The shift in risk to European taxpayers might be there; but it is a far more disturbing signal than that.
In these times the difference between banks with a deposit surplus and not – is exacerbated.
Banks with a deposit surplus gets an even bigger surplus, as they are getting risk conscious (they have enough bad debt on their books as it is): They simply don’t lend money out.
Normally banks with deposit surplus lend money to those that have a shorter or longer term lending surplus – as they should. But with above mentioned risk aversion those with deposit surplus flies towards quality i.e. sovereign bonds – even towards CB short term deposits.
We see the same phenomenon in Denmark where the interest rate of the 2 year sovereign bond is below the tomorrow/next interbank rate – i.e. a dearth of sovereign bonds. The week deposits in CB is a staggering 180 bio. DKK at an interest rate of .3% where the 2 year sovereign bond is .13% (as of yesterday). – inverse interest structure.
The banks with lending surplus can’t get their funding and run to the central bank hat, bowler or helmet in hand. Their credit quality is not necessarily worse than the banks with deposit surplus – it might actually be better on average. A credit squeeze of this type is to fast and to big to allow a slimming of the books.
Central Bank reactions
In this case the central bank will issue more sovereign bonds than strictly necessary to absorb the nervous deposit banks. In Spain’s case that isn’t necessary, because there is an abundance of sovereign bonds – cheaply available from foreign (i.e. German et alia) banks.
In Denmark the option of buying sovereign bonds isn’t there and no amount of issue of short term papers can alleviate that – 180 bio. is approximately three times the annual budget deficit. So the issue would more likely than not result in negative interest on sovereign bonds (as happened towards the end of last year). What can be done is to increase the spread between CB deposit and lending rate.
This technique has severe limits though: A deposit rate of .3% is so close to 0 that you can taste it, so you can’t lower. Increasing the lending rate is difficult also as the troubled banks are already lending as little as possible – to the detriment of businesses which need to pay salaries before their costumers pay their bills. (We are talking short term credit)
The only thing for the Central Bank is to issue the credit – and be less fuzzy about the collateral they get.
We are here talking strictly a liquidity issue, not solidity: The banks are just as bankrupt as they have been all along.
This is why the ECB and the Bundesbank take the raise in interest rate on Spanish sovereign bonds with such languid coolness – aye, utter indifference.
The only ones getting hurt are the speculators. The other European banks are offered an opportunity to get rid of their Spanish bonds – which they jump at – a totally desirable effect – as it will make a restructuring of the Spanish debt that less complicated. Speculators getting blown over and a nice breeze in the CB sail. The ECB might even try to short Spanish Sovereigns.
The more Spanish sovereigns sold back to Spain the better, as it will place the solidity problem strictly where it belongs in Spain. Thus the encouraging words on the progress of the reforms.
The IMF does not contradict the ECB: The IMF perspective is the indubitably needed recapitalisation of the Spanish banks – but new shares is an investment, not cash.
The CB CEO’s are not going to let the speculators run the show.
Central Bank CEO’s are not total morons – but some investment advisers and bankers leave room for more doubt.