Europe's LTRO: The Downside and the Upside
The Long-Term Refinancing Operations of the European Central Bank have been hailed by the markets as a major step toward stemming the European sovereign debt crisis. But critics have called it a kind of a Ponzi scheme which is bound to collapse. In today's column, we'll discuss how the LTRO could actually be a very helpful bridge to a healthier Europe, but how, if it fails, it could plunge Europe into a deeper morass.
The LTRO is a very simply proposition at its core. Banks can borrow from the ECB for a term of as long as three years by pledging certain collateral. The collateral is subject to a "haircut," which is the bond market's equivalent of a margin equity requirement. For most euro-zone sovereign bonds, the haircut is effectively zero. The rate on the loan is 1%, and the loan isn't subject to margin review. That is, if the trading value of the pledged asset drops, the ECB can't demand more collateral. So essentially, a bank can buy any sovereign bond that yields more than 1% and earn arbitrage profit....607 more words left in this article. To read them, just click below and try Real Money FREE for 14 days.
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