In Bizarre Admission, ECB Warns Its Policies Threaten Financial Stability, Could Lead To A Crash

Is the world's largest hedge fund central bank finally starting to appreciate the devastating consequences of its asset reflating ways?

In some ways it is almost ludicrous to presume that a central bank which at the beginning of the year laughably "found" that its QE has reduced inequality in the eurozone...

... may have finally looked in the mirror objectively, and yet on Wednesday, it was the ECB which admitted that historically low eurozone interest rates - which it is solely responsible for - and which are expected to persist into the foreseeable future (and beyond) are causing increased risk-taking that could threaten financial stability.

"While the low interest rate environment supports the overall economy, we also note an increase in risk-taking which could… create financial stability challenges," ECB vice-president Luis de Guindos said non-ironically in a statement... which to us sounds an awful close to a mea culpa. Then again, we know that central banks never admit responsibility for "increases in risk-taking" so we wonder if he was just trolling everyone.

Or perhaps he isn't: "Signs of excessive risk-taking" were spotted by the Frankfurt central bank among non-bank financial players like "investment funds, insurance companies and pension funds." Indeed, many "have increased their exposure to riskier segments of the corporate and sovereign sectors" the central bank said. Of course, it is the ECB's own policy of negative yields has prompted investors to seek out riskier bets in search of returns.

Curiously, while the ECB’s twice-yearly update to its risk assessment shifted focus from May’s trade war concerns, “downside risks to global and euro area economic growth have increased” in the meantime, it warned. Such dangers included “persistent uncertainty, an escalation in trade protectionism, a no-deal Brexit and weak performance of emerging markets,” notably China, the ECB said.

In another stark admission of reality, the ECB said that an economic downturn - one which is virtually assured for Europe - could crash prices for riskier and less liquid assets as actors like asset managers or hedge funds sell up in a hurry.

"This may have implications for the ease and cost of corporate financing which could exacerbate any real economy downturn," the ECB warned, adding that elsewhere in the economy, lower interest rates also "appear to be encouraging more borrowing by riskier firms" in non-financial sectors, as well as inflating property prices in some parts of the eurozone.

If only there was something the ECB could do to prevent this...

Alas it won't, because returning to a far more familiar place, the ECB judged that authorities in the 19 eurozone countries were already taking steps to head off financial stability risks from property bubbles.

Meanwhile the central bank found that “bank profitability concerns remain prominent” as growth has weakened and eurozone policymakers further lowered a key interest rate in September. As well as outside pressure, banks “have made slow progress in addressing structural challenges."

Here, for some odd reason, the ECB valiantly refuses to admit that keeping the yield curve consistently negative is catastrophic for bank profitability, and instead of admitting fault, the central banks points to silly diversions such as banks that do not have Apple apps. The central bank also points to "slow improvements" on multiple fronts to explain lack of bank profits, like disposing of so-called “non-performing” loans, where borrowers have fallen behind on payments.

Lenders must also cut costs and reduce overcapacity, and are largely failing to diversify their businesses, the ECB judged, effectively urging banks to keep firing people. Because it's not like the Eurozone has an unemployment problem.

The good news according to the ECB: most banks have the liquid assets on hand to withstand any foreseeable financial shocks.

We'll find out soon enough.