Saturday, 17 May 2008

The ECB and The Scorpion

In the fable of the scorpion and the frog, the frog is surprised that the scorpion's nature comes out in the dealings between them. The ECB is similarly surprised the banks have arbitraged their rules, despite arbitraging rules being in the very nature of banks. From the FT:
The European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.
You mean banks are chucking assets into SPVs, issueing paper, never trading it but claiming it is worth par, getting the blessing of their reliable friends the rating agencies, repoing it with the ECB, and smiling all the way to their Treasuries? Surely not. That wouldn't be in the spirit of the rules...

When I talked about this in February I thought the ECB knew what was going on and at least tacitly approved. It seems not. And now banks are creating euro tranches in dollar deals specifically to appeal to buyers with access to the ECB window. That makes sense - these deals presumably trade tight because of the certain funding. This is irritating the ECB, who are now looking for `an exit strategy' from this mess. But presumably one that doesn't send liquidity crashing down in the Eurozone. That will be interesting.

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