The political and monetary dysfunction of the eurozone continues to hobble the continent’s ability to pull itself out of its long-running economic malaise.
Thursday’s decision by the European Central Bank (ECB) to begin buying up asset-backed securities (ABS) in a bid to revive the continent’s moribund securitization market would have probably happened ages ago if it weren’t for misplaced opposition from core eurozone members, most notably Germany, to growing the ECB’s balance sheet.
Such opposition isn’t rooted in what some believe to be inherently conservative German economic values. Instead, it stems from the base fear that Germany and the other “core” eurozone members are being taken advantage of by their “free-spending” eurozone partners on the periphery. This sort of “us vs. Them” attitude has cost the Europeans valuable time in what should have been a fairly easy economic recovery. Given Europe’s sad economic state, it may be time for Germany to step aside and allow the ECB to do its job.
The ECB jolted markets on Thursday by announcing further interest rate cuts across the eurozone. It cut its main benchmark refinancing rate by 10 basis points from 0.15% to 0.05% and did the same for its main depository rate, taking it further into negative territory, from -0.1% to -0.2%. That negative rate basically means that the ECB is essentially charging banks 0.2% interest to park their money with them. When the ECB cut the depository rate to negative back in June, it did so with the hopes that member banks would withdraw their funds from the ECB and start lending it out to businesses.
It hasn’t worked out so well. European banks still aren’t lending as much as the ECB would like them to, even with the negative depository rate. Encouraging banks to lend, especially in today’s tough economic climate, is no simple task. But it is even harder in the eurozone, where fiscal policy (government spending) and monetary policy (central bank action) aren’t coordinated. Politicians in Europe’s core economies, most notably in Germany, have blocked the ECB from taking the sort of aggressive action needed to pull the eurozone out of the mud.
Bailing out banks and governments on Europe’s periphery is understandably unpopular in Germany, so its politicians have had to walk a fine line during the crisis, only agreeing to act when it was absolutely necessary or when a German bank was in trouble. Banks and national governments have been patched up just enough to protect the euro from total collapse. Anything beyond that was considered superfluous. Europe has moved from crisis to crisis, creating an air of instability that has bred investor skepticism, hindering economic growth across the entire continent.
This stands in stark contrast to the swift and coordinated action taken by the U.S. Government and the Federal Reserve in 2008 to stabilize its broken banking sector. The Fed, the Treasury Department, and Congress worked together to blast the economy with cash and helped create a mechanism in which troubled banks could offload their bad assets. It didn’t matter if a troubled bank was in New York, North Carolina, or California—the U.S. Was united in getting the nation back up and running.
Europe’s fractured response to the economic crisis serves as a reflection of its fractured political system. Angela Merkel was German first; European, second. While many banks in the eurozone have recovered from the financial crisis and are well capitalized, plenty of them, especially those on Europe’s periphery, are effectively insolvent and cannot lend a dime, even if they wanted to.
The recent near-collapse of Portugal’s Banco Espírito Santo this summer is a good example of the current state of affairs. BES was the only major Portuguese bank not to take a government bailout at the height of the eurozone debt crisis, and it was largely seen as a model of good banking. Turns out the bank was basically hiding billions of euros of bad loans it made in Angola years ago and had been funding its operations through short-term borrowing on the commercial paper market. When that paper dried up in the spring, BES was forced to come clean, nearly taking the eurozone down with it in the process.
It would be foolish to think BES was unique or that the problem is confined just to Europe’s periphery. Indeed, at the end of July, Erste Bank, one of Austria’s largest lenders, said it was writing off 1.1 billion euros worth of bad loans and mortgages it made in Eastern Europe, much of which were issued in the run up to the financial crisis.
Mario Draghi, the head of the ECB, has had enough. He is now openly defying the political superstructure of the E.U. And pushing the limits of his office in an effort to finally turn the region’s economy around. Last week, at the annual central banker pow-wow in Jackson Hole, Wyoming, the normally obedient Draghi called on European governments (ahem, Germany) to step up and take a larger role in helping to combat the eurozone’s economic issues. In other words, Germany either needs to get with the program and support him or get out of the way.
On Thursday, Draghi gave a nod to Germany and lowered interest rates, but he also did something for himself by saying he was going to try and restart the securitization markets across the eurozone by purchasing asset-backed securities directly from the banks. This would expand the size of the ECB’s balance sheet, which is basically like printing money, something that Germany has been vehemently opposed to. Nevertheless, Draghi believes that restarting ABS purchases is crucial to getting the banks to lend more as they won’t have to take on all the credit risk themselves—just collect the fees from doing the deals and sell the securities to other investors. He’s probably right, but the ECB will need to make some big purchases to get things going. For that, he will need support from all the major eurozone countries, including Germany.
But Draghi doesn’t want to stop at just buying up ABS. He wants to buy government bonds, too, known as “quantitative easing.” Draghi sees what QE has done in the U.S. And he wants the same thing to happen in Europe. It is unclear how exactly QE would work in the eurozone given that there are 18 sovereign nations to deal with. Whose bonds do you buy and for how much? In any case, the ultimate goal of QE is to instill confidence among investors. QE has been credited for the run-up in the stock market in the U.S. Whether the rally is “real” or not is inconsequential; Draghi just wants a change in sentiment that will ultimately boost the economy out of its hole. Nothing gets someone spending like a new credit card (thanks to those ABS purchases) and seeing their retirement accounts swoon (thank you, QE).
Draghi is testing the waters with the ABS proposal. If Germany doesn’t freak out, he will go full QE. So far, there has only been muted skepticism out of Berlin to his plan, but that’s better than members of the Reichstag threatening to take the ECB to court to try and declare its actions unconstitutional, as some have threatened in the past. With Germany’s economy going nowhere and the rest of Europe sinking, it may be time to let Mario run the show.
