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European Central Bank Responded Strongly to US Mortgage Troubles

In response to the turmoil in the US housing markets, the European Central Bank (ECB) injected another $10.4 billion in one-day liquidity into the system on Tuesday. Mark Landler starts his New York Times article by reinforcing the stereotype about Europe being on vacation and then describes some criticism of the ECB's strong financial injections:

The rest of Europe may be deep into its annual summer idyll, but the European Central Bank has been a hive of activity since last Thursday, when it thrust itself into a market rattled by fears of a credit crisis. On Monday, the bank injected 47.7 billion euros ($65 billion) into the financial system to keep European money markets from drying up. It was the third emergency operation in three business days, starting with a bold injection of 94.8 billion euros ($129 billion) on Thursday morning.

The moves have put a spotlight on the European Central Bank, which has traditionally played a supporting role to the United States Federal Reserve during global financial crises. This time, the Europeans acted earlier, and on a far larger scale, than the Fed or their Asian counterparts. Some market commentators have accused the bank of panicking, saying its intervention could send the wrong signal to hedge funds or other institutions engaged in high-wire investing: Namely, that they should expect a monetary safety net. Still, the remedy seems to have worked, at least for now, preventing the problems in the United States mortgage-lending market from draining broader markets in Europe.

Was it indeed an overreaction that sends the wrong message to the markets? Or will it turn out to be a quick an efficient way to calm the financial investors?

T
he European Central Bank declared yesterday (August 14) according to the New York Times that recent financial market turmoil was largely over, "a sign that the bank would probably proceed with a plan to increase borrowing costs in early September to curb inflation caused by a rising economy." The article continues to mention that:

Data released Tuesday showed that the pace of economic growth in the 13-nation euro zone slowed in the second quarter to 0.3 percent, about half the rate of the first quarter. France and Germany, the two largest euro members, registered 0.3 percent growth in the same period, less than economists had forecast, but in line with the central bank's prognosis of steady growth that would allow it to raise its benchmark rate by a quarter-point.


David Vickrey writes in
Dialog International about the German banks, who participated in risky US credit schemes:

When I was working as corporate banker, I noticed how the WestLB seemed to participate in every credit disaster that came along.  Whether it was the Mexican debt crisis of the 1980s, the bankruptcies of the biggest leveraged buy-outs (LBOs) or lending money to the corrupt Enron Corporation, WestLB was always there with a big exposure. But WestLB never really had to pay a price for its incompetent management and reckless credit policies, since it was a quasi-state institution, backed by the taxpayers of North Rhine-Westfalia.  Now the NRW taxpayers can count on seeing their taxes used once again for bailing out the bank from its own disasterous mistakes.

David puts some blame on Alan Greenspan for the current crisis and criticizes Deutsche Bank's decision to employ him as an advisor: 

Today, Deutsche Bank announced it had retained former Federal Reserve chairman Alan Greenspan as an adviser to its investment banking business: "Dr. Greenspan's position as one of the architects of the modern financial system gives him a unique perspective from which to help our clients make critical risk management decisions," said Josef Ackermann, chairman of Deutsche Bank's management board and its group executive committee.
There is a great deal of irony at play here, for Greenspan bears a great deal of blame for the mess we are in due to the reckless lending practices of the past decade.

In an earlier post in Dialog International, David writes that the IKB Deutsche Industriebank to "chased after the easy money on Wall Street rather than performing the hard work of financing the long-term growth of German Mittelstand enterprises." When they got into trouble Germany's government-owned development bank KfW provided up to Euro 8 billion (!) in guarantees to IKB. Now the  German Taxpayers Union (Bund der Steuerzahler) is furious, writes David.

So..., the German (or European) safety nets go beyond support for poor welfare recipients, but includes the financial markets. Is this safety net totally contra-productive, because the banks will assume to be bailed out in the future? Or was the quick government support a smart decision to prevent the current troubles from growing?

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Don S on :

Hmmm. Is 1.2% annual growth a sign of a need for higher interest rates?

David on :

I think the ECB has done a good job of calming the markets with the injections of liquidity. In the end, it is the small investor who gets whipped-sawed by the pack behavior of the hedge funds. Germany needs to reform its banking system. The Bundeslaender need to either privatize the Landesbanken or change their charters so that they are restricted to financing trade and idustry that directly benefits the taxpayers in those states. It makes no sense that the Landesbank in Saxony is buying junk mortgage securities in the US. I critize Deutsche Bank for its arrogant practices, but at least in that case it is the shareholders - not the German taxpayers - that suffer.

Sonja on :

Interestin point, David.

Pat Patterson on :

Would the ECB have this indendence to act if the European Council goes ahead with its adoption of the Article 9 of the Reform treaty? Anybody? But I do agree that the central banks and national reserves should provide the liquidity as long as the credit is extended to the mortgage holders and not to the funds and the short sellers.

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