Pending the unloading of the real bazooka that the market has been expecting from Angela Merkel, the ECB has decided to fight for time by propping up the banks through the LTRO. This course of action displaces private activity and is producing several distortions. Let’s look at a few of the most significant ones. Firstly, together with the stated QE policy of the Fed and the BOE, it is keeping short rates (and in the US and UK also long rates) very low, amidst a torrent of liquidity. However, the chain of transmission has stopped working, and these banks are not passing on their cheap funding to corporate clients. They are doing two things with the ECB funds; either they hoard it for fears of rainy days, or they use the funds to invest in government bonds that yield many hundreds of basis points more than their funding, even for short term issues, thus pocketing a substantial spread. The problem with this seemingly simple strategy is that if any of these governments were to default or restructure, they would be compounding their problems, given that the very problem that most of these banks are tackling is the high proportion of government bets among their assets.