The big news of the day on Thursday was Mario Draghi’s pronouncement that the ECB would do “whatever it takes” to shore up the Euro. He also used the same phrases about the need to keep the monetary channel open prior to preceded previous interventions. Two-year Spanish bond yields, which had risen to unprecedented levels, came in by over 150 basis points and global stock markets rallied.
But how seriously should we take this talk? While the ECB is the only actor that can buy the Eurozone enough time for the member states to put in place the needed fixes (and bear in mind there is no guarantee that process will be a success), even measures the Eurocrats appeared to think were on the “shock and awe” scale fizzled. For instance, the ECB’s last big intervention, the LTRO, was a back-door bailout to sovereigns (banks could borrow at 1% from the LTRO and buy sovereign paper at much higher yields). Even Euroskeptics thought the LTRO would buy the Eurozone 12 to 18 months of breathing room. Instead, its impact had worn off within three months.
However, the specter of Spain in such a dire situation and Italy going seriously wobbly has focused the minds of the authorities. Key politicians may appear to be coming around to dropping some of the idees fixes that have stood in the way of giving the ECB rein to hold the crisis at bay.
Helpful NC readers of the European press focused on news of a big shift that appeared to be underway in Germany. Ambrose Evans Pritchard explained why the Germans were critical:
Mr Draghi’s comments came as Spain claimed backing from France and Germany for activation of the eurozone’s rescue fund (EFSF) to buy Spanish bonds, though this would require calling the Bundestag’s finance committee back from holiday for a vote. Action by the EFSF would provide “political cover” for the ECB to join the fray in a two-pronged attack.
There were press reports that finance minister Wolfgang Schaeuble, who mere days ago said he was indifferent to the prospect of Greece leaving the Euro, had relented and said he believed some form of intervention is necessary. Note that Merkel is artfully (at least publicly) having it both ways by making oracular statements along the lines of “every institution should live up to its responsibilities.”
But now it seems the tectonic plates might not be moving. Schaeuble has denied that he is in favor of bond buying and insisted that the rescue facilities in place were sufficient to do the job. This is consistent with a Reuters report on Friday that Schaeuble nixed a request by Spain for as €300 billion lifeline (this in addition to the just-approved €100 billion rescue) if it continued to face high borrowing costs (and that looks pretty likely). Schaeuble said no additional fund before the ESM is operational (expected to occur in the fall).
But numerous analysts and commentators (including this blog) have deemed the current programs to be too small to handle the Eurozone’s burgeoning needs. Think tank Open Europe issued a new report detailing how having Spain locked out of financial markets (which is where things are headed ex a change of course) would exceed the capacity of current programs. Per the Telegraph:
Leading think-tank Open Europe made the estimate based on the assumption the Spanish government would be forced out of the markets for three years because of its unsustainable borrowing costs, as happened in Greece, Ireland and Portugal.
Between now and mid-2015, Spain has funding needs of €542bn, with its banks requiring up to €100bn on top of this. The Spanish regions possibly require another €20bn, according to the study.
A Greek-style bail-out for Spain would bleed dry the eurozone’s €500bn rescue fund, making an alternative solution essential….
“The current bank rescue plan is clearly insufficient, while a full bail-out – which could be in the region of €650bn – is impossible [said Raoul Ruparel, head of economic research at Open Europe].”
Moreover, even if German political leadership were to change its stance, that would not be sufficient for the ECB to move into high gear. The Bundesbank, as well as German members of the ECB, appear to remain firmly against dramatic new measures. Bloomberg tells us that the Bundesbank said in the wake of the ECB statement that it is opposed to more bond purchases. On Friday, the Bundesbank reiterated its objection to reviving the securities markets program which allowed for direct bond buying (and truth be told, when it was implemented last year, it made matters worse). The German central bank no doubt continues to disapprove of giving the soon-to-be-live European Stability Mechanism a banking license, which would allow the ECB to monetize sovereign debt (note that Draghi has not officially changed his stance of being against that option).
While it is hard to be certain from this remove, it looks as if the EBC’s efforts to mount a full court press on the German political leadership and Bundesbank, both via the media talking up Armageddon (a replay of the scare tactics used to get the TARP passed) and private arm-twisting, are not getting the needed traction.
The big date is next Thursday, when the ECB’s governing council meets. Draghi has raised expectations, and the lack of meaningful follow-through on Thursday would be proof that he was unable to overcome opposition. Note that even if the pro-bailout forces are gaining ground on the holdouts, the longer the to-and-fro goes on, the less leverage the proponents have. If Spain about to go into financial asphyxiation and Italy starting to go critical won’t produce a change in posture, it’s hard to see what would.
