25/10/2013 06:32 BST | Updated 23/01/2014 18:58 GMT

ECB's Asset Quality Review Is a Work of Art - Minimalist Art

Just another brick in the wall. In what is a potentially vital piece of the jigsaw in the project to keep the Euro afloat, the ECB had a mission: design a bank asset quality review that was just tough enough to gain credibility, but not too tough, for fear of scaring the horses and inducing queues of depositors to form outside banks when the results come out.

So what we got was a masterpiece of reverse engineering to achieve just what was required - just enough. It can't be denied there are some tough-sounding parts, some titbits of rectitude: an examination of gross liquidity ratios, excessive LTRO usage, and rigorous scrutiny of off-balance sheet exposures and the risk-weightings which banks choose to apply to their assets.

We are assured these matters will all receive diligent attention in the asset quality review (AQR), and may even lead to a subjective decision to raise the required capital ratio above the standard level of 7% (8% for large, systemically important banks). Ok, sure, we'll wait and see what happens!

Very sensibly the AQR will take a Q4 2013 snapshot of balance sheets, so as to discourage banks from indulging in an unseemly fire sale of assets or reduction in customer loans, by not giving them enough time to do so.

We even got some headmasterly rhetoric from M. Draghi along the lines that we must have no fear, the AQR would be stringent enough to ensure some banks fail to ensure the process had credibility (me - preferably very small ones that have little chance of spreading contagion fear), he further insisted that governments must have a backstop in place - this was a thinly veiled tilt at Germany, which is in turn insisting that every cent is bled out of private bond and equity holders of every possible description first, before the ESM is tapped for bank re-capitalisation.

The trouble is this AQR does very little to address the potentially lethal death embrace of banks and their governments that exists as a result of the banks' enormous holdings of sovereign bonds. Of course it doesn't - a proper risk-adjusted examination of the various hues of government bonds stuffed into banks' balance sheets, with realistic risk weightings, would be far too scary and if it ever saw the light of day, may bring the whole Tower of Babel crashing down.

So there were are, just enough to give the banks another year to deleverage before the European Banking Authority stress tests and, with results not due for a year, just enough time for Germany to become satisfied with the ESM's rules of engagement.

Should we consign tapering to the bin?

One does begin to wonder whether the Fed will ever feel confident enough to taper QE. September's anaemic jobs data were hardly the ideal backdrop for the commencement of this month's budget and debt ceiling shenanigans in Washington and leave moving averages of job creation still well short of the 200,000 per month that the Fed would surely like to see to give any hope whatsoever of reaching 7.0% unemployment as a result of anything but 36.8% of Americans staying at home and not trying to find work.

With Yellicopter about to take the helm at the Fed, it's now becoming entirely possible we don't see QE tapering in 2014. This is not good. Stock markers will soar, high yielding EM currencies will appreciate, irrespective of current account deficits, loan covenants will slowly be dropped. This will end in tears.