The Bundesbank's in Hot Water... Will It Take the Heat or Throw the ECB Under the Bus?

Phoenix Capital Research's picture

 

Yesterday we discussed the political fall-out for German Chancellor Angela Merkel regarding revelations that the Bundesbank has in fact put Germany on the hook for over €2 trillion via various back-door deals.

Today we need to consider how those same revelations will impact the Bundesbank itself. Already we're seeing its head Jens Weidmann (also a policymaker at the ECB) taking a hard-liner approach to dealing

Weidmann says not ECB's job to tackle Spain's problem

Spain should take a rise in its bond yields as a spur to tackle the root causes of its debt woes, not look to the European Central Bank to help by buying its bonds, European Central Bank policymaker Jens Weidmann told Reuters.

Weidmann, who has led a push by some policymakers from core euro zone countries for the bank to begin planning an exit from its crisis mode, said no ECB policymakers favoured using the bank's bond-buying plan to target specific interest rates on sovereign bonds, and ECB board member Benoit Coeure was simply stating a fact by saying last week that the programme still existed.

In a wide-ranging interview, Weidmann, who turns 44 on Friday, also said he saw no reason to discuss a third LTRO, the funding instrument with which the ECB has pumped over 1 trillion euros into financial markets since late last year.

Weidmann, who is head of Germany's Bundesbank, which gives him a powerful voice on the ECB's 23-man Governing Council, spoke to Reuters against a backdrop of growing tensions in Spain, where benchmark sovereign bond yields are near the closely watched 6 percent level.

http://uk.reuters.com/article/2012/04/18/uk-ecb-weidmann-idUKBRE83H0C820120418

Relations between the ECB and Bundesbank have been deteriorating for some times now. Disgusted with its monetary profligacy, two Bundesbank officials Axel Weber and Jürgen Stark, resigned from the ECB last year. Since that time Weidmann and the Bundesbank have fired a warning shot across the ECB's bow.

Germany launches strategy to counter ECB largesse

The plans have major implications for monetary union, dashing hopes in Southern Europe that Germany might accept a few years of mini-boom at home to help lift the whole system off the reefs.

Andreas Dombret, a key board member of the Bundesbank, said the body would be given powers to check "excessive credit growth" and impose "maximum leverage ratios" to nip economic overheating in the bud.

The Bundesbank will be able to impose "counter-cyclical capital buffers" on lenders, and use "macro-prudential haircuts" in the securities markets. It is understood that the menu of new tools will include limits on the loan-to-value on mortgages along the lines of those used in Hong Kong and other Asian states.

The new framework - introduced by German government in a draft law this week - is partly inspired by the Bank of England's new system but it also has a German twist...

German house prices rose 5.6pc last year after a decade of stagnation. Officials in Frankfurt are watching the property data closely, fearing that Germany may succumb to the sort of housing bubble that engulfed the Club Med bloc in the early years of EMU.

"The Bundesbank does not want to be blamed for making the same mistakes as central banks in Ireland and Spain where they did not address asset bubbles early enough," said Bernhard Speyer from Deutsche Bank.

The German authorities are in effect preparing a form of quasi-monetary tightening to offset ECB largesse...

"If the eurozone is to adjust, southern countries must be able to run trade surpluses, and that means somebody else must run deficits," said Dr Speyer.

"One way to do that is to allow higher inflation in Germany but I don't see any willingness in the German government to tolerate that, or to accept a current account deficit.

http://www.telegraph.co.uk/finance/financialcrisis/9174661/Germany-launches-strategy-to-counter-ECB-largesse.html

The ECB recognizes a warning shot when it sees one. Indeed, ECB President Mario Draghi knows that if inflation rises in Germany, the latter will take very serious actions, including potentially threatening to walk out of the Euro:

Draghi Says Inflation Risks Prevail as Economy Stabilizes

European Central Bank President Mario Draghi said policy makers are prepared to act against inflation threats if needed, while assuring investors that the ECB doesn't plan to withdraw emergency stimulus any time soon.

"All the necessary tools are available to address upside risks to price stability in a firm and timely manner," Draghi told reporters in Frankfurt after the ECB held its benchmark rate at a record low of 1 percent today. At the same time, it's premature to talk about the ECB's exit strategy, Draghi said, adding that the economic outlook is subject to downside risks and inflation will remain contained in the medium term.

The ECB is balancing the threat of inflation in Germany, Europe's largest economy, against the need to fight the sovereign debt crisis. While nations from Greece to Spain are battling recessions and record unemployment, workers in Germany are winning some of the biggest pay increases in 20 years.

 [ECB President Mario Draghi] declined to comment on recent wage settlements in Germany, where 2 million public service workers are set for a 6.3 percent raise over two years, according to the Ver.di union. It would be the biggest increase negotiated by the union since 1992. IG Metall, Europe's biggest labor union with about 3.6 million workers, is demanding 6.5 percent more pay.

http://www.bloomberg.com/news/2012-04-04/draghi-says-inflation-risks-prevail-as-economy-stabilizes.html

And so the ECB has found its hands tied: if it continues to monetize aggressively, inflation will surge and Germany will either leave the Euro or at the very least make life very, very difficult for the ECB and those EU members asking for bailouts.

After all, doing this would score MAJOR political points for both Merkel and Weidmann who have both come under fire for revelations that the Bundesbank has in fact put Germany on the hook for over €2 trillion via various back-door deals.

Against this backdrop, it's quite clear that the EU's banking system remains under extreme duress. Case in point, European financials have in fact wiped out all of the gains produced by LTRO 2 in just one month's time. Small wonder. When we take a big picture perspective of Europe, the entire banking system is a disaster waiting to happen.

Consider the following:

  1. According to the IMF, European banks as a whole are leveraged at 26 to 1 (this data point is based on reported loans... the real leverage levels are likely much, much higher.) These are a Lehman Brothers leverage levels.
  2. The European Banking system is over $46 trillion in size (nearly 3X total EU GDP).
  3. The European Central Bank's (ECB) balance sheet is now nearly $4 trillion in size (larger than Germany's economy and roughly 1/3 the size of the ENTIRE EU's GDP). Aside from the inflationary and systemic risks this poses (the ECB is now leveraged at over 36 to 1).
  4. Over a quarter of the ECB's balance sheet is PIIGS debt which the ECB will dump any and all losses from onto national Central Banks (read: Germany)

So we're talking about a banking system that is nearly four times that of the US ($46 trillion vs. $12 trillion) with at least twice the amount of leverage (26 to 1 for the EU vs. 13 to 1 for the US), and a Central Bank that has stuffed its balance sheet with loads of garbage debts, giving it a leverage level of 36 to 1.

And all of this is occurring in a region of 17 different countries none of which have a great history of getting along... at a time when old political tensions are rapidly heating up.

As bad as the above points may be, they don't even come close to describing the REAL situation in Europe. Case in point, regarding leverage levels, PIMCO's Co-CIO Mohammad El-Erian (one of the most connected insiders in the financial elite) recently noted that French banks (not Greece or Spain) currently have 1-1.5% capital relative to their assets, putting them at leverage levels of nearly 100-to-1.

And that's France we're talking about: one of the alleged key backstops for the EU as a whole.

 

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