Tuesday, June 7, 2011

The ECB is Just Another Example of Disastrous Central Banking

Report: A HOUSE BUILT ON SAND? The ECB and the hidden cost of saving the euro

As we can see, in the run up to the sovereign debt crisis the cheap money dished out by the ECB might have mitigated the impact of the financial meltdown by saving some financial institutions, but it also provided perverse incentives for undercapitalised banks. It deterred them from attempting to increase capital stocks externally (by issuing debt or shares) as would happen under a business-as-usual scenario. In fact, the availability of cheap liquidity encouraged them to take on more risk in an attempt to increase profits and raise capital internally. With liquidity coming so cheap, banks could invest money into what looked to be relatively high return yet low risk assets – in an effort to maximise profits and avoid issuing capital calls. At the time (2009 - 2010) these assets were mostly weaker eurozone government bonds which have now lost value, making these banks even more vulnerable.

In turn, this had significant knock on effects for eurozone governments, since it actually led to an increase in market demand for peripheral debt as banks continued to buy government bonds (using cheap ECB credit). For their part, peripheral eurozone governments took this increase in demand to mean that markets were not overly worried about their poor finances, which reduced the pressure for these governments to reform.
What a stupid, predictable mess. No one involved in this should be allowed to have any authority over public finances. The ECB bought a year of time and made the problem significantly worse.

Where is Andrew Jackson when we need him?

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