Peter Praet, Member of the Executive Board and chief economist of the European Central Bank (in the middle). Joint ECB/MIT Conference – 13 Mar 2017. (ECB Audiovisual Services).
Last Saturday 8 July the Belgian newspaper De Standaard published an interview with Peter Praet, Member of the Executive Board and chief economist of the European Central Bank. Praet said it plainly “We do say that we still need a long period of accommodative policy before we are ready”. What he means by ‘being ready’ is obviously a reference to inflation. Central bank’s mandate is to maintain inflation in the long run below but close to 2%, and clearly the Eurozone economy is still far from the target.
In short, Praet resists the latest cries from Germany for the ECB to reverse its extra accommodative monetary policy (QE, quantitative easing). At this point, it should be noted, the central bank has so far injected into the economy more than €2 trillion at zero interest rate. The money has been actually ‘donated’ to Eurozone banks, through the so called refinancing operations. There is no other way to support a deflationary or a too low inflation economy than this. However, there is one more purpose, of key importance, in flooding the banks with zero cost money. But, mind you this is never openly discussed by the decision makers let alone advertised. Let’s dig a bit into it.
It’s always the banks
Everybody knows by now that in the 2008-2010 financial crisis all the major banks in the US and Europe went bankrupt. The insolvency of Lehman Brothers and the earthquake caused by its liquidation terrified governments and monetary authorities. The result was that the bankers were saved by governments with cash from taxpayers and by the money printing machines of the central banks. The politicians recapitalized the bankers for free with trillions and the central monetary authorities, aka central banks, donated them even more.
Only the American central bank, the Fed and the ECB offered to bankers liquidity of $4.5 trillion and €2tn respectively for free. The American banks were more quick to take advantage of that, and managed to recapitalize themselves within a few years, using questionable profiteering and spinning off other people’s money around the globe, as they had been doing before 2008.
Still undercapitalized
The European banks still haven’t arrived at this point and are today dangerously undercapitalized. The largest German lender, Deutsche Bank which tried to imitate its US counterparts in New York’s financial universe, attracted the interest and the hostility of the American regulators and the US Department of Justice and is now in a precarious position. In short, the European banks are now in a sorry state, with non performing loans or ‘investments’ of €1tn. This is around 6% of euro area’s GDP. Only two weeks ago the Italian government used a round sum of €15 billion of taxpayers’ money and guarantees to rescue two lenders, the oldest bank of the world, the Monte dei Paschi di Siena (established in 1472) and the Vento Banca. Last week, another Italian bank asked also for government money, the Banca Carige.
There is no an end then to the problems of the Eurozone banks. In Eurozone, the entire south, Ireland and the ex communist countries of central Europe are always haunted with piles of non – performing loans (NPLs). The problem however is not restricted to those ‘usual suspects’. The German, the French, the Belgian and the Dutch banks are not in an enviable position either. They are troubled by less bad loans, but are dangerously undercapitalized and haunted by dubious ‘investments’ in the grey markets of derivatives and other risky bets.
Supporting euro area banks
In short, ECB’s monetary policy has as its untold but primary target to support the euro area banks, with piles of zero cost money. Given the difficult position of the banking industry this is absolutely needed. Without ECB’s generous backing, the Eurozone banks would go bankrupt, starting from the south and east. Soon, the plague would expand, starting from Germany. This brings us back to Praet.
He said, “There are still a lot of bad loans in the sector (European banks), we have yet to see whether the adjustments will have been sufficient. Banking union is essential. The resolution component is too slow. There can be flexibility for solving historical problems, but the sector needs to adapt”. This is the least to say for the Eurozone banking industry. Mario Draghi, the President of ECB has repeatedly stated that monetary policy cannot alone straighten the distortions of the euro area economy. He demands that governments do their bit. Praet is of the same opinion. He said “I talk to politicians regularly and they all know what needs to be done. But they are also afraid that they won’t get elected again afterwards”.
Inactive politicians
This is particularly true for the NPLs. The problem is by now seven years old, from the time of the 2008-2010 financial crisis. The German banks for example are still distressed from bad maritime loans. Recently they were obliged to stop auctioning bankrupt shipping companies and vessels, because prices for second hand fell to so low levels, as to make the sales meaningless. The German government not only doesn’t dare intervene, but Berlin even avoids discussing the matter. In some ways this is absurd, since Germany is afloat in cash. Very to the point Praet said, “Germany, where there’s money left over and they don’t know what to do with it”.
Still Berlin refuses to spend some of it, in order to cure the illnesses of Germany and why not of the entire euro area. On the contrary, this week the German Chancellor Angela Merkel, in a rare intervention on ‘independent’ ECB’s policy, asked Draghi to reconsider the extra relaxed policy. She said “We’re not yet back where we want to be in terms of the ECB’s monetary policy“. This interference is quite illogical from an economic point of view, but it makes political sense for Merkel’s Christian Democrats, because there is an election coming in September. The German depositors, which constitute the largest part of the voters, are strongly complaining for years about ECB’s zero interest rate policy. No matter if this policy is needed to support the country’s and Eurozone’s ailing banks and staggering economy, Merkel still insists on caressing the ears of the depositors/voters, by asking Draghi to increase interest rates.
The elephant in the room
About the elephant in the room, that is the load of €1tn of NPLs, there is very little interest and discussion. Politicians think that the current arrangement can drag on and on, with ECB doing its bit and them just seeking re-election. On the European level, action is even more difficult to identify. Italy is allowed to bail out her banks in the old way, by using taxpayers’ money, a method which has been in theory prohibited. Still, the EU Commission gave its approval to Rome to break the law. To be reminded the famous agreement about the European Banking Union of 2015, has outlawed the bail out of banks with taxpayers money, and imposed the bail in, with the money of banks’ depositors and bond holders. But yet again this new method is vote repellant and for that reason still not used by politicians.
No wonder then, if last Tuesday’s European Council, the all powerful Eurogroup made up by the 19 euro area ministers of Finance, repelled the problem by giving ‘instructions’ to the Commission to continue monitoring it. It concluded that “Incentives for banks to deal with NPLs proactively should be enhanced, whilst avoiding the disruptive effects of fire sales. Measures should both address existing stocks of NPLs and prevent a further accumulation of NPLs in the future”.
As expected, banks are again to get more ‘incentives’, in order avoid the reality of ‘fire sales’. As for the problem in its entirety, the ministers of Finance recommend…monitoring and deferrerance to the future. As if it can resolve itself. A first year economics student could have put together a solution, but he or she is not elected. Those who are, target re-election, not problem solving.
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