Mario Draghi's big bazooka has backfired.
The new president of the European Central Bank fired almost half a trillion euros into the European banking system in cheap loans last month in the hope that this barrage of liquidity would, among other things, ease the funding strains of the Continent's beleaguered financial institutions.
It hasn't worked out like that. The flood of money has, instead, flowed back into the coffers of the ECB. The deposits of private banks at the central bank reached a new record high of €455.3bn on Friday, despite the fact that the ECB pays a rock bottom interest rate of 0.25 per cent.
So why are they doing it? It is not as if there are no profitable lending opportunities out there. Financial institutions could earn considerably more by lending short-term to fellow European banks, which constantly need cash and are willing to pay a high rate for it, as demonstrated by recent spikes in the use by some banks of the ECB's expensive overnight lending facility.
What this pattern of behaviour tells us is that banks are putting a considerable premium on safety. They are worried that if they lend to a peer, the borrower could go bust overnight and they would not get their money back. Fear in the banking sector has not been this high since the fall of Lehman Brothers in 2008.
When the credit crunch first started to bite in 2007, the ECB said that Europe's banks were solvent but illiquid. In other words, what they needed was cash to tide them over. And the ECB was ready to provide however much was needed in the form of cheap loans. But the behaviour of the banks shows that the industry itself simply no longer believes this illiquidity story. If they did, banks would be happy to put their excess cash to work by lending to each other, rather than hoarding it at the ECB.
Other parts of the financial markets do not believe it either. European banking shares slumped last week. The market capitalisation of the Italian bank UniCredit tumbled after it announced a rights issue that was more discounted than the markets had expected. It is becoming clear that European banks will not regain the confidence of either their peers or investors until the sector's balance sheets are thoroughly cleaned up.
The European Banking Authority regulator has ordered banks to raise €115bn in new capital from the private markets by June. But that remains well below the estimates of analysts of the size of the capital hole. Injections of public money – whether from governments or the pan-European bailout fund – are likely to be needed.
But the ECB refuses to push for this extensive recapitalisation, preferring instead to flood the banks with cheap lending in the hope that this will refloat confidence. The central bank has also resisted attempts to require European banks to take losses on their lending to governments such as Greece. The governor of the Bank of Cypress called for the 50 per cent haircut on Greek bondholders to be reversed last week.
The ECB's refusal to deal firmly with insolvent banks makes for a striking contrast with its strictness towards troubled eurozone governments. It still refuses to engage in large-scale sovereign bond purchases in order to stabilise panicking debt markets, arguing that to do so would be a fatal moral hazard.
At the end of last week, the ECB's total bond purchases stood at €211bn, or around 2.5 per cent of the outstanding eurozone sovereign debt market. The Bank of England's bond-purchase programme, by contrast, is closing in on 20 per cent of the gilt market. The Fed's bond-buying programme is of a similar order of magnitude. That implicit backstop seems to be one reason why bond yields in the US and the UK are at record lows, enabling our governments to fund themselves with ease, despite weak growth and fragile domestic banks.
Mr Draghi will hold his first press conference of the year on Thursday. Most analysts expect the ECB to keep rates on hold, despite the fact that much of Europe is sinking into recession. And a new policy on ECB bond purchasing seems out of the question – at least for now. A series of bond auctions over the coming weeks is likely to turn up the heat under the eurozone still further. Italy needs to borrow €53bn in the first quarter alone. Rome's short-term borrowing costs have fallen slightly in recent weeks. But the country's 10-year market interest rates are still stuck at around 7 per cent. Spain must pay around 5.5 per cent to borrow for that period.
Unless those interest rates are cut roughly in half, those countries are going to find it increasingly difficult to roll over their borrowings. And with the bailout funds still seriously underpowered, despite repeated attempts to leverage them up, the prospect of a disorderly default by a major eurozone economy will continue to haunt the global financial markets. Credit rating downgrades and unsuccessful capital raising efforts by banks are also likely to throw combustible material on the flames over the coming months.
Could another downward lurch in the crisis, ultimately, force Mr Draghi's hand? That is the assumption that a number of analysts are working on. They argue that if it came to a choice between throwing the ECB's rule book away and watching the single currency break up under the stress of a financial and sovereign debt crunch, Mr Draghi would choose to save the euro. The trouble is that no one can be sure. And while there is doubt, there is no end in sight for the eurozone crisis.
Madoff was not such a hedge-fund aberration after all, say academics
Remember Bernie Madoff? When news of the New York financier's gargantuan ponzi scheme broke in 2008, the hedge-fund industry insisted it was an aberration. The rest of the sector was trustworthy and upright, we were informed.
But research by three financial academics, Alexander Kempf, Alexander Puetz and Gjergji Cici, shows that sharp practice is more widespread than those statements suggest. The study, presented at an American Finance Association's meeting in Chicago yesterday, shows that the equity valuations that some US hedge funds report in quarterly filings to the Securities and Exchange Commission do not match actual stock prices.
Out of 2.3 million positions disclosed by 864 hedge funds between 1999 and 2008, the study found that 150,000 deviated from official closing prices: around 7 per cent of the total. The academics also found evidence that these were not innocent mistakes, but attempts to "smooth" results to make their returns profile look less volatile.
And that's equity prices, which anyone can check. It's frightening to consider the valuations of some of the complex and illiquid assets – derivatives, securitised bonds and the like – that hedge funds snap up in their pursuit of high returns.
None of this is necessarily illegal, since, as the study notes, there is an "ambiguous legal environment" over valuation reports. Perhaps not. But is it the sort of behaviour we expect or desire from those to whom we entrust our money?