The ECB And Germany - Another Spat Develops

Includes: EZU, FGM, FXE
by: Acting Man

As we noted in our update on the last ECB rate decision, Mario Draghi said in his press conference that the ECB wishes for the creation of a larger ABS market (asset backed securities) in Europe in order to be able to monetize more debt. The difficulty for the ECB, as Draghi explained, is that it is forbidden by statute from financing governments, while monetizing bank loans directly has the disadvantage that they lack a market price and an independent credit rating. While one of the emergency measures the ECB has taken in the course of the crisis was to allow national central banks to accept such bank loans as collateral, these are only taken aboard at very large discounts in order to reflect the associated risks. This is obviously not a useful means for goosing credit expansion.

Hence the pining for more ABS issuance. The ECB also has plans to steer more credit in the direction of small and medium-sized enterprises in the periphery, as the high interest rates on private sector credit in the periphery have failed to decline along with the yields on sovereign bonds. After the G-7 meeting, Draghi talked about the "many options" the ECB is considering, once again mentioning ABS as a potential target of ECB purchases. Apparently, the ECB doesn't want to get left behind in the global race to debase. It can even point to a very large decline in euro area inflation expectations for justification of more easing measures. After all, the "price stability" policy also encompasses averting "deflation" (this is to say, falling prices).

According to Bloomberg (emphasis added):

European Central Bank President Mario Draghi said the ECB is considering buying asset-backed securities among possible options to support lending to small and medium-sized companies. 'We looked at a variety of things, one of which was this ABS,' Draghi told reporters after a Group of Seven meeting of finance chiefs in Aylesbury, near London. 'We're still looking at that, it's one of the many options. We don't have a position, certainly, on that.'

The ECB is keen to rally lending at banks, which account for about 80 percent of corporate financing in the euro area, compared with less than 20 percent in the U.S. Lending to households and companies in the region contracted for an 11th month in March, and small- and medium-sized companies, which account for the bulk of employment in Italy and Spain, have been particular victims.

'On the lending side, we see that the situation is still tight, especially in the periphery, but not exclusively,' Draghi said. Still, 'the situation is in a sense getting less bad,' he said. 'In other words it's still tight, but it's less tight than it used to be.' ECB Executive Board member Joerg Asmussen said on May 8 that the central bank has discussed ABS purchases, while his fellow board member Yves Mersch said the same day that it was 'looking at ways to restart the ABS market.'

Acquisitions in the ABS market are 'not easy for the ECB to do because we're in a completely different set-up from the U.S., where you have a capital market,' Draghi said today. 'So the ABS in this case would have to contain assets from the banking system of the euro system and you can understand what sort of moral hazard there is there.' Last month, the ECB Governing Council tasked technical committees at the central bank to investigate ways to stimulate lending to small- and medium-sized businesses.

So this is the situation at present -- the ECB continues to look for things it can buy with money from thin air. Never mind that in the crisis countries, there may be literally nothing left to lend due to the massive capital consumption during the boom. It is not enough to simply print money. Borrowing by entrepreneurs is ultimately about obtaining capital, not just money. There is a clear difference between the two; money is the medium of exchange, but it cannot actually fund production.

Disputes Over Monetary Rectitude

In any case, Germany and the Bundesbank are often quite critical regarding the ECB's various crisis policies, and the latest ideas haven't escaped criticism either. While the BuBa wrote in its amicus curiae brief to the constitutional court that it regards "OMT" as being in conflict with the ECB's statutory