ECB Stimulus

Mario Draghi's Lonely Battle

Draghi ECB
Will euro zone countries support Mario Draghi's plan to buy asset-backed securities or turn on him?
  • Why it matters

    Why it matters

    If governments reject the European Central Bank president’s plan to purchase asset-backed securities, the crisis in the euro zone may linger longer.

  • Facts

    Facts

    • ECB President Draghi wants the central bank to buy up to €500 billion in asset-backed securities to stimulate bank lending and economic growth.
    • Euro zone countries have been reluctant to guarantee asset-backed securities, which would allow the ECB to buy more.
    • Some euro zone countries, including Germany, think the assets are too risky to be held by the ECB.
  • Audio

    Audio

  • Pdf

The European Central Bank has been anything but conventional of late. With the euro zone’s economy stagnating and inflation this week hitting a post-financial crisis low, ECB President Mario Draghi is preparing to take another leap into uncharted territory, and this time without help from governments.

For the first time in its history, the ECB will buy a new set of riskier, private assets from banks in its latest bid to revive lending and economic growth on the struggling continent.

While the decision was taken in September, the details will be fleshed out by Mr. Draghi after the ECB governing council, its top decision-making board, meets on Thursday. Euro zone governments have mostly turned down Mr. Draghi’s invitation to join the program.

The lack of public support could translate into a rare personal setback for Mr. Draghi, whose outspoken leadership has helped dispel doubts about the health of the euro.

ING Bank economist Carsten Brzeski sees Mr. Draghi as a modern-day Sisyphus condemned for eternity to roll a boulder up a hill only to watch it roll back down.

Up until now, the steps taken by the ECB to stimulate growth and bank lending have been largely ineffective.

At stake is the health of the euro zone’s economy and the central bank’s battle to prevent prices in the 18-country bloc from slipping into negative territory, a situation know as  deflation. This goal was dealt another setback on Tuesday after annual inflation in the currency bloc hit a five-year low of just 0.3 percent in September, according to the statistics agency Eurostat. This is far below the ECB’s annual inflation target of 2 percent.

To prevent a further slide, the ECB hopes to buy as much as €500 billion in so-called asset-backed securities, a type of complex, risky debt partly blamed for the 2008 financial crisis that bundles housing mortgages and personal and corporate loans into a single consolidated debt instrument. The market for asset-backed securities largely dried up in Europe after the financial crisis, removing a key source of funding for small businesses. The ECB is hoping to revive that lending.

“We don’t think the ECB is ready to make history as a modern-day Sisyphus.”

Carsten Brzeski, Chief Economist, Germany, ING Bank

Mr. Draghi is fighting a lonely battle. Governments in the euro zone have balked at the ECB’s cry for help. Mr. Draghi, in announcing the asset-backed securities plan in September, said he would need government backing to put real money behind the new program. If the ECB is going to buy potentially toxic assets off bank balance sheets, it wants government guarantees in the event these assets turn sour.

“He will not get these,” one German government source, who declined to be named, said flatly.

The German finance minister, Wolfgang Schäuble, this month said he was “not especially happy” with the debate. But Germany is not alone. The Netherlands and Finland have also refused. Even France, which has long pushed the central bank to do more, is balking at the ECB’s call to offer guarantees for poor-quality paper. One E.U. source said there are “across-the-board concerns” in the currency bloc.

The ECB’s latest plan has also drawn criticism from conservative monetary policy quarters, and especially from Germany, where many worry that the ECB is doing far more than it should and not leaving enough of the euro-zone rescue job to governments. Germany’s representative on the ECB’s governing council, Bundesbank President Jens Weidmann, voted against the latest round of measures in September.

The ECB’s former chief economist, Jürgen Stark, warned in a Handelsblatt editorial this month that Mr. Draghi risks creating a “bad bank.”

 

Draghi-meeting-AP
European Central Bank President Mario Draghi wants the bank to buy asset-backed securities as a way of stimulating growth in the euro zone. Some of his bank colleagues aren’t so sure. Source: AP

 

The problem for the ECB is that there is not much high-quality asset-backed debt on the market. The ECB has said it will buy senior tranch-graded asset-backed securities. Mr. Draghi would only purchase riskier so-called mezzanine tranches with government help.

Whether there is enough high-quality debt in this category available on the market to have a real impact is uncertain.

“The market in Europe has a volume of about €1.3 trillion, but on the secondary market only about €160 billion would come into question for the ECB at this point,” said Christian Aufsatz, who leads the European asset-backed securities research team at the British bank Barclays.

Still, the signal Mr. Draghi is sending could be important. The fact that the central bank has set itself the task of reviving the asset-backed securities market, it is hoped, will encourage banks to overcome fears and create new bundles of securities. It could also push regulators to move forward with creating common rules for the European market, the lack of which has restricted the use of asset-backed securities compared to the United States, where the economy has revived more quickly since 2008.

While government guarantees would certainly help, “I don’t think it fatally undermines the program,” Richard Barwell, chief European economist of the Royal Bank of Scotland, told Handelsblatt. “I still think they can do a lot of good.”

“I have reason to question whether they will then issue new loans to doubtful loan applicants.”

Hans-Werner Sinn, President, Ifo Institute

There are other problems. Some economists fear that, by purchasing only high-quality paper, Mr. Draghi could be driving out other investors that are looking for safe places to put their money. “It could lead to a crowding out of private investment by the ECB,” said Hans-Joachim Dübel of financial consultant Finpolconsult.

The ECB itself has hired financial consultants Blackrock Solutions to help it with the program. This group “should help to get the ABS program on its feet,” an ECB spokesperson told Handelsblatt. But this too could create conflicts of interest, warned Mr. Dübel, as the parent company Blackrock has its own investment operations and its “own goals,” he said.

Even if Mr. Draghi succeeds in jumpstarting the market, some economists are skeptical that ABS purchases are the right tool to revive lending. Hans-Werner Sinn, head of the Munich-based Ifo Institute and a long-time critic of the ECB, argued the program will do little to revive lending in southern European economies – the problem is not the banks but the health of the businesses asking for money.

 

Deaghis dilemma-01

 

“The banks will first rid themselves of problematic old credit demands. I have reason to question whether they will then issue new loans to doubtful loan applicants,” Mr. Sinn said.

The ECB is running out of options. In September it underwhelmed with the launch of a separate program that involves lending long-term funds directly to banks. All-in-all the ECB hopes to inject about €1 trillion into the euro zone economy. Should these plans fail, economists believe the ECB is unlikely to stop there.

“We don’t think the ECB is ready to make history as a modern-day Sisyphus,” Mr. Brzeski said in a recent research note. “Therefore, new actions, ideally both by governments and the ECB, to push the euro zone economy over the stagnation hill look highly probable.”

 

The authors are Handelsblatt editors covering international financial issues from Berlin, Frankfurt and Düsseldorf. Andrea Cünnen and Jan Hildebrand also contributed to this story. To contact the authors: cermak@handelsblatt.com, muenchrath@handelsblatt.com, riecke@handelsblatt.com

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