18 April 2012

WSJ: Europe's rescue plan falters

The banks' voracious buying had helped bring down the interest rates, providing relief for troubled countries that need to issue tens of billions of euros of bonds this year. But the banks, lately the primary buyers of Spanish and Italian government bonds, no longer have much spare cash to continue such purchases. That is sending rates back up, rekindling investor fears about Europe's ability to arrest the three-year-old sovereign-debt crisis and return the region to health.

"Eventually the liquidity extended by the ECB will be fully deployed, and at that point Spanish and Italian banks will either have to stop buying sovereign bonds, removing the largest buyer from the sovereign market, or sell bonds" to raise cash for their own needs, said Alan Broughton, an analyst at RBC Capital Markets.

The chief purpose of the ECB bailout was to keep the banks themselves well-funded. They have tens of billions of euros of their own debt coming due this year. In that sense, the loans have succeeded: they have greatly reduced the risk that a European bank will suddenly run out of money and become an albatross around the neck of a weak country.

A growing array of analysts and others worry that the flood of ECB loans in some ways could be counterproductive. The cheap money has reduced the urgency with which some banks are cleaning up their balance sheets, a trend that some critics worry could delay the industry's return to health.

The banks' dwindling cash piles and the return of market turbulence has some experts, such as Citigroup chief economist Willem Buiter, predicting the ECB will be forced to make another round of loans later this year. That is something the central bank's German faction is reluctant to do. ECB hawks, especially the German contingent, are very wary of the inflationary impact of the programme, and already are pushing for the formulation of an exit plan.

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