Markets shocked by Trichet’s haircut

 

Jean-Claude Trichet also yesterday provided details about the new liquidity rules, which will come into force in February 2009, to give the banks time to adjust. From the onwards, the ECB will apply a haircut, or discount, on asset-backed securities of 12%, in addition to a 5% valuation discount for assets that are not marked-to-market (which is the case with most of these assets), making for a cumulative haircut of 16.4%. Here is the some opaque ECB press release, where this information is contained in column five in a table, which refers to category V assets.  For unsecured loans, the ECB will now apply a haircut of 5%, which is a very significant change, since this is the largest asset class. FT Deutschland reports that the Spanish central bank expects a fall in ABS as security pledges by Spanish banks of 14.5%. Interesting, the credit default swap react very negatively on these details, as the default premia for European banks shot up by 13 basis points.

 

El Pais leads its economic section with a story refuting that Spanish banks had abused the system, which was the reason why this rule change became necessary, and insisting that the rule change will have little overall implications for the liquidity of Spanish banks, as there remained plenty of assets to pledge as collateral.

 

 

The Financial Times has a good in-depth report about these changes, and the alarmed market reaction, as some commentators feel that these unexpected tough rule changes would lead to a squeeze in credit growth well into 2009, and would make a compensating rate cut more likely (see further down why that is unlikely). The report also makes the point that the rule change would frustrate plans by a UK bank to open an office in Dublin with the sole purpose of gaining access to ECB funding.

 

 

 

Buiter on the ECB rule change

Willem Buiter offers a long discussion of the ECB rules changes, and makes the following points. He noted that since the crisis erupted the share of Spanish banks in the Eurosystem’s refinancing operations went up from about 4 to 10.5%, that of Irish banks from 4.5 to 9.5%. Since these are the countries with the weakest housing markets, one would assume a relatively high amount of pledges of residential mortgage-back securities. He said the ECB liberal collateral policy has two potential problems. It subsidies bad banks, and even if the securities were properly priced ex-ante, a default could seriously destabilise the eurosystem itself, and lead to inflationary money-printing. He was scathing about the time delay for the introduction of the new rules, which means that Spanish banks will probably increase the number of RMBS pledged in repo operations.

 

 

 

The ECB will meet inflation target not until 2010

The financial markets were also spooked by Jean-Claude Trichet’s downbeat assessment of inflation, which echoed Bundesbank president Axel Weber’s recent warning about inflation. Inflation, which was well above target since the middle of 2007, will not come down close to target until 2010. For next year, the ECB raised its average inflation forecast from 2.4 to 2.6%, a projection which makes an interest rate cut this year improbable. The story was obviously carried by every newspaper, with only few nuances.

 

 

Paul de Grauwe on the ECB

Paul de Grauwe writes in the FT that the ECB is partly to blame for the sharp economic downturn – not because of its interest rate policies but primarily because of its malign neglect of the exchange rate, which has been the biggest factor behind the sharp deceleration of growth. He concludes that the ECB should do its utmost to ensure that the recent fall in the euro is not reversed.

 

 

Thomas Fricke on the euro area and the US

In an angry comment, Thomas Fricke contrasts the policy response of the US and of the euro area to the crisis. He said the euro area was finally decoupling, only in the wrong direction. While US crisis management ensured continued growth through fiscal stimulus and lower interest rates, euro area interest rates went up, despite no increase in core inflation, while the exchange rate appreciated. He also wrote that he expects a strong increase in unemployment

 

 

Janet Yellen: Don’t be fooled by that Q2 GDP release

Janet Yellen, the San Francisco Fed president, said there are three reasons to believe that US growth will falter after the unusually positive Q2 GDP release. First, as reported by the Calculated Risk blog, consumer spending is weakening, second export growth, which account for the lionshare of the strong Q2 numbers will also fall as the dollar has strengthened and as the world economy slows down, and the third is a deepening of the adverse feedback loop of unemployment and mortgage defaults. She also said the financial crisis is likely to get worse.

 

Another, slight-off topic, but interesting US-specific discussion, is a rebuttal by Bureau of Labour Statistics of claims that the US systematically understates the inflation rate by several percentage points, as reported by various US blogs, including Econbrowser and Economist’s View.

 

 

Bob Shiller on US house prices

Bob Shiller has produced an analysis of the US property market that is depressing even by his own standards. He says that the house price decline this time could be worse than during the Great Depression, when it was 30% - it is 20% nominal now, and rising. He also said there were 10m home owners with negative equity. And he said the consensus of a bottoming out of the house price recession is wrong. When the market stops declining, it is likely to move sideways for a long time, meaning further falls in real terms, as reported by the Big Picture blog.

 

 

 

German investment recession will last one year

FT Deutschland reports that Germany’s investment recession will last at least until next year, according to a survey prepared by KfW bank. Since November last year, new domestic orders for investment goods have already fallen by 11%. The forecast is that investment will only start picking up slowly in the spring, and then more strongly in the third and forth quarters next year.

 

 

French disapprove cross financing of RSA

The latest polls suggest that 74% are in favour of the new negative income tax RSA but 61% of those disapprove of its cross financing by a capital income tax rise, reports Le Monde. The disapproval is higher among employees (61%), but lower for freelancers (51%). See our press review yesterday for more details on the measures.

For a critical assessment of the RSA read Paul Fabra's comment in Les Echos.

 

The Irish Budget deficit

The Irish Government brought forward the Budget by nearly two months, the first time this ever happened. It came as new figures confirmed the biggest annual jump in unemployment since records began. Brian Cowen will announce a range of new measures to help first-time homebuyers in particular as an attempt to kick-start the flagging property market. It will be part of a range of "stimulation packages" aimed at various sectors of the economy to reverse the deepening downturn,writes  the Irish Independent. The paper speculates that one reason for bringing forward the Budget date may be to seek an urgent decision from the EU Commission, in the form of EU approval for borrowing to cover what is expected to be an even bigger deficit next year.

 

 

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