ECB President Jean-Claude Trichet said Thursday that European Banks have “pledged more private paper, such as asset-backed securities, to the European Central Bank to use as collateral in its liquidity-providing repurchase operations, but that does not mean that the ECB is bailing out private banks.” Trichet said that “It is clear that all of us on both sides of the Atlantic have noted an increase of the collateral [that is] in the form of private paper. Treasuries were less utilized by banks as collateral and we have observed that on both sides of the Atlantic.” That’s the kicker. There’s just one problem. Trichet’s statement is disingenuous and grossly misleading. There is little similarity between the actions of the ECB to those of the Fed, both in kind, and in magnitude.
An excellent piece by Dow Jones gives a rundown on the gory details. The article reports that senior European bankers estimate that up to 500 billion Euros in ABS of questionable value has been pledged to the ECB in return for short term financing.
While the ECB’s Trashit says, “Hey! Everybody’s doing it, not just us”, it’s important to distinguish a couple of things. First, the Fed does not take ABS collateral in its open market operations, although they do accept it along with all other kinds of conventional collateral at the discount window and via the new Term Auction Facility (TAF) which the Fed started in December. The amounts taken at the discount window are inconsequential, and the TAF, at a rolling $60 billion, which it appears the Fed may make permanent, is insignificant compared with what the ECB is reportedly doing.
The Fed also takes a relatively small amount of Mortgage Backed collateral for its repo operations. The amount of MBS backed repos at any time is usually no more than $10 billion, and often not more than a few billion. The Fed is pretty tough about collateral. Their collateral rules for the TAF require 50% overcollateralization.
While the Fed may have $60 billion in TAF credit outstanding, there’s no way to know how much of it is backed by ABS collateral. It’s probably safe to assume that not all of the collateral accepted is ABS.
On the other hand, it would appear that the ECB is possibly financing up to a half trillion of ABS according to the Dow Jones report, quoting people supposedly in the know. The fact that the ECB’s Trashit felt it necessary to defend the ECBs actions lends validity to the estimates.
Much of this ABS collateral is likely to be fictitious capital, that is paper that is backed by assets which are worth less (Did Buffet really say “worth less” or “worthless” in his recent comments about the direction of the dollar?) in many cases much less, than the notional value of the securities. Under the circumstances the ECB is turning the Euro into trash compared to the US Dollar. The USD is sound money by comparison. At least the paper issued by the Fed is more than 90% backed by Treasury debt. That could be one reason why the US Dollar Index charts are evidencing the possibility of a major bottom. Compared to the Euro, you could say that the dollar is as good as gold. Yeah. Right.
Many market followers may be making the erroneous assumption that the US Fed is the most reckless actor in the grand scheme of desperately propping up the collapsing credit bubble. The ECB (and the BOE, another bad actor) have actually been far more reckless in aggressively bailing out failed institutions, financing worthless paper, and debasing their currencies. The Bernanke Fed has actually been a model of restraint in comparison.
Of course, everything is relative. It’s a question of who’s “less bad,” and in the end, none of it makes much difference anyway. We are all going to have to pay for it.
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