value and opportunity

This is a very atypical post for this blog, however once in a while, also value investors have to look at macro themes as well.

In the past few weeks, all the issues around the Euro, Europe and the financial crisis accumulated in the following thesis:

The only way out is if the ECB brings out the bazooka (printing money by buying Government bonds)

After the summit, the market seems to dissapointed because the polititians and the ECB did not bring out the “bazooka” that was expected.

The market was highly dissapointed, which for instance this comment reflects:

But Draghi made it crystal clear Thursday that mounting calls for the ECB to step up its bond purchases to help end the euro zone’s debt crisis are in vain.

“The purpose of the SMP [Securities Markets Program] is to reactivate the transmission channels of monetary policy. As I said in the statement to the European Parliament, the SMP is neither eternal nor infinite,” Draghi said.

So this means total doom for the Eurozone, right ? Not so fast.

Very few commentators bothered to actually read the full ECB announcement.

Lets look at the first paragraph of the statement:

The Governing Council of the European Central Bank (ECB) has today decided on additional enhanced credit support measures to support bank lending and liquidity in the euro area money market. In particular, the Governing Council has decided:

To conduct two longer-term refinancing operations (LTROs) with a maturity of 36 months and the option of early repayment after one year.

To discontinue for the time being, as of the maintenance period starting on 14 December 2011, the fine-tuning operations carried out on the last day of each maintenance period.

To reduce the reserve ratio, which is currently 2%, to 1% as of the reserve maintenance period starting on 18 January 2012. As a consequence of the full allotment policy applied in the ECB’s main refinancing operations and the way banks are using this option, the system of reserve requirements is not needed to the same extent as under normal circumstances to steer money market conditions.

To increase collateral availability by (i) reducing the rating threshold for certain asset-backed securities (ABS) and (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. These two measures will take effect as soon as the relevant legal acts have been published.

Further down we find the following statement:

The NCBs are allowed, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use

So in plain English this means the following:

1. The ECB is now providing 3 year money to banks for an UNLIMITED AMOUNT
2. Almost ANY KINDOF COLLATERAL is accepted, even bank loans
3. The national banks in each country can decide on its own which kind of collateral is acceptable

From a liquidity point of view, in my opinion this is a xxxxing big bazooka for the banks. For the this year and the next year, they will not have to worry about liquidity because they can refinance almost anything at the ECB.

A very clever national Governement could use this program even more aggresively by selling 3 year bonds for example to a state owned bank and refinance them for this maturity with the ECB at no risk at all.

The banks still have their capital ratio issues, but this program effectively ensures liquidity for the Euro Bankings ystem for the next 3 years at a very low cost.

Summary: In my opinion, the market severely under estimates the potential impact of the announced measures. For many banks this will be the lifeline to survive the next few years and potentially even Governements could gain a “back door access” to the ECB. I am not saying that banks are a “buy” right now, but this should take a lot of stress outof the EUR banking system.