In early December, I wrote in Foreign Policy
Crises, however, are not fables. They do not exist to teach us lessons or help us learn to mend our ways. The forces at work are utterly indifferent to the narratives we attach to them. Like everything else, they are simply a chain of events. One damned thing after another. Our task is to understand how this chain is likely to unfold and uncover what, if anything, we can do to mitigate the damage.
. . .
Before anything else, the banks must be saved, most likely through an open-ended lending facility like the Federal Reserve’s Term Auction Facility (TAF). They must come before taxpayers, before pensioners, before the reforms that might transform southern Europe into a dynamic player in the global economy.
Not because it is fair or just or right. It is none of these things.
On December 8th the ECB announced that it would be expanding the LTRO into a 3 year open ended facility, similar to TAF. They beat my published timestamp, though I feel compelled to say – not my deadline – by three days.
Today, Tyler writes
It would be an exaggeration to claim that the ECB has taken over European capital markets for three years, but you can see where my thoughts are headed. What happens when the three years is up, or as that time approaches?
. . .
The Eurozone is now in a recession, with further financial shocks likely to come (more Greek problems, Portugal falling into receivership, Irish referendum, French election, slowdown in China, etc.) What is the probability that #1 comes to pass? I say below fifty percent. Just how bad is #2-3? What other options are there? How long would it take for de facto bank nationalization to lower the economic growth rate? How long would it take before re-privatization is an option?
By the way people, we’re exploring the best case options here, they did avert disaster in December! For now.
Regular reader know my long standing policy advice that averting disaster for now – kicking the can down the road – is the essence of success. In part, I want to use this example to highlight why this makes sense.
There are more things on heaven and earth than are dreamt of by any policy maker, or blogger. Few people know how the medium and long term will actually unfold and I hope I am not waxing to Hanson-esque to say that arguments about the long term are really arguments about the arguers status.
If we actually want to help the world, we focus on details and that usually means the short term. Things we can see closely and understand the nuances of. In short, we Stop Disaster.
One day we will lose and the world will come to an end. The apocalypse only has to win once. Our job is to make sure that that day, isn’t today.
However, to Tyler’s ultimate question: “What is the end game”
I do think its to early for that. Right now we hold the line. However, what you want to see is two things
1) The unsecured interbank lending market to function smoothly and at the target rate.
2) The marginal return to capital to rise above the target rate.
Given the structure of the LTROs – should they continue – there would then be more hesitance to use them because there is no advantage and there are transactional complications.
If you can achieve the same funding unsecured overnight, and you have ample real demand there is no need to park collateral at the ECB. You pull whatever you financing you need out of the unsecured markets and then use your collateral to back more flexible liquidity arrangements, like Repos.
So, in a return to normalcy desire to use the LTRO just rolls off.
If that doesn’t happen, then well we have bigger problems which we need to deal with as they come based on how they actually manifest.