No, really, RBS and Lloyds are being bailed out by the EU

Cormac Hollingsworth replies to Open Europe, and demonstrates that RBS and Lloyds really are being bailed out.

 

“I was just shouting at the Bank of England, that’s why I couldn’t take your call.”

It was 2008, and the treasurer of a top five building society had just returned my call. I obviously asked him what cause he had to shout at the Bank of England, it’s not something a bank does lightly.

He replied:

“They’re idiots, they think the only thing we should give them as collateral in our repos is gilts. If we were in the Eurozone, we could use any part of our liquidity portfolio as collateral.”

I was reminded of this diatribe when I read Open Europe’s reply to yesterday’s blog post.

In the long-term refinancing operation, the ECB is providing exactly the kind of funding that my building society treasurer has never got from the Bank of England: term funding against loans that the eurozone banks have on their balance sheets, that no-one else in the market will receive as collateral.

A bailout is providing something the private market won’t do, and thereby preventing the collapse of the banks.

In 2008, when the banking market froze and banks could get neither overnight liquidity from the money markets, nor term funding from the wholesale markets, the UK led the way in imposing stress tests. In return, it provided a bailout by access to the Bank of England, and access to government guarantees for funding guarantees so the banks could restart borrowing term funding in the wholesale markets

For Open Europe to say that the ECB’s operation is not a bailout at all poses the question of why the ECB is doing the LTRO for the first time ever.

The reason is that in autumn, the European banking system froze up in a new credit crunch, this time caused by sovereign debt exposure.

In reaction, the Eurozone have followed the UK bailout plan with some tweaks to bail out their banks: the Eurozone has done stress tests, and while the Eurozone banks have always had access to the ECB, but the final part, term financing presented some challenges: during a sovereign crisis it would be difficult for the sovereigns to start guaranteeing their banks.

Eurozone governments were smart enough not to invite ridicule by offering guarantees, and so the final part of term financing was left to the ECB in the form of the LTRO.

The LTRO is part of a bailout of the whole Eurozone banking system. And if the ECB needs to do this, why isn’t the UK?

Open Europe is emphatic about this.

They say UK banks could do this transaction anyway in the sterling private markets:

These banks could obtain this money in pounds and then change it into euros”.

They explain that:

“[UK banks’ reasons] for doing this [ECB LTRO operation] is not because they cannot borrow this money from the Bank of England or because they could not survive without it – which the Left Foot Forward blog and some others seem to believe – but simply because it is a cheap source of euros.

But this misses part of the point of the LTRO, which is to provide term funding for assets which the private markets will no longer take as collateral, as the FT reported here. And that’s why Open Europe’s argument just doesn’t fly.

Repo markets are global, and if some collateral is not acceptable in euros it sure as hell won’t be acceptable in a smaller market like sterling.

But all the evidence points to the UK banks having as much difficulty as European banks in term funding:

UK banks are having to shrink their balance sheets; the governor of the Bank of England says things are as bad as when Lehman went bust; and the Bank of England’s own Credit Conditions Survey points to a UK bank funding crisis as bad, if not worse than 2008/9.

Since the start of the crisis, the Bank of England has an added question to its Credit Conditions survey, which asks quite simply whether lending conditions are tight due to difficulty in raising funding in the wholesale capital markets.

The latest survey has two negative readings, -21.9 for scarce mortgage lending, and -42.6 for corporate lending. These surveys were slightly positive in late 2009 and early 2010, but during the credit crunch, they were as low as -48.7 for mortgages in Q1 2008, the corporate squeeze came later in 2009 Q1 with a low of -28.7.

So the difficulty of financing corporate lending is worse now than in the credit crunch, in the case of mortgages it’s tough but not at the extremes. But at these stress levels in 2008/9 a long list of banks all collapsed. That banks are not collapsing now means that the bailouts have at least left the survivors more robust. It doesn’t mean that they’re not in trouble.

So this leads us to why the Bank of England isn’t doing an LTRO, and takes us right back to the treasurer of my favourite building society: the Bank of England is still only buying gilts. The only operation the Bank of England are doing is trying to spend another £50 billion. But this isn’t going to help the banks.

Clearly financing stresses are terrible, and our banks sorely need term financing for collateral that no-one else in the market will take. But that’s just what the Bank of England won’t give, in case it’ll cause moral hazard.

Here’s what Paul Tucker, the bank’s executive director, said a year ago:

“The Bank of England can provide liquidity insurance to individual, credit-worthy institutions and to the banking system as a whole, by accepting those less liquid assets as collateral, for a fee, in exchange for more liquid assets, including reserves.

But such liquidity insurance must be provided in a way that takes account of the potential for ‘moral hazard’ — the incentive for individual banks to undertake riskier activities because of the presence of a central bank backstop.”

It is of the most material relevance that even though the Bank of England governor says that financial stresses are as bad as when Lehman went down, the Bank of England is not providing an LTRO.

