The Greek talks continue, and the FT reports that the IIF has made a “final offer” of a 65-70% NPV write-off. Well, that is just about achievable on the terms that have been talked about in the press (and making a few assumptions). A 30-year bond with a par value of 50 paying a 4.5% coupon, assuming a 30-year interest rate of 9%, represents an NPV loss of about 70%. But with a 3% coupon, which the IMF is still talking about, the NPV loss is 80%. The dispute over the coupon appears to be the sticking point and the reason for the finality of the IIF’s offer.


Bloomberg reports that the ECB is to extend further its list of eligible collateral before the second LTRO in February. This represents a further easing of collateral conditions in Europe and should be good news for the banks (which are apparently busily manufacturing qualifying collateral). Bloomberg quotes an analyst as saying that the ECB’s operations are “only a temporary solution”, but I cannot see an economic reason why that should be so — it could continue to fund the banking system indefinitely. Excessive lending by the ECB might provoke inflation if it promoted a credit boom; but the point is that bank balance sheets are in danger of contracting for other reasons, and those reasons remain in spite of the ECB’s actions. There may, of course, be a political constraint on how long the ECB can keep up this kind of thing, but it is hard to make an assessment of whether, or when, such a constraint would be binding.

Some chatter about how much banks might borrow in the next 3-year LTRO got me wondering how much of the Eurozone banking system the ECB was already funding. Combining the monthly (Oct) and quarterly (Q3) series for Eurozone banks’ liabilities (which do not quite add up to the right total, but are close enough to give an impression), I find that ECB lending to Eurozone credit institutions of EUR 887bn represents 2.7% of the total liabilities of such institutions. This does not sound like a lot, but it is also 6% of their total short-term funding (i.e. repo, deposits and debt securities maturing in less than two years) and 40% of their capital and reserves. Looked at another way, I suppose these figures highlight three things: first, the vast majority of the short-term funding of the Eurozone’s banks in aggregate is still supplied by the market and not by the ECB; second, the banks are hugely reliant on short-term funding; and third, the banks are, and remain, highly leveraged (capital and reserves being 6.7% of total assets).

The Euro as a Funding Currency

Another analyst quoted by Bloomberg says that the ECB’s actions will tend to weaken the EUR. Well, perhaps, but actually the EUR strengthened all through 2009, and weakened in 2010 after the ECB’s withdrawal of its extraordinary support programmes precipitated the first phase of the euro crisis. There is a lot of speculation about the EUR becoming a funding currency for carry trades. I first discussed this idea on 3rd January, and by the 10th I had grown sceptical. I wrote: “It is not clear that the availability of credit trumps its funding cost — i.e. that international players will borrow expensively in EUR, rather than cheaply in USD, because of the ECB’s actions.” There is an argument that the expectation that the EUR will fall, at a time when the US economy is looking a little perkier, makes EUR more attractive than USD for carry trading; but the interest-rate differential, and the fact that EUR did not consistently weaken last time the ECB offered extraordinary funding to banks, are enough to maintain my scepticism.

British Politics

I am disappointed to see that the UK Labour Party appears to be abandoning its support for further fiscal stimulus and accepting the coalition government’s wrong-headed austerity programme. I fear that economic literacy may have no representative at the next election, to the great detriment of the country.

This Week

All week: China Spring Festival Holiday.
Tue: BoJ; ECOFIN; Eurozone flash PMI’s and industrial new orders; UK public sector net borrowing.
Wed: Japan trade balance; German Ifo; UK MPC minutes, prelim. GDP and mortgage approvals; US pending home sales; FOMC statement and press conference.
Thu: US durable goods orders, initial claims and new home sales.
Fri: Japan CPI, monetary policy minutes and retail sales; Eurozone M3; US advance GDP and revised Michigan sentiment.