dont want us. We don’t want them.
Time to say goodbye…

Bit harsh on the Spanish. The new govt has ensured accelerated loss recognition, recapping and mergers.
Also on the fiscal side, they seem to have negotiated a less unrealistic target.,
Since Draghi took over, the BUBA loons have been emasculated (metaphorically alas) and more pragmatic policies brought into force.

@ Tull

im not necessarily trying to be harsh on the Spanish, simply noting who has made progress and who has not. Whether it makes sense to make “progress” on implementing austerity is, of course, another thing altogether, but the LTRO has certainly allowed Spain to run a looser adjustment process on both the fiscal and financial requirements than the Italians have. And i would suggest they have a long way to go on both fixing of regional fiscal problems as well as banking loss recognition

@ Bond 9:53

De Grauwe article very interesting, he nailed it:

” In fact the existence of a monetary union is likely to intensify the asset inflation in Spain. Unhindered by exchange risk vast amounts of capital are attracted from the rest of the euro-area. Spanish banks that still dominate the Spanish markets, are pulled into the game and increase their lending. They are driven by the high rates of return produced by ever increasing Spanish asset prices, and by the fact that in a monetary union, they can borrow funds at the same interest rate as banks in Germany, France etc. After the boom comes the bust. Asset prices collapse, creating a crisis in the Spanish banking system. ”

ECB restriction from interference in local CB’s is a huge factor. FOMC in the US is designed to go in there locally and manage local bubbles. It has huge powers to do so. Arguably the ‘Compact’ is trying to redress this imbalance. In doing so, because EMU is not a federal political system similar to US with other democratic checks and balances such as the meshing of the political system with the Fed, the only direction for the EMU to take is one similar to the direction taken in the management of the ruble by the USSR. Is the euro the new ruble?
Expect to see more binding conditionality and loss of democratic sovereignty as the socialist banks attempt to get their money back from the EMU.

@ Colm 2.03pm

Ironic that the academic chair De Grauwe now holds is funded by the guy who made his fortune out of the sort of asset bubble (US rather than Europe) collapse De Grauwe was forecasting

@Paul Hunt – agree with you, and can’t accept that, in the article’s analysis, that “the sovereign crisis was allowed to become a banking crisis”.

This defies the timescale – the banking crisis blew up in August 2007; the mis-steps taken overthe next three years – the “no senior bondholder left behind” policy, turned it into a full-blown sovereign crisis.

The ECB needs a re-written ‘remit’ beyond the ‘galloperin henflation henflation henflation’ …. of the ‘fiscal corset’ and ‘no-bank left behind’ generation …

… and a centralised EZ banking regulation and bank resolution etc ….

… and a separation, if not a divorce, from the bundesbank traditions ..

… that should do for now.

@David O’Donnell ….!3 years later having arrived back in Ireland from Boston,where a property crash had recently occured, David McWilliams stated on the Late Late show that there was a property bubble in Ireland which would certainly lead to a crash and negative equity.

Nobody listened to Paul de Grauwe or David McWilliams.

@ B_Eoin_B,

I see the LTRO as double-edged. For example, say Spanish banks, a big positive is that the LTRO should increase Net Interest Income and create a buffer to absorb some losses. (though would any increase their balance sheets to the degree required to cover losses?)

The negative is that it increases (/isolates) sovereign risk within the country and enables others to sneak out.

“Banks have been given unlimited sources of funding to make easy profits”
A point David McWilliams made in his punk economics video, to the usual scorn from certain quarters on this blog.

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