Thoughts on ECB

European officials must have known they were going to disappoint the market with the decision to simply postpone draining liquidity. The firewall around Greece failed. The firewall around Ireland has failed. The politicians have dropped the ball and the left Trichet holding the bag. Many from the periphery appeared to lobby the ECB to help out. Trichet in essence says there is little it can do and that it is really up to the governments. What Trichet announced today seems like the bare minimum of what it could do without immediately intensifying the crisis.

That said, little is really resolved. The amount of refinancing needed next year by peripheral countries and their banks is staggering. There is some thought that the Fed's purchases of Treasuries will free up funds and that just like the earlier Fed programs had helped foreign institutions, so do will its asset purchases. But this is insufficient really given the magnitude of the problems.

If the problem is in part that some banks, like in Portugal, have become dependent on ECB liquidity as they have been locked out of the wholesale funding market, it is not clear how extending ECB liquidity provisions address this. Kicking the can until end of Q1 2011 is hardly a sustainable solution. We do note that Spanish, Italian and Belgian sovereign refinancing needs next year are front loaded in Q1 11.

Trichet indicated that the bond purchase program continues. Unlike the BOE, BOJ and FOMC, the ECB never provided an amount that it would buy. It has always been open-ended. In the six months of the program the ECB has bought about 67 bln euros of sovereign bonds. In the first month of QEII, the Fed has bought more than $100 bln worth of Treasuries.

Because of the open nature of the ECB's program, Trichet does not need to say they will buy more bonds. They simply will (or could) and that this means investors will again have to closely monitor the amount it buys through looking at the size of the sterilization operation. This may help explain why the euro has recovered here a bit. There is talk that the ECB is buying large amounts of Portuguese and Irish bonds now.

The debt dynamics in Europe (private sector banks and public sector, which includes regional governments that are significant in some countries) are such that there continues to be a finite number of solutions: faster growth, which seems unlikely, or easing of the debt burden, which entails restructuring of some sort.