Wednesday, March 28, 2012

Eurozone periphery governments "encouraging" banks to buy sovereign debt

Bloomberg: “There’s a moral hazard element to this,” Ken Wattret, chief European economist at BNP Paribas SA in London, said in a telephone interview. “The ECB is clearly worried that in some countries the lower the risk premium on sovereign debt, the less urgency there will be to make some changes.”
The ECB should be concerned. The Eurozone periphery governments are effectively telling their banks: don't worry about your customers for now. We ARE your main customer. Get your 1% 3-year ECB loans and buy our government debt - keep the rates low.

The banks of course are ready to oblige. After all it is a profitable trade even at these lower yields, particularly since there is no capital charge currently for banks holding their nation's government debt.

Italian banks' net purchases of Italian government bonds
and 3m moving average (Source: Credit Suisse)

Spanish banks' net purchases of Spanish government bonds
and 3m moving average (Source: Credit Suisse)

This poses two major problems for the Eurozone periphery:

1. The government bonds effectively crowd out lending to private customers (both corporate and households). There is no incentive for these banks to lend to private clients when they can just buy government paper. This will push the Eurozone further into recession.

2. As the Bloomberg quote points out, the artificial lowering of yields takes away the urgency/incentives needed to get government spending under control for periphery nations.
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