More Thoughts About The Fed And ECB

The launch of the new 4-year lending facility by the European Central Bank was disappointing.  Participation was light.  Some 255 banks (of 382 eligible institutions, which represent more than 1300 entities) borrowed a total of 82.6 bln euros.  The consensus was for 150 bln euros, and less than 100 bln was thought to a failure.  

Our expectation for poor results was based on three considerations.  First, we feared a stigma  so that strong banks would resist.  Second, the Asset Quality Review and stress test (results next month) might deter participation.  Third, prudence suggests that waiting for December, even if one wanted to participate.  We thought that banks that had large LTRO borrowing outstanding would likely participate.  Italian and Spanish banks outstanding LTRO borrowings are roughly 164 bln euros and 163 bln respectively. 

That the ECB could not give away 4-year funding at 15 bp will be cynically dismissed as evidence that the scheme was misguided from the start.  The problem the cynics will say is from the demand side not supply, or that the price of money is not the significant problem during the de-leveraging wave that is being driven mostly by the regulatory environment.    

We are hesitant about reading too much into the dismal participation today.  A repeated poor take down in December would be more significant.  We suspect ECB officials will also be reluctant to accept failure at this juncture.  The disappointing participation does not really mean that a sovereign bond purchase scheme is more likely. There remain numerous formidable technical, legal and political obstacles. 

To be sure, there are numerous other forms of QE if officials wanted.  The ECB could buy bank bonds, corporate bonds, and even EFSF/ESM/EU bonds.    This is not a prediction, but a description offered to demonstrate that a sovereign QE program is not the only, or even most likely, response to the disappointing TLTRO.