by Jack Crooks
Saturday, January 21, 2012 at 7:30am
We’re constantly talking about how much help the euro zone needs to escape the economic mess they’ve created. So will the European Central Bank (ECB) monetize debt? Will the European Financial Stability Facility (EFSF) be sufficiently funded as a bailout mechanism? Will Germany agree to back-stopping periphery nations?
Earlier this week the International Monetary Fund (IMF) put forth a new, albeit unoriginal, proposal to garner funds from its non-European members that will serve as a backstop should there be a major shock to the European financial system. The IMF wants to raise another $500 billion. But, laughably, they’re hoping the G-20 can come to an agreement and make this happen.
With all that said …
Why Didn’t the ECB Cut
Interest Rates Last Week?
Perhaps they’ve evaluated the impact on investor/consumer sentiment after recent rate cuts. And perhaps they thought it would be more beneficial to portray a modicum of confidence in an economy that’s pretty much doomed, regardless of who you ask.
By not cutting rates, the ECB suggests the economy doesn’t precisely need rate cuts to achieve stability. And it implies the current dealings between governments and international policymakers are headed in the right direction.
I’m inclined to say the latter is impossible. But that attitude wouldn’t get us anywhere.
Instead, I’ll ask: Why is it that other central banks seem more concerned than the ECB, which sits at ground zero of the number one crisis facing the global economy?
For example …
- Brazil’s central bank is still cutting interest rates to avoid the financial fallout from the euro zone. They just cut their benchmark rate to 10.5 percent from 11 percent and hinted of more cuts ahead.
- South Africa’s central bank is holding tight with interest rates at 30-year lows because they fear a global economic revival may not pan out to a sufficient degree.
- China is on the verge of easing up on last year’s stretch of tightening since it is realizing significant slowdown in key areas of its economy. Lending is expected to exceed last year’s total even though there is a case to be made against the effectiveness of additional lending in an economy that shows major signs of overinvestment.
- Even Australia, the yardstick economy to which most developed nations can’t measure up, saw its central bank cut interest rates at the last monetary policy meeting. If you wonder why, maybe the news this week that employment unexpectedly fell offers a clue.
What Could Those Folks at
the ECB Be Thinking?
|Have Mario Draghi and the ECB done enough to get the euro-zone’s finances under control?|
If the answer to that question eludes you, and not knowing bugs you, you’re not alone …
The ECB confounds most investors by not cutting interest rates while the Federal Reserve and other central banks around the world prepare to go easy with interest rates should the euro-zone problems encroach on their economies.
So let me give you my take on it that might help you set expectations for ECB policy going forward:
Rate cuts and monetization aside, the ECB’s ability to help support banks is determined by collateral. If a bank can put up collateral of sufficient quality, then it can receive needed funds from the ECB. If banks can’t put forth quality collateral, and the ECB wants to do something about it, they can lower the standards of what they accept … assuming they have that flexibility.
And this from Leto Market Insight:
In order to keep euro-zone banks liquid in the months ahead, the ECB may need to lower its standards for qualified collateral. But this brings us to the next problem: The ECB is not sufficiently capitalized to accept the additional risk of poorer quality collateral. The ECB’s paid-in capital was €6.36 billion against €2,733 billion assets at the end of 2011, representing a leverage ratio of assets/capital of 430! For comparison, the Federal Reserve has a paid-in capital of $26.9 billion against $2,928 billion assets, a leverage ratio of 109.
It’s impossible to determine if further ECB interest rate cuts or reduced lending standards would rescue the euro-zone’s economy and its currency. But it sure seems like what they’re doing isn’t working.