The European Central Bank Acts to add Liquidity to European Banks

Posted by PITHOCRATES - January 7th, 2012

Week in Review

The European Central Bank (ECB) offers up some cheap loans to add some liquidity to the Eurozone economy.  A liquidity problem caused by the Eurozone debt crisis.  Which was caused by excessive government deficit spending.  So the ECB’s solution to this problem is to throw more cheap money into the economy.  Problem solved (see Europe banks gobble up cheap loans offered by Central Bank by Henry Chu posted 12/21/2011 on The Los Angeles Times).

Faced with the threat of another regional recession, the European Central Bank said Wednesday that it was doling out more than half a trillion dollars in special long-term loans to hundreds of financial institutions in a bid to keep credit flowing…

The money, lent at the low interest rate of 1%, proved attractive to many financial institutions that are highly exposed to government debt and that have therefore found it hard to borrow commercially.

“It provides some stability to the funding of banks which have more or less completely lost market access,” said Sony Kapoor of the think tank Re-Define.

But the record response to the ECB’s offer is a sign of how dire the situation has become, Kapoor said. He warned that the new loans failed to address the heart of the euro crisis: the loss of faith in Europe’s banks and in the heavily indebted governments that stand behind them, especially in peripheral countries of the Eurozone…

Meanwhile, European government bond yields rose on fear that banks might back away from buying more sovereign debt amid pressure to reduce risk on their balance sheets.

Perhaps not.

This is why there is no easy solution to the Eurozone debt crisis.  European banks aren’t buying sovereign debt.  Because their balance sheets are full of risky sovereign debt.  So much that these banks have lost market access.  They can’t borrow because they are now risky, too.  Much like the countries of the Eurozone who are having trouble selling bonds.

All of this bad debt has resulted in a liquidity crisis.  And weakened European banks.  So the European Central Bank stepped in to relieve this liquidity crisis.  By providing low interest loans.  In hopes that these banks will use that cheap money to buy more of that risky sovereign debt.  That has caused the liquidity crisis.  And weakened European banks.

So either the banks will sit on that money to improve their balance sheets.  Or they will further weaken their balance sheets by buying more of that risky sovereign debt.  Neither which will fix the underlying problem.  Too much debt.  These countries with too much debt need more austerity.  To reduce their borrowing needs.  Before the European banks start failing.

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