And the proof of the need within the UK is that the UK banks take the LTRO from the ECB. As Ed Balls suggested, when the Bank of England can’t help themselves for fears of moral hazard, under the current regime, help that’s needed to UK banks won’t be given.

See also:

If RBS’s board is not held to account, it could become a new LeylandCormac Hollingsworth, February 24th 2012

Swinney on Scotland currency – more questions than he answers?Ed Jacobs, February 2nd 2012

All in it together? RBS fat cat “in line for £7m payout”. Seven. MillionShamik Das, January 27th 2012

Progressives need a positive vision for ScotlandEd Jacobs, January 26th 2012

A word for 2012: LiquidationCormac Hollingsworth, January 4th 2012

21 Responses to “No, really, RBS and Lloyds are being bailed out by the EU”

  1. keith ferguson

    No, @OpenEurope, RBS and Lloyds ARE being bailed out by the EU, writes @CormacHolly: //t.co/5ENTgZyA

  2. Political Planet

    No, really, RBS and Lloyds are being bailed out by the EU: Cormac Hollingsworth replies to Open Europe, and demo… //t.co/duyAokSg

  3. Patron Press - #P2

    #UK : No, really, RBS and Lloyds are being bailed out by the EU //t.co/qIAuciFh

  4. leftlinks

    Left Foot Forward – No, really, RBS and Lloyds are being bailed out by the EU //t.co/MfXFLLTc

  5. Richard Murphy

    Left Foot Forward – No, really, RBS and Lloyds are being bailed out by the EU //t.co/MfXFLLTc

  6. Pulp Ark

    No, really, RBS and Lloyds are being bailed… //t.co/XOhvr9D2 #Sustainable_Economy #bailout #EU #Europe #Lloyds #muslim #tcot #sioa

  7. Anonymous

    But this misses part of the point of the LTRO, which is to provide term funding for assets which the private markets will no longer take as collateral,

    ===========

    They won’t take them as collateral because they are worthless. That’s the problem. 1 million Euros of Greek debt used as collateral for anything isn’t collateral.

    That’s the core issue. Governments are bust.

    Governments force banks to to lend to them

    Governments are not credit worthy, so banks are taking hits on loans and collateral.

    You can’t change the fundamental problem with financial engineering such as QE or LTRO.

    Governments are a busted flush.

  8. Anonymous

    But all the evidence points to the UK banks having as much difficulty as European banks in term funding:

    ==========

    One major factor is low interest rates plus high inflation. People won’t lend to banks unless forced when the returns are negative in real terms.

    1. Raise interest rates
    2. Government stops borrowing and competing for funds.

  9. Pucci D

    No, @OpenEurope, RBS and Lloyds ARE being bailed out by the EU, writes @CormacHolly: //t.co/5ENTgZyA

  10. Cormac Hollingsworth

    No, @OpenEurope, RBS and Lloyds ARE being bailed out by the EU, writes @CormacHolly: //t.co/5ENTgZyA

  11. Ian Fraser

    Background on why #RBS and #Lloyds are accepting 'bail outs' from ECB's LTRO scheme //t.co/TbnxGSAt

  12. Shamik Das

    No, @OpenEurope, RBS and Lloyds ARE being bailed out by the EU, writes @CormacHolly: //t.co/5ENTgZyA

  13. Martin Steel

    No, @OpenEurope, RBS and Lloyds ARE being bailed out by the EU, writes @CormacHolly: //t.co/5ENTgZyA

  14. prempunjabi

    RT @leftfootfwd: No, really, RBS and Lloyds are being bailed out by the EU //t.co/JNEYPvlj

  15. Contractor Mortgages

    No, really, RBS and Lloyds are being bailed out by the EU | Left Foot … //t.co/BJkZolso

  16. Edw!n IJsman

    RT @Ian_Fraser: Background on why #RBS and #Lloyds are accepting 'bail outs' from ECB's LTRO scheme //t.co/Enc5ModB

  17. OccupyDenHaag

    RT @Ian_Fraser: Background on why #RBS and #Lloyds are accepting 'bail outs' from ECB's LTRO scheme //t.co/Enc5ModB

  18. H. O.

    RT @leftfootfwd: No, really, RBS and Lloyds are being bailed out by the EU //t.co/7mzC9mF4

  19. The Bank of England is like a lifeguard who's afraid of rubber rings | Left Foot Forward

    […] also: • No, really, RBS and Lloyds are being bailed out by the EU – Cormac Hollingsworth, February 29th […]

  20. Martin Steel

    RT @leftfootfwd: No, really, RBS and Lloyds are being bailed out by //t.co/4CyjgUHZ

  21. Cormac Hollingsworth

    No, really, RBS and Lloyds are being bailed out by the EU //t.co/7sjtqiBr what I wrote earlier in the week should have added Lloyds

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