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Bank door QE

2011-12-13 08:21:03

Dec 12th 2011, 13:09 by Buttonwood

THE grand bargain postulated before last week's fruition - that the euro zone

governments would agree a fiscal pact in return for the ECB buying lots of

government bonds - hasn't quite happened. But perhaps it is being done via a

different route.

The ECB did agree to lend money on extended terms to European banks, and

relaxed its collateral rules. The move was generally welcomed as a sign that

Europe was ready to stop a Lehman-type collapse resulting from the freeze in

the interbank lending markets.

But euro zone leaders have been hinting quite broadly that the banks can take

that money from the ECB at 1% and invest the proceeds in government bonds, and

earn a very nice yield premium along the way. This is a sort of back door QE,

or perhaps bank door QE is the better name for it. In the early 1990s, the Fed

deliberately engineered an upward-sloping yield curve to allow US banks to

rebuild their balance sheets after the savings & loan crisis; borrowing at 3%

and investing in Treasury bonds at 6-7%.

There are some questions over whether banks will take this risk, given that

they might have to mark to market any losses on their government bond holdings.

And there is no sign yet that this bargain is having much of an effect on bond

yields.

Of course, this bargain is on a cynical view, like two drowning men hanging on

to each other; bankrupt banks supporting bankrupt governments. The taxpayer

stands behind both, of course, but this kind of deal is designed to create an

implicit commitment on the part of taxpayers without making the costs explicit

to voters.