The European Central Bank’s (ECB) simultaneous announcement of an asset purchase program and cuts to its main interest rates should provide a strong message to European leaders: We have done all we can, now it’s your turn.
The divergence of national economies within Europe, with the core (France, Germany, Netherlands) pulling away from the struggling periphery (Greece, Spain and Portugal), has meant that it has proven difficult for lower rates to translate into the higher bank lending needed to boost troubled economies. This has helped to exacerbate the underlying tensions within the monetary union and has begun to impact the health of the region’s larger economies.
ECB President Mario Draghi explicitly stated that the asset purchase program, under which the ECB will purchase European asset-backed securities (loans pledged against a collection of assets) from the market, is being undertaken to get around these transmission problems.
Used in concert with the already announced Targeted Long-Term Refinancing Operation, whereby Eurozone banks can gain access to cheap funding from the central bank in return for higher lending, the idea is to get funding to small and medium-sized businesses that have languished as the Euro crisis has worn on.
In essence, however, this will mean that the ECB is promising funding to banks to create asset-backed loans that they will then purchase. If that sounds circular, it should.
And it has caused financial writer Frances Coppola to worry that the ECB is exposing itself to a big moral hazard problem:
[As] far as I can see, the SME ABS programme is either going to be too small to make much difference, or is likely to encounter serious problems with loan quality at some point, putting the ECB’s balance sheet at risk.
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As Coppola points out, while this scheme may be sufficient to help some healthy firms that have struggled to raise financing in recent years it relies heavily on a sharp increase in the supply of these types of loans. That, in turn, poses its own problems.
The quality of the loans are linked directly to the health of the underlying assets that they are pledged against. Within Europe, firms with the greatest potential to benefit from this scheme will be concentrated in already healthy economies in the core. So just as with interest rate cuts, the countries likely to benefit most are the same ones that are least in need of it.
Although Draghi pledged his commitment to “structural reform” within the Eurozone, he also repeated his call for a discussion on the overall stance of fiscal policy — suggesting he wants governments to ease up on their austerity programs and start spending again.
In his press conference following the rate cut announcement, Draghi dismissed talk of a “grand bargain” between fiscal and monetary powers in the monetary union. However, he did add “we all just have to do our own jobs.” The implication is that Draghi has done his job and — short of entering the topsy-turvy world of aggressively negative interest rates — has no more weapons at his disposal. He needs governments to step in, too.
If I were Angela Merkel, I would read that as a challenge.
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