LTRO = QE, or How the ECB Is Similar to the Fed

Although we often read in the press or hear from banking and political leaders that the ECB doesn’t buy back sovereign bonds, contrary to the Fed, thus hinting that « we Europeans are more virtuous than the Americans », it’s totally false.

LTRO = QE, or How the ECB Is Similar to the Fed

The ECB, like the Fed, does finance part of the sovereign debt, but it uses another vehicle : the banks. In fact, the ECB does not acquire any sovereign debt directly, but it loans out large amounts of money to the banks which then buy their countries’ debt, so the result is the same.

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Last April, Slovenia had to issue 1.1 Billion euros to finance itself. But nobody wants to buy that debt with the country’s catastrophic situation. Its bad debt amounts to 20% of GDP and its banking system is practically bankrupt. But that didn’t stop the ECB from lending this 1.1 Billion euros to the Slovenian banks which then turn around and buy their country’s bonds! So, tell me, what’s the difference with the Fed, which directly buys the federal debt? There is none. And, on top of that, what do the Slovenian banks offer as collateral for the ECB loan? Well… the sovereign bonds they just acquired, because that’s all they have! And thus the ECB is stuck with Slovenian debt on its balance sheet, even though it doesn’t appear on the same line as if it had acquired it directly, but the difference is very tiny (if the Slovenian banks have to re-structure their debt or go bankrupt, the ECB will in fact own those banks, but they’ll be worth nothing because the Slovenian state will be in jeopardy).

But, beside these case-by-case loans, the ECB is offering giant loans, « open to any bank that wishes it and for the amounts desired », as has explained Mario Draghi : LTROs, or Long-Term Re-financing Operation(s). There have been two, so far, in December 2011 and in February 2012, of 500 Billion euros each! These loans helped with lowering Italy’s and Spain’s interest rates, which were then rising dangerously, which just goes to show that a great portion of that money has been recycled by the Italian and Spanish banks into their countries’ debt. The mechanism is the same one as we just described for Slovenia.

These LTROs are 1% loans on three years, which means they’ll have to be reimbursed within a year and a half. According to the latest ECB figures, only 352 Billion have been reimbursed so far, and there is still 666 Billion euros to be reimbursed. And the banks which have profited the most from these loans were, of course, the ones in worst shape.

As a consequence, who would believe that these Italian and Spanish banks could eventually reimburse those amounts? And, to the point, in his last press conference, Mario Draghi suggested that another LTRO might be in the cards… Call it bravery… or Quantitative Easing, in central bank « lingo ».

I have to say there is, indeed, a little difference between the Fed and the BCE. For the former, at least, we know the numbers (QE3 is $85B a month, $45B for Treasury bonds and $40B for mortgage-backed securities, or MBSs), but with the ECB, we cannot know precisely how much of this Trillion euros is being invested in sovereign bonds, because it is disseminated throughout many different European banks (and the ECB also uses other tools than LTROs, as in Slovenia). The ECB is doing just like the Fed, but it is adding more opacity…