1) Banks can take out cheap loans with low quality collateral and buy government bonds, and then do the whole thing again in a sort-of MF Global leverage trade.
2) Three years from now all these trades will unwind leaving Europe who-knows-where.
On the second point, Reuters quoted the Bank of Finland chief Erkki Liikanen as “also worried about ample liquidity provision leading to future problems and has said the ECB must think about how to unwind the extraordinary measures.” We wonder how scary this will be to watch when the time comes.
But really, it isn’t the ECB’s job to prop up government debt and financial markets; it is the job of governments to get their finances in order. This may take longer than three years but hopefully the ECB’s emergency cushion will keep banks stable long enough for governments to do their jobs.
The more that banks are able to lend amongst themselves at market rates and with collateral that are acceptable by everyone, the better it will be for financial markets to regain their footing. The ECB has done a great job, but as the Reuters article notes, “Central bank sources say they are worried that banks will become too reliant on ECB funds, removing the incentive to restart lending between themselves.” Good call.
The original Reuters article is here.