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ECB Shovels Free Money to European Banks

I wondered whether the inauguration of a new Spanish government was behind the decline in their debt yields yesterday. But no, as it turns out, it was the European Central Bank unloading its bazooka and lending massive amounts to European banks, which they can convert into government debt for some easy money.

The European Central Bank loaned a massive €489 billion ($639 billion) to hundreds of banks for an exceptionally long period of three years to shore up a financial system that is under pressure from the eurozone’s government debt crisis.

It was the biggest ECB infusion of credit into the banking system in the 13-year history of the shared euro currency.

Wednesday’s loans to 523 banks surpassed the €442 billion ($578 billion) in one-year loans from June, 2009, when the financial system was reeling from the collapse of U.S. investment bank Lehman Brothers.

The ECB is trying to make sure that banks have enough ready cash so they can keep on lending to businesses. Otherwise, a credit crunch could choke off growth and spread the debt crisis to the wider economy through the banks.

Some have described this as a back-door bailout. By giving 3-year loans at 1% to European banks, it allows them to transfer that money into sovereign debt, where they can get a much higher yield. This doesn’t solve the problem of growth in the Eurozone, but it does get the near-term liquidity crisis under control. It does this at the expense of the normal rules of capitalism, as Yglesias notes, where companies that make bad bets pay the price by going out of business.

But whereas a direct government bailout might still have left some banks insolvent absent formal legislative action to bail the banks out, this way senior bank managers all get to keep their jobs. It seems to me that we’re continuing to see a breakdown of the basic evolutionary mechanism of capitalism, which ensures that “unfit” firms go out of business thus invisibly selecting the most functional business models as the most widespread. If dominant banks never go out of business, then they’ll never be replaced by better-run banks.

Precisely. Many clamored for the ECB to be the lender of last resort. But there’s a big difference between employing that power to help out shaky sovereigns and employing it to shovel free money at banks. Sovereigns like Greece and Italy have already lost their heads of state; the banks haven’t had to fire anyone. Yet there are two sides to every loan, and the banks participated on one side. They haven’t had to pay any price for that.

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David Dayen

David Dayen