With most papers leading on "here comes the recession"-type stories, it would be very easy to overlook the report on page five of yesterday's FT that the "ECB is to tackle abuse of liquidity aid". And no wonder. The story sounds either a) very technical or b) something about the financial equivalent of binge drinking.
But there's a bombshell being delivered here - the European Central Bank is about to stop bailing out eurozone commercial banks. And that could mean another big lender going 'bust'. Time to reach for your tin hat again…
The ECB is about to stop bailing out eurozone commercial banks
The European Central Bank has said nothing official as yet about its plans to take a closer look at its support for European banks. In true eurozone style, the ECB's thoughts are being carefully leaked in a dull bureaucrat-ese that's easily ignored and designed not to prompt a panic.
ECB policymakers have agreed a "certain amount" of refinement to the central bank's rules," said the governor of Luxembourg's central bank, Yves Mersch, at the weekend. The changes under consideration weren't "a broad-based revolution", he added. However, as markets evolved, "we have to adjust our framework regularly to market practices" which would "concern some instruments".
Hardly a "stop the press!" moment. But fortunately, Not Wellink, the Dutch central bank chief and a major figure on the ECB council, has been a bit more specific. He said that banks were becoming addicted to the Frankfurt 'liquidity window'. That's where the ECB has been providing cheap funding for eurozone banks by lending against the collateral of a whole range of so-called asset-backed securities (ABS).
Let me explain. A number of European banks weren't able to borrow enough cash to keep their balance sheets balanced because other investors weren't prepared to lend them the money. The only way they've managed to keep their heads above water recently has been to shovel the dodgy loans they have made onto the ECB – a sort of financial pass-the-parcel. Without it, those banks would have gone bust, a la Northern Rock.
But the bad news for these lenders is that it looks like the party's over. "If we see banks dependent on central banks, then we must push them to tap other sources of funding", Mr Wellink told Dutch financial daily Het Finacieele Dagblad. "There's a limit how long you can do this. There is a point where you take over the market".
Exactly. I can't think why it's taken the ECB so long to work out that it's storing up problems for the future. After all, it was prepared to hike interest rates two months ago when worried about too much inflation. Perhaps it was because the Bank of England and the US Federal Reserve had to put in place their own panic measures – sorry, emergency funding arrangements - while the ECB already had something suitable in place.
But this is where the second part of the problem arises. Though its policy buys time, the ECB ends up with a shed-load of assets whose value is highly debatable at best. That's bad enough in itself, but there could be much more fallout. The Maastricht Treaty – one of the EU foundation stones - formally prohibits long-term taxpayer support of this kind for the EMU banking system.
"The ECB is in an unenviable situation", says Paul McCulley of Pacific Investment Management. "The lender of last resort should be just that, not a permanent provider of funds."
Spanish banking sector could be facing collapse
So it's starting to look like the game could be up for a large chunk of the Spanish banking system. We've written before about the parlous state of the Spanish property market and, as a result, the hole into which the country's banks have dug themselves. The latest Bank of Spain data shows that the country's banks have increased their ECB borrowing to a record €49.6bn (£39bn). "A number have been issuing mortgage securities for the sole purpose of drawing funds from Frankfurt", says Ambrose Evans-Pritchard in The Telegraph. "These banks are heavily reliant on short-term and medium funding from the capital markets. This spigot of credit is now almost entirely closed".
But the ECB will have to end this bailing-out soon. Now it's possible - just – that the central bank can deal its way out of this mess, and somehow avoid the carnage that a Spanish bank bust would cause. But as the world's banking glitterati gather in Jackson Hole, they've got plenty of hard thinking to do. After all, if Spain's banking sector collapses, it would result in even tighter credit, less lending and less spending.
One – admittedly unorthodox solution – could be for the ECB to simply pretend that Spain doesn't exist. If that sounds silly, that's because it is. Yet, that hasn't prevented British buy-to-let lender Paragon from trying to disown an entire sector of amateur landlords who have fallen on hard times.
According to The Guardian, Paragon now says that investors in the kind of overpriced city-centre apartments which are now virtually unlettable and unsellable should not be classed as buy-to-let investors. "These properties were targeted by speculative purchasers who thought they could make a quick buck by flipping them. That is not the buy-to-let market. Buy-to-let investors do not own a property unless they can demonstrate that there is tenant demand".
It's an interesting solution to the housing bubble implosion – just stick your fingers in your ears and pretend it's not happening. But somehow we don't think it'll catch on.
Turning to the wider markets…
UK shares rallied strongly on Friday, as the FTSE 100 index climbed 135 points, 2.5%, to 5,506. Property stocks soared, with Liberty International - surrounded by bid rumours – jumping 8%, while British Land added 6% and Hammerson 5%. Banks also fared well with Royal Bank of Scotland and Barclays both gaining 5% while Lloyds TSB put on 7%. BT climbed 3.4% on vague bid talk. But Michael Page lost 4.4% having rejected Adecco's advances. The London market was closed yesterday for the August bank holiday.
Shares in Europe dropped yesterday, with the German Xetra Dax losing 0.7% to 6,297 and the French CAC 40 shedding 1% to 4,356.
US stocks fell sharply last night, with the Dow Jones Industrial Average dropping 242 points, or 2.1%, to end at 11,386 and the wider S&P 500 and the tech-heavy Nasdaq Composite both shedding 2% to 1,267 and 2,366 respectively.
Overnight the Japanese market shed 100 points, 0.8%, to 12,779, while in Hong Kong, the Hang Seng was almost flat, down 0.1% to 21,088.
This morning Brent spot was trading at $113, spot gold was at $821, silver at $13.52 and platinum at $1,443.
In the forex markets this morning, sterling was trading against the dollar at 1.8441 and against the euro at 1.2547. The dollar was trading at 0.6803 against the euro and 109.72 against the Japanese yen.
Also this morning, Bovis Homes said first-half profit plunged 83% after banks granted fewer mortgages. Sales dropped 43%.
Our recommended article for today...
Diversionary tactics or simple coincidence?
- The world's markets have remained calm in the face of fluctuations in global currencies, spasms in world commodity prices, the Beijing Olympics and war in South Ossetia. But could all these events be linked in some way? To read the article, click here: Diversionary tactics or simple coincidence?
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