Greeks should beware EU gifts, says Crossbridge Capital’s Manish Singh
Manish Singh, director and head of Investment Services at Crossbridge Capital says the second Greek bailout is anything but a gift.
In a recent WSJ interview ECB President Mario Draghi was asked – What is the first statistic you look at in the morning? His response – stock markets. If the same publication had asked the same question to his predecessor, Jean-Claude Trichet, you could safely bet a child’s tooth fairy money, that Trichet’s response would not have been the stock markets but the level of European inflation. The two approaches underline the fundamental shift that has occurred in Europe over last four months.
Second helping or last orders?
The ECB’s second round of cheap funding, LTRO (long term refinancing operation), on February 29, saw another big uptake. LTRO 1 in December had 532 banks borrowing €489bn; LTRO 2 had 800 banks borrowing €529bn. At a borrowing rate of 1% for 3 years, this is hardly surprising. If I were a bank I would want some of that too! A broader and higher uptake bodes well to allay funding stress for banks, both large and small.
While confidence has returned and stock markets have rallied, the biggest contribution of LTRO has been to prevent the collapse of the banking sector. If it weren’t for LTRO, the heightened refinancing cost that banks were facing meant existing assets on their balance sheet (mortgages, loans to consumers and corporates) would not be renewed but instead called by the bank or sold in a forced sale. Forced balance sheet adjustments in one go would have bankrupted the banks and sent the whole system into a death spiral. An argument clearly lost on the single-minded austerity seekers who treat balancing the fiscal deficit as a mathematical problem that can be solved simply by cutting the excess.
Helped by cheap funding, banks will reengage in profitable (and hopefully sensible) lending, pocketing the spread and offsetting the prior accumulated losses in the process. But this will be a long process so LTRO 2 is not the last we have seen of LTRO. In terms of LTRO’s goal of achieving additional lending into the real economy, LTRO 2 is expected to add almost €310bn (€193bn in LTRO 1) i.e. banks will now have more funds to lend. Now whether the banks use this liquidity to pocket the spread on the carry trade or to lend more to the real economy will strongly shape what direction the crisis takes next. Pocketing the spread will mend banks balance sheets but will reduce lending in the economy and stifle growth.
LTRO has not eliminated the risk of systemic failure it has merely taken it off the table. Let’s keep in mind that a trillion euros of additional bank debt will make any systemic failure in the future even greater than the one we are faced with today.