The ECB’s Plan To Do ‘Whatever It Takes’ To Save Europe Is Not Going To Work

The ECB’s plan to boost the prospects of small and medium size companies in Europe by purchasing asset-backed securities is likely to fail due to the fracturing of the region’s economies.

Fractured euro
Peripheral issuers have been excluded from the market. ECB/Gareth Davies JP Morgan

With the announcement of the ABS program it looked as if ECB President Mario Draghi’s famous pledge to do “whatever it takes” to save the euro was finally being demonstrated rather than just promised. However, the divergence in economic performance between core countries like Germany and (until recently) France and the periphery including Italy, Greece and Portugal could scupper the central bank’s ability to improve the Eurozone’s prospects.

The problem is that the peripheral economies have been locked out of the securitisation market because they are unable to offer investors enough of a yield to cover the risks they would be taking on. Although the ECB’s plan should ease funding costs for these businesses, it is unlikely to be able to make a significant difference unless it can encourage a damaged banking system to take on significantly more risk despite existing financial stresses of borrowers and growing concerns about the broader macroeconomic outlook.

As Gareth Davies, credit analyst at J.P. Morgan, said in an interview with the Wall Street Journal:

If the ECB buys only ABS backed by SME debt then the stock of bonds available on the open market — about €10 billion — is far too small to have any meaningful impact. For the program to be successful, the ECB would need to buy non-corporate assets, such as ABS backed by residential mortgages, or encourage the issuance of SME-linked deals on a scale never seen before.

Non-corporates are private firms or partnerships that do not have access to corporate debt markets. This means that they have not benefitted from the so-called reach for yield by investors that has helped depress debt yields across much of the developed world, leading to a record negative yield on German government debt earlier this month (effectively lenders were paying the German government to borrow).

Euro area SME funding
SMEs in distressed countries continue to view access to finance as a very pressing problem. ECB

This chart from the ECB shows the funding problems facing small companies in the periphery. SMEs in Greece, Spain, Italy and Portugal all report serious concern surrounding their ability to access finance while Finland, the Netherlands, Austria and Germany all report a far healthier economic environment.

What this suggests is that even if the ECB manages to increase the size of its balance sheet through the ABS purchase program, it is likely to benefit the core more than the periphery. Stagnant economies and the threat of deflation across the Eurozone are helping to increase perceived risks for both borrowers and lenders.

Though it may seem an odd suggestion considering the events of the recent financial crisis one way to address this problem could be the creation of a supranational mortgage guarantee body — a sort of Eurozone Freddie Mac or Fannie Mae. Mortgage debt traditionally accounts for a large percentage of non-corporate funding and a paper last year suggested that buoyant asset prices could offer one route to an increase in entrepreneurship:

We find that an increase in collateral value leads to a higher probability of becoming an entrepreneur. Conditional on entry, entrepreneurs with access to more valuable collateral create larger firms, more value added and are more likely to survive, even in the long run.

Of course, with states guaranteeing lending on the one side and central banks purchasing the resulting assets some analysts would argue that it amounts to the housing market “effectively been socialized“. That may be true, but unless and until governments are willing to take a share of the risk of funding small businesses directly a socialized housing market may be a necessary evil.