ECB Backdoor Purchases of Sovereign Bonds

Mario Draghi may know what he's doing after all.  After months of leading the markets to believe that he would follow in his predecessors footsteps and do nothing close to resembling serving as a lender of last resort, Mr. Draghi has opened the window for European banks to borrow money at the official rate of one percent for three years.  The collateral being accepted for these loans could be as poor as lowly rated subprime paper.

So far the interest in the program has been incredible with the ECB loaning out close to 500B euros with another program due to take place in February.

The hope with this program is that the borrowing banks will use this money to buy the sovereign debt of their respective countries with anything left over being loaned for investments in the economies of the various countries in the euro zone.

The only remaining question that is left is "Is this enough?"  It definitely is better than nothing.  It actually is a lot better.  Rates in government paper has dropped significantly.  As Floyd Norris states in an article he wrote:

On Tuesday, the same day the banks were putting in their requests for loans, Spain held an auction of Treasury bills. A month earlier, it had to pay an annual rate of 5.1 percent on three-month bills and 5.2 percent on six-month securities. This time the rates were 1.7 percent and 2.4 percent. Credit that plunge to Mr. Draghi.

Rates have also fallen significantly on government debt out to three years, but the declines in longer term rates have been smaller. 

Rates on longer term paper have not shown the same results and chances are that they may have little affect on them overall simply because of the length of the loan from the ECB.  The hopes are that by giving banks the nice spread between the loan rate and the treasury rates banks will continue to buy bonds bring down costs of sovereign debt but also giving the banks a chance to make some money and help them recapitalize.  With a healthy banking system, hopefully the economies of the European union can bounce back.

Lets hope that this helps solve the Euro crisis and helps alleviate the pain many citizens of the zone are experiencing due to misguided austerity being forced upon them by the Germans.

One final note:  Ireland may not necessarily be getting better.  Austerity has taken a huge chunk out of the Irish economy and nobody knows how long it will take to get back to prior levels after this mess is over.