And even if the ECB were to pull the trigger, would it act decisively? To be effective, the ECB would need to make clear it is willing to act on a monster scale. Half a trillion, or even a trillion won’t cut it. But the ECB has less latitude that the Fed did in the crisis. It isn’t permitted to rescue sovereigns directly. And that brings us to the second problem, that the so-called core nations (the creditor countries) as well as in some cases the ECB itself is blocking the path to ways to get around this impediment.
Draghi, as FT Alphaville points out, flagged that Eurozone member countries are increasingly having to fund themselves from domestic sources (and the ECB) as cross border lending has dried up. Draghi attributes it to the actions of national regulators. From his statement:
There are at least two dimensions to this. The interbank market is not functioning, because for any bank in the world the current liquidity regulations make – to lend to other banks or borrow from other banks – a money losing proposition. So the first reason is that regulation has to be recalibrated completely.
The second point is in a sense a collective action problem: because national supervisors, looking at the crisis, have asked their banks, the banks under their supervision, to withdraw their activities within national boundaries. And they ring fenced liquidity positions so liquidity can’t flow, even across the same holding group because the financial sector supervisors are saying “no”…..
Then there’s another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia have to [do], as I said, with default, with liquidity, but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate. They come within our remit.
This strikes me as an optimistic spin. If regulators were the drivers of the financial Balkanization of Europe, then presumably different noises from the authorities would lead to a change in behavior. However, as Marshall Auerback has been saying for some time, there has been an ongoing run on banks in periphery countries as depositors move funds to banks in the core out of concern for suffering forced conversion into a lower-valued currency in the event of a Eurozone exit. With Citi now placing the odds of a Greek departure at 90%, this is a legitimate concern. So if banks have reason to think that matching assets and liabilities on a national basis is sound business in the current environment (as reports from Gillian Tett also suggest), it’s going to be harder to change behavior than just having regulators make different noises. Banks and investors have to believe that the risk of a Eurozone breakup has been reduced to zero.
By e-mail, Marshall Auerback mused as to whether things were already past the point of no return:
Dealing with this issue means an unconditional backing of all of the national sovereigns including, yes, Greece. Because failing to stand behind ALL of the members of the eurozone contradicts the currency union’s central premise: namely, that it is permanent and indissoluble.
Openly discussing the possibility of a “Grexit”, then, simply exacerbates the current problem and sets up another round of speculative attacks as the vultures guess which is the next member to go.The problem is that it is unclear that all of the member states recognize the inherent logic behind this.
In particular, Germany and The Netherlands have made persistent and less-than-subtle threats to boot out Athens if the latter seeks to amend the terms of its bailout package. They and others, such as the Finns, are moving in the opposite direction from Draghi. I have been documenting this. One cannot just assume that the Constitutional Court will keep rubber stamping the ECB and that the Bundesbank will simply let the ECB go ahead and do “whatever it takes”.
But without securing German support, how do you stop the bank run? People now say the BUBA is a “paper tiger”. Really? The fact of the matter is that deposits are leaving the banks on the periphery and going to banks in the core. The banks in the core lend to the System of European Central Banks (with basically the ECB “on the hook”) which then provide lender of last resort financing to the banks on the periphery. It may be that by April the banks in Greece, Ireland and Portugal had lost half their deposits and the banks in Italy and Spain had lost a quarter of their deposits. To understand the eventual significance of this process, let us assume the bank run continues and the banks on the periphery overall lose the majority of their deposits, the banks in the core have corresponding huge claims on the ECB, and the lender of last resort position of the ECB is now equal to a majority of what was the outstanding deposits in the banks on the periphery.
What kind of a banking system is this? A dysfunctional and a highly unstable one. One would have a set of banks on the periphery that are massively dependent on ECB lender of last resort financing. That would probably be dysfunctional, as they would be disinclined to lend to their normal client base. What does “whatever it takes” really mean? It’s a paradox. To make his “whatever it takes” pledge credible, Mr. Draghi has to go well beyond the traditional boundaries of economic and central banking orthodoxy. But in going well beyond these boundaries, does Mr. Draghi risk creating another crisis of confidence in the euro?
And will the Germans and others let him?
Despite the reports of wavering, the answer still appears to be “nein”. And the window for changing their mind is about to close.