-Governments Try To 'Stuff Paper Down Banks Throats' -Funding Worries, Capital Shortfall Seen As Barriers To Bond Buying NEW YORK (Dow Jones)--More money, more problems? Flush with low-cost lucre from the European Central Bank, euro zone banks may now have a new challenge: fending off political strong-arming to buy distressed government debt. While acceding to that pressure could temporarily hold back the risks of a default and a breakup in the euro zone, some worry that this politicized intervention into financial markets will only create deeper problems down the road. For some, the sheer magnitude of the nearly EUR500 billion provided in the ECB's three-year tender Wednesday all but compels banks to support battered sovereign debt markets. The cheap loans, bearing interest rates at 1%, have led some analysts to call the tender a version of the "carry trade" that allows investors to take low-cost borrowing and invest it in riskier, higher-yielding assets. The central bank's cash infusion has coincided with entreaties from euro zone politicians, or what economists euphemistically refer to as 'moral suasion', for banks to serve as a cavalry brigade in Europe's war against surging bond yields and market contagion. But economists warn that political interference in markets run the risk of creating huge inefficiencies. Even before the ECB's tender, officials such as French President Nicolas Sarkozy exhorted banks to invest in euro zone sovereign debt, which led at least one observer to liken the dynamic to the spectacles often seen in developing countries. "You see this in emerging markets all the time," said Eric Stein, portfolio manager at Eaton Vance, with $177.8 billion in assets under management. He said it was a case of elected officials "stuffing government paper down the banks' throat. The interconnection between banks and governments couldn't be stronger." With crisis enveloping global markets, it's tempting for both government and central bank officials to steer banks in this direction. "The ECB is probably not going to be displeased if banks use some of these funds to add to sovereign debt positions," said David Gilmore, partner at FX Analytics. Because banks don't need to hold capital reserves against their government bonds, "there's this implicit wink and a nod to use some of [the loan money] to buy government debt." Gilmore referred to a regulatory quirk known as a "Basel Committee" rule. That assigns a zero risk-weighting to sovereign debt for the purposes of gauging a bank's capital adequacy ratio, and is seen by many as a key original cause of the euro zone's problems. This "risk-free" assumption led to an overpricing of sovereign debt as it meant the capital cost of owning it was lower. There is a widespread belief that this rule needs to be changed to acknowledge the risks laid bare by Greece's and other countries' crises, but the fear is that regulators will be compelled to keep it in place to goad banks into buying governments' bonds. Eventually, that could create more mis-pricings and capital imbalances. And even with the mix of enticements and pressure, institutions might still be reluctant to stock up on sovereign bonds. The wrenching liquidity crunch that has bedeviled European markets and the weaknesses in their own balance sheets do not make the prospect of investing in these severely stressed bond markets very attractive--not when there are downgrade fears dogging France and questions swirling about the solvency of Italy and Spain. Many would surely prefer to hang onto the ECB's cash or invest it in safer assets. Banks clearly have financing worries of their own. On Thursday, Bank of New York-Mellon estimated that banks have somewhere north of EUR720 billion of their own bonds set to mature next year, with EUR282 billion due in the first quarter of 2012 alone. Meanwhile, a deadline looms for Europe's banks to find new sources of capital. In August, the European Banking Authority said banks would need at least EUR114.7 billion in new funds, setting a January 20 deadline for how they would raise more. Some believe the political pressure, when combined with this ingrained risk aversion, will lead banks to focus more closely on their home markets. The result: a less liquid, more "nationalized" euro-zone bond market that undermines the borderless objectives of the euro project. "If there should be a break-up of the euro zone, the last thing you want to be stuck with is non-[national] paper that goes bad," Stein said. The integration of euro zone bond markets that existed prior to the crisis "will come unglued, and become more nationally focused going forward," Stein said. "The forces for that are already in place." Early indications suggest Italian banks are lining up as the main backstop to their government's debt. Italian news reports stated Italian central bank pressure was behind the massive EUR116 billion that was absorbed by that country's banks in the ECB tender, raising the likelihood that they will be buyers in the Italian government's giant calendar of forthcoming bond offerings. -By Javier E. David, Dow Jones Newswires; 212-416-4564; javier.david@dowjones.com
Thursday, 22 December 2011
Euro Zone Banks Face Political Pressure After ECB Tender
Newly flush Euro Zone Banks Face Political Calls To Support Bond Markets
By Javier E. David
Of DOW JONES NEWSWIRES
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