Will the ECB Keep the Bull Market Alive?

02/13/2012 7:45 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

In the next month, there will be unprecedented action by the European Central Bank, says MoneyShow’s Jim Jubak, but he cautions that it may have unintended consequences for your investments.

Moral hazard. It’s a term that gets thrown around a lot, especially after the global financial crisis.

What it really means is that you have got a situation where investors, or banks, or some kind of financial institution are encouraged to take risks because somebody has built a safety net on their own. So you can say the mortgage market in the US encouraged risks because people thought that Fannie Mae and Freddie Mac were government guaranteed…and to some degree they were, because tax payers have picked up the losses.

Well the big law as of right now is that you can actually put a date on it—well, two dates, December and now February 29 looking forward. These are the dates when the European Central Bank is going to flood the European banking system with billions and billions and billions, hundreds of billions, actually even a trillion and a half euros.

Basically the idea is that the bank will accept all kinds of collateral—an extra 2,000 kinds of collateral—and then loan the banks money back on that. So basically, banks can take all kinds of stuff they have got on their books, ship it off to the European Central Bank, and get back cash.

Now, part of the moral hazard here is for the banks themselves, because it really gives them the ability to raise cash even if they are holding something that is kind of flaky. The hazard that is sort of greater is not so much for the banks, but it is for the whole financial system.

Here you have got a situation where investors were looking at the possibility of a Greek default on February 5 and 6…where coming out of the weekend, it was well, if Greece doesn’t meet a deadline by 11 a.m. on Monday morning, Greece is headed for a default.

How did the markets react? Well, they went down in Europe probably about three-tenths of a percentage point. In the US, it was even less, and a lot of that was because people were sitting there going "Oh well, what’s the risk? After all the ECB is going to put a trillion euros worth of new loans out on the market, money for banks, so there is no risk in the system."

So here you have got a desperately dreaded event for years and years and it doesn’t have any effect on the market. You have got to say to yourself, OK, in the short-term this may well be true.

The European Central Bank can put a trillion and a half euros, if you can take what they already provided in December and a trillion of it looks like they are going to provide at the end of February… If you put that out there and say hey, this means that banks have got so much liquidity there really is no problem.

All this does, however, is shift the risk around. And it says well, OK, so how does the ECB get that trillion and a half euros back? And what happens if Greece defaults and then Portugal comes down the road and says "Oh, we’d like to do that too please."

That is what we mean by moral hazard.

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