LTRO fever is the biggest factor behind the glorious rally of 2012. Interrupted by worries around Greece, speads have tightened further and faster than most in the market can remember, such is the difference in tone from the grim defeatism of 2011.
Out of all the emergency measures the European Union has thrown at the crisis — government guarantees, reviving the covered bond SMP, forced capital injections — the LTRO is the only one that has stuck. It is perfectly understandable that, having finally triumphed after so many damp squibs, the bloc’s policy makers are considering another dose of 1% three year as soon as this September.
But is there a fundamental need for another LTRO? The ECB is on to a good thing, yes — but the larger the dose, the bigger the comedown, and artificially keeping the European banking system afloat by stuffing it to the gills with cheap money could do more harm than good.
The idea of the mooted third LTRO is supposedly to avoid a maturity hump in three years’ time. It’s hard to see how it would achieve this objective, however, with the second LTRO barely a week away. Banks might have been encouraged to spread their borrowing over two maturities if they had been given a clear indication that a third operation would take place, but as it stands, they will likely take as much in next Tuesday’s LTRO as they need — unless the ECB advises them of a September tender beforehand.
Even so, how does an extra seven months avoid a maturity hump? In an ideal world in which banks barely needed to break a sweat to refinance debt, it could do so. But predicating a third LTRO on such conditions would be treacherous. Whether conditions in the funding markets stay the same, improve or deteriorate, we are unlikely to be in that ideal world in three years time.
If the ECB wants to maximise the positive effect of the LTRO by launching another tender, it should save it for this time next year. That would give the market both a safety net and something to look forward to whilst also allowing time for Europe’s economic situation to improve: the continent’s banking system would be insulated from damage whichever way the market moved. Shoving it down banks’ throats in September would be hasty. After a while, force-fed geese topple over and can’t walk. Banks do the same, but without producing a delicious pâté.
Perhaps the ECB could devote that extra breathing space to figuring out how it could structure a third LTRO in such a way as to begin to wean banks off the central bank teat. That was, after all, its intention but a year ago. Charging banks more to use the facility but keeping the levels comfortably below market rates would ensure it offers arbitrage but not to the extent that better-off banks can exploit it.
It is supposed to be an emergency facility, after all.