Sunday, 27 May 2018

ECB plan can be a panacea or another desperate measure

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How many of you out there have actually been proper, fully paid-up lending bankers? I have. I didn’t really enjoy it all that much – selling bonds was much easier, paid more and brought a better expense account. However, I do remember being taught that lending to an insolvent borrower in order to prevent him from going under was as much an offence as serving alcohol to a drunk reveller.

Anthony Peters, SwissInvest Strategist

I wrote earlier this week that the ECB can offer bridge financing but that it should not be part of the core banking group of troubled eurozone members. Who will remember this when St Mario offers up his bond buying programme today? The pre-announcements which were leaked into the markets yesterday indicate three main features, namely the unlimited amount, the lack of a rate cap and the issue of the ECB rescinding its preferred creditor status. To me, it is the third one which is most interesting.

By assuming full capital risk, the ECB is doing exactly what the commercial banks were doing – and got slated for –  namely exposing its shareholders to the full destructive force in the event of a default, should it occur. Go back and read some of the press of a few years ago. Read some of the sound-bites from the political class about the greed and foolishness of the banks for lending to sovereign governments in the belief that, just because they were part of the eurozone, the risk was tantamount to lending to Germany.

How could they be so dumb and believe that? As of today, it seems we are being told that said assumption was not so dumb after all and that now, because the ECB is doing it too, it is alright for us to start assuming it again.

The euro-enthusiasts will celebrate the saving of the euro project and the euro-sceptics will spit, as they always do. I will harp back to my days as a young corporate banker and recall the lectures we received about testing a company’s solvency by way of a rather clever funds-flow matrix and being warned to guard from lending in order to forestall insolvency and bankruptcy.

The reason, we were told, that banks lose money when companies cease trading is because they fail to identify the point of no return. As it is illegal to trade when insolvent, the sole reason technically insolvent companies stay afloat is because some poor chap in the corporate lending group at their bank can’t face being responsible for losing a client hopes that by giving a bit more, they might just pull back from the brink.

Once the ECB opens the floodgates, there will be no going back. It matters not one iota what “tough” conditions are set behind closed doors, the ECB and its shareholders – that’s the entirety of the eurozone’s tax-payers – are on the hook.

The only way out is by way of inflation and the best way to get that is to exit the straitjacket of the single currency, devalue aggressively and leave the unfortunate lenders to their own devices

As far as the stress tests are concerned; well that’s another subject altogether. I would hope that the ECB intervention is no more than a temporary measure, the provision of bridge financing, but I find it hard to believe that all of the troubled eurozone countries will be able to drag themselves back into both a cyclical and a structural fiscal surplus and that they will hence begin to redeem outstanding debt. The only way out is by way of inflation and the best way to get that is to exit the straitjacket of the single currency, devalue aggressively and leave the unfortunate lenders to their own devices. The question now is whether they now may also find themselves taking the ECB with them when they go?

I could of course also be completely wrong: St Mario may be awarded the Grand Cross with Oak Leaves

I could of course also be completely wrong and maybe today’s ECB announcement will spell the arrival of a panacea, all will end up being fine in the garden and St Mario will be awarded the Grand Cross with Oak Leaves. I am, trust me,  the last person not to wish for that to be the case.

Alas, investors are called investors because the invest and they have largely sitting on the sidelines looking for a signal to do what they are paid to do. I suspect that they will be out there later today and again tomorrow with their buying boots on and following the herd.

They will be pleased with the course of the Democratic National Convention – I think Slick Willy would marry Barack O’bama if he had the chance – as the probability of a further four years of a known quantity increases. It looks as though the list of unknown unknowns has shortened and that it good for risk assets. Never mind the quality, buy the yield.

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