Mario Draghi announces that the ECB has a new tool.

Mario Draghi

Jyllands Posten has:

What is going on?

1)      Interest rates remain where they are – for now.

2)      “Outright Monetary Transactions” (OMT) will be instituted

3)      The ECB will buy unlimited of Sovereign Bonds.

4)      The Bonds purchased will have a maturity of 1-3 years.

5)      Euro-zone banks will deposit amounts in the ECB corresponding to the amount extended in purchase of bonds.

6)      These supporting buys will depend on “strict” conditions on savings and reforms. With “dire” consequences in the event of non-compliance.


Something had to be done, as “systemically important” banks are experiencing large scale bank runs. Alone in first quarter 2012 Spain experienced a flight of liquidity of 100 bio. EUR. This money landed as deposits in other European countries making the CB’s coffers burst at the seams – and forced German sovereign bonds into negative territory. At the same time this lack of liquidity had to be replaced by the Spanish state – which wasn’t possible, at the interest rate exploded – simply because the buyers had fled the country.

The serious part is that the money fled from the frying pan into the fire: They were deposited in banks that had a surplus of liquidity – to some extend – and as banks do NOT lend money to other banks. That much is evident from the LIBOR scandal. The interbank market isn’t there anymore – the LIBOR could be manipulated, as it had lost its original raison d’être:  Interbank offered rate!

The tricky part is actually what is understood with “strict” and “dire”. These rather fluffy words are perhaps best understood in context with forming a Euro Bank Inspection under the ECB. This ECB Bank Inspection will deal only with “systematically important” banks – i.e. banks that are too large for the nation in question. That is all fine and square with Spain’s Santander and BBVA, not to mention Bankia, where the garbage can for dead banks had lifted the lid off and all of a sudden was integrated into a “systematically important” bank – not quite the intention; but the result.

If this supposition is correct this will mean that “systematically” important banks will be taken out of the national control and will have to answer to the ECB Bank Inspection. The other side is, that governments should be curbed in their tendency to relax banking rules and finance a budget deficit through irresponsible lending by the banks, thus resulting in tax revenue to balance the public budget, thus financing public deficit with private debt.

The dire consequences are more immediately apparent: With a huge stock of short term bonds any access to financing can be cut off with a fire sale. The mere rumour that the ECB is selling will make short term interest rates skyrocket.

The short maturity also caters for the return of the absconded liquidity in so far as if confidence is not restored  –  the deposits in foreign banks will not return in that case – the bonds will come due and the liquidity forwarded by the stricken state to the distressed “systematically important” banks will come due simultaneously.

All in all a rather neat construction, where risk is covered by taking the fled capital as hostage.