Euro Plan Produces Meaningless Euphoria

Europe (and the US for that matter) has passed the point of any traditional economic recovery. The amount of debt outstanding is not serviceable. Even if economic growth were to resume, it would not affect this condition. Adding more debt may extend the charade but cannot favorably impact the outcome. Massive defaults are inevitable.

Political will and actions are irrelevant. So too is economics. Europe is now subject to the simple laws of arithmetic and the equation they face is not solvable. They are facing mathematical impossibility.

The only question to be answered is whether the governments will allow traditional defaults to occur or whether they will default via inflating the debts (and their citizens’ savings) away. Both alternatives lead to the same outcome — depression and bankruptcies.

This report from Bloomberg comes via Andrew Breitbart. It indicates that the euphoria was short-lived. The emboldening is mine:

Massive European bailout operation appears to be failing

An enormous drama played out in Europe on Wednesday, leaving officials in a state of shock.

For months, pundits have been demanding that the European Central Bank (ECB) purchase toxic bonds from Greece and Spain and Italy in order to bring down yields (interest rates), which are now unsustainably high. The ECB has been steadfastly refusing to do so, because that would violate EU treaties and regulations. The Germans are opposed because they see ECB bond

purchases as a free ticket for Greece, Italy and Spain to return to completely profligate spending.

So the ECB did something different on Wednesday — a “Long Term Refinancing Operation” or LTRO. The ECB offered unlimited amounts of euros in 3-year loans to banks at 1% interest. The analysts had expected the banks to borrow only €250 billion or so.

So the first shock was that 523 banks applied to borrow €489 billion, almost twice as much as the analysts had expected. This announcement was initially met with glee by investors, who assumed it meant that there would be a lot of money floating around, and it would pour into the stock market as usual, and stocks went up.

The ECB’s intention with the LTRO program was to make lots of money available to banks so that they would use that money to buy up toxic bonds from Italy and Spain, and so that they would lend that money to businesses, in order to promote growth. Thus, the LTRO is supposed to be a form of quantitative easing.

However, that’s not what happened. The second shock was that the banks used 61% of the 3-year €489 billion loans to pay off previous 7-day, 3-month and 1-year loans from the ECB. Thus, the net borrowing was much smaller, about €190 billion.

Furthermore, eurozone banks will have to come up with €750 billion in 2012 to pay off other debts. So it’s clear that the banks are going to hoard this LTRO money to pay off their own debts, rather than lending money to businesses or buying other people’s toxic bonds.

One UBS analyst said, “We still believe it is difficult to reconcile a government desire for banks to continue buying debt with the need for banks to reduce risk exposure associated with government debt.” In other words, if you want banks to survive, you’d better not expect them to take on more toxic debt.

So this LTRO apparently will help banks get past the year-end obligations and some of next year’s debt payments, but will do absolutely nothing for employment or productivity or economic growth in Europe. It’s just more money that will sit in the banks’ mattresses, doing nothing, not contributing to the economy and not contributing to inflation.

Here’s an additional angle to the above.

It seems that European banks HAVE been buying some toxic Spanish and Italian bonds in the last few weeks, pushing yields (interest rates) down a little.

But once a bank has those toxic bonds in its portfolio, it’s allowed to use them as collateral to borrow money from the ECB. That’s apparently what’s been happening.

So one possible unintended outcome of the LTRO is that it may actually REDUCE bank purchases of toxic bonds, since banks don’t need to purchase them any more to get ECB cash. Bloomberg

All government intervention is undertaken to force outcomes that markets (read economic actors) do not want. Political desire is usually no match for economics. In this case, it appears the initial intervention has failed to achieve its objectives. Other attempts will likely be forthcoming. They will meet with similar results. Nothing can be done but extend the charade. That will only be for a brief time and at the cost of greater pain.