Friday, 5 September 2008

Drug policy

The ECB is taking steps to withdraw the crack cocaine of the Eurozone financial system, cheap liquidity. From the FT:
the cost of raising funds from the ECB against any kind of asset-backed bond or unsecured bank debt will rise, once the rules are implemented in February...

The most straightforward changes were an increase in the haircuts, or discount, applied to the worth of collateral. For asset-backed securities, such as mortgage-backed bonds, this was increased to a flat rate of 12 per cent from a base of 2 per cent. If a bank has created such a bond and kept it on balance sheet for repo purposes, a further 5 per cent haircut is added.

For normal unsecured bank debt, the haircut is also increased by 5 percentage points from a 1.5 per cent base.
As Willem Buiter points out, this is going to be interesting for those Eurozone banking systems that are suffering from a housing crash and a concomitant liquidity drought:
Between August 2007 and July 2008, the share of Spanish banks in the Eurosystem’s allocation of main refinancing operations and longer-term refinancing operations went up from about 4 percent to over 10.5 percent. The share of Irish banks went up from around 4.5 percent to 9.5 percent.
I still think Buiter is wrong on the central policy issue: the ECB should take (some limited) risk if by so doing it helps reliquify the financial system as a whole. But like him I applaud these steps towards stopping the gaming of the ECB's collateral facility. And I think this is a big signal to short Spanish and Irish banks with lots of 2005-2007 vintage mortgage exposure.

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