‘ECB cash will ease pressures on banks’
Eurozone bank failures may cause US credit squeeze — Kaufman
Agencies | Dec 23,2011 | 22:52
Mervyn King, first vice-chair of the ESRB (right), and Andrea Enria, second vice-chair of the ESRB, attend a press conference in Frankfurt, Germany, Thursday (AP photo)
FRANKFURT — Recent measures taken by the European Central Bank (ECB) to make liquidity available to eurozone banks will ease pressures in the banking system, the European Systemic Risk Board (ESRB) said Thursday.
“The actions taken by the ECB very recently will ease funding pressures and I think you’ll see increasing evidence of that in the next six months,” ESRB Deputy Chairman and Bank of England Governor Mervyn King said.
The warning lights for Europe’s financial system were “flashing red”, King told a news conference following the fourth regular meeting of the ESRB.
“There is no doubt that the ESRB is concerned,” he said.
The body, which was set up to monitor and prevent systemic risks in Europe’s financial system, has already warned that the current eurozone debt crisis poses a systemic risk.
“Since then, overall conditions have worsened, as a result of the intensification of negative interlinkages between sovereign [debt] risks and the uncertainty about the resilience of the financial system, and on account of deteriorating growth prospects,” King added.
The ECB has been under intense political pressure to step in and save eurozone countries sinking under huge mountains of debt but it insists its firefighting efforts are limited to acting as lender of last resort for banks only and not for governments.
The ECB has consistently argued that it is up to overspending governments to get their finances in order and restore the markets’ confidence in their ability to repay their debts, which is the underlying cause of the eurozone’s current ills.
Last week, the central bank said it was extending the maturity of its loans to three years to ensure favourable rates of funding for banks over a much longer period.
On top of this, it relaxed its rules for the collateral required as guarantees and also halved the ratio of reserves that banks must hold at the ECB, also freeing up capital.
On Wednesday, banks borrowed nearly half a trillion euros on the cheap from the ECB via the new three-year lending facility.
Until now, the ECB has lent for a maximum of one year and the new arrangement is part of a series of unprecedented measures to keep credit flowing in Europe at a time when banks are increasingly wary of lending to each other due to the debt crisis.
Analysts said the three-year funds would help ease tensions in the banking system, at least in the immediate term, but they were sceptical it would provide the long-lasting boost to confidence that markets had been looking for.
Separately, well-known Wall Street economist Henry Kaufman said eurozone bank failures could lead to a credit squeeze in the United States, hurting an already subpar US economic recovery.
A deterioration in the European financial system “could cause some of the American financial institutions to become more conservative and limit their own balance sheet expansion, a credit squeeze that would place a limit on the American economy,” Kaufman said in an interview with Reuters.
“A failure in the eurozone area, a malfunctioning of the euro, would have negative repercussions for the US not just in terms of a slowdown in US exports to Europe, but also because of linkage between American financial institutions and European institutions,” said Kaufman, who is president of the economic and financial consulting firm bearing his name.
Kaufman earned the sobriquet Dr. Doom in the 1970s — long before Nouriel Roubini acquired the title in recent years. Like Roubini, Kaufman was prescient in his warnings about excessive debt in the financial system.
These days, with markets focused on Europe’s excessive debt, he says severe spending cuts in southern Europe could send those countries into a downward spiral with no prospect of recovery.
“Debtor countries need to expand their economies and austerity measures diminish those countries’ ability to grow and service their debt,” Kaufman said.
Before establishing his eponymous firm in 1988, Kaufman spent 26 years at Salomon Brothers Inc. His prediction on August 17, 1982, that interest rates would fall sparked a stock market rally that helped kick off the 1980s bull market.
This year, the stock market has been held back by worries about Europe, where rising borrowing costs signify concerns that the debt contagion that has hit smaller nations will engulf large nations and large banks. The fear is exposure to European banks will hurt US banks as well.
Big banks in Europe have sold large amounts of insurance in the form of financial instruments known as credit-default swaps to protect against the risk of countries defaulting on their sovereign debt.
That has increased the number of parties that could incur losses if such defaults occur.
“We don’t know the full depth of these links,” Kaufman said in the interview. That makes the European financial situation “hazardous” despite the ongoing effort by European policy makers to gain time, he noted.
An expert on how credit flows through the economy, financial system and financial markets, Kaufman, who received the Foreign Policy Association’s Statesman Award — presented by former Federal Reserve Chairman Paul Volcker earlier this month — said Europe will probably need “a major overhaul of its institutional arrangements” to escape its financial quagmire.
A combination of strategies will probably be needed to solve the eurozone problem, he said. One would be to gain time for debtors to reestablish their economic capacity.
The head of Europe’s bailout fund said recently that around 600 billion euros ($782.82 billion) were available to fight Europe’s debt crisis, more than Italy’s and Spain’s combined funding needs for 2012.
Another strategy would be to reduce the debt of borrowers like Greece, Portugal or Italy, a reduction to which creditors would have to agree.
“That would require some private-sector institutions to take losses and/or that the debt of these marginal borrowers be transferred directly or indirectly to some official European institution such as the European Central Bank,” he said.
Banks are resisting pressure to help indebted eurozone countries by using cheap money lent by the ECB to buy more sovereign bonds.
“Since none of these alternatives are easy, the conclusion must be that risks in Europe remain high,” Kaufman said.
Debt stands in the
way of recovery
One huge obstacle in the path of more normal US growth is the amount of non-financial debt relative to US gross domestic product, Kaufman said.
On the eve of the 2008 financial crisis, non-financial debt exceeded US gross domestic product by $19 trillion, while 20 years earlier, non-financial debt exceeded US GDP by just $4 trillion, he observed.
“There are no easy ways to close that gap... to return to a path of more sustainable US economic growth,” he said.
Households have been reducing their debt. Federal Reserve data showed household debt service levels fell in the third quarter, continuing a pullback from a peak reached in the third quarter of 2007.
Still, “total household indebtedness is still quite high by historical standards,” Kaufman indicated.
Without the large borrowings of the US government, the recession would have been deeper and the business recovery, subnormal as it is, would have been delayed, Kaufman said.
While the growth of US government debt will have to slow in coming years, it is “quite unlikely” the US government will adopt “appropriate fiscal policies” soon, he said.
“Near-term pressures are not strong enough to impose discipline, US interest rates are historically low, and buyers of our debt are still easy to find,” he added.
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