ECB to buy corporate bonds: Will government financing be the next step?

On 1 January 2015 Lithuania will become the 19th member state of the euro area, further deepening economic and financial integration with European countries. To mark this occasion as well as to discuss euro area enlargement and policy reforms that are aimed at strengthening the functioning of the single market and the EMU, the Bank of Lithuania together with the European Central Bank, the European Commission and the Ministry of Finance of the Republic of Lithuania is organizing a euro changeover conference “Single Market, Single Currency, Common Future”. Speakers at this conference included Jyrki Katainen (at the rostrum), Vice-President of the European Commission in charge of Economic and Monetary Affairs and the Euro, Mario Draghi, President of the ECB, (second from right), Algirdas Butkevičius, Lithuanian Prime Minister, (second from left), Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania, (first from left) and Rimantas Šadzius, Lithuanian Minister for Finance (first from right). (EC Audiovisual Services 25/09/2014).

On 1 January 2015 Lithuania will become the 19th member state of the euro area, further deepening economic and financial integration with European countries. To mark this occasion as well as to discuss euro area enlargement and policy reforms that are aimed at strengthening the functioning of the single market and the EMU, the Bank of Lithuania together with the European Central Bank, the European Commission and the Ministry of Finance of the Republic of Lithuania is organizing a euro changeover conference “Single Market, Single Currency, Common Future”. Speakers at this conference included Jyrki Katainen, Vice-President of the European Commission in charge of Economic and Monetary Affairs and the Euro, (at the rostrum), Mario Draghi, President of the ECB, (second from right), Algirdas Butkevičius, Lithuanian Prime Minister, (second from left), Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania, (first from left) and Rimantas Šadzius, Lithuanian Minister for Finance (first from right). (EC Audiovisual Services 25/09/2014).

Last Monday, the European Central Bank initiated its covered bank bonds buying programme. But it wasn’t until the major international news agencies started reporting information early on Tuesday from ECB unidentified sources about its plans for corporate bond purchases too, and only then the central bank policies had an immediate and conspicuous effect on real markets. European stocks immediately celebrated, recuperating large parts of the losses they endured last week after a new Greek gaffe. Athens had announced plans to prematurely exit from its EU-ECB-IMF inspired, controlled and financed rehabilitation programme, causing turmoil in all markets.

In any case the reports about the intentions of ECB to institute early in 2015 a corporate bond buying programme have not been belied. As mentioned above ECB is already buying covered bank bonds in all Eurozone countries, Greece and Cyprus lenders included under certain conditions. Early in September the Governing Council of ECB had also decided to introduce a programme of Assed Backed Securities purchases, targeted to enhance the availability of bank credits to Small and Medium Enterprises. Again, Greek and Cypriot SMEs are included. It seems then that the ECB contemplates now a new plan to directly finance the big business sector, by purchasing corporate bonds.

Targeting growth and jobs generation

All these actions are intended to revive the faltering European economy and protect it from the deflation danger. The anticipated direct positive effects on the economy include enhancement of credit options available to SMEs (covered bond and ABSs purchases) and the big businesses (corporate bond purchases). The new ECB financing will further supress the cost of money in any form. In this way real investment projects and consumer spending will be encouraged. Both effects are expected to help create more jobs.

Undoubtedly the newly printed and circulated cash by the ECB is to have more effects. It is already leading to a cheaper euro. This said, the new decline of the euro/dollar parity is likely to support Eurozone exports and impede imports and therefore support growth. Luckily, the recent fall of the dollar prices of crude oil protects the Europeans from an abrupt price hike of energy, which could be triggered by the declining euro/dollar parity.

Discouraging reality

But let’s return to the big picture. Sadly, in today’s Eurozone the economic scenery is at least discouraging. All ECB’s programmes, which flood banks with free cash, have proved impotent to create a positive noticeable impact on the real economy. One of the main reasons is that the Eurozone banks are unable to increase their overall loan balances to real economy players, no matter how much money the ECB gives them as a gift. The programmes used so far by the ECB to flood banks with cash {Long Term Refinancing Operations (LTROs), Targeted Long Term Refinancing Operations (TLTROs), the recently initiated covered bank bond purchases and the planned for December ABSs purchases}, one after the other prove incapable of persuading the banks to increase their loans to real economy agents. Actually the opposite is true.

Businesses and consumers, in more than half Eurozone countries find it nearly impossible to get bank loan. The reason is that all the 120 ‘systemic’ lenders of Eurozone, including the banking giants of Germany and France, are so much overgrown that their balance sheets cannot afford to add new assets (loans). As a matter of fact for at least one year now they have being downsizing both the assets and the liabilities sides of their balance sheets.

Banks are downsizing

In reality, for the last ten years the lenders have abandoned their primary role of financing the real economy. They use most of the money bestowed to them by depositors, investors and central banks, in order to bet it all in every possible and impossible risky market. The Western financial crunch of 2008-2010 that still torments us all was of their own exclusive making. The banks recklessly inflated their balance sheets to the point of burst. Despite the recent downsizing though, Eurozone banks still badly need more capital, in order to comply with the new EU rules, which impose increased coverage of assets (loans and investments) with equity (capital).

The Sunday banking news

Actually this Sunday 26 October, the ECB is to announce the individual capital needs of the 120 major Eurozone banks, ahead of officially assuming on 3 November its new role as the banking industry’s watchdog. All financial and government agencies are eagerly waiting to read the numbers. Not to forget that the bank-government unholy links are the base of our present-day financial troubles of the Atlantic economic volume.

The unfortunate conclusion is that the Eurozone banks need at least a few years of free money injections by governments and the ECB in order to again become able to play their role as the financiers of the real economy. Of course this will be achieved only if the bankers abandon the mentality that has so far brought the Western financial system to its knees.

Clearly, with the banks unable to fully perform their role, the ECB seems to have decided to directly finance the SMEs through its initiative of ABSs purchases, and now with its reported intention to accord loans directly to big businesses, by buying corporate bonds. In short the ECB is overpassing the entire banking industry and tries to perform the role of lending to the real economy. However this arrangement leaves out the governments.

Financing governments too?

Who is to undertake the task of financing them? If the ECB considers undertaking this task too, by buying government bonds, a major political problem will certainly surface. Germany will vehemently deny the prospect. And yet Berlin had happily accepted in 2010, ECB’s purchases of Greek, Irish, Portuguese, Spanish and Italian government bonds from German and French lenders of a value of around €150 billion. On that occasion the ECB had saved from bankruptcy major German and French banks, which had recklessly financed Athens, Dublin, Lisbon, Madrid and Rome. Can Germany and France keep insisting on such a flagrant use of double standards and deny a new round of purchases of government bonds by the ECB? Hopefully not.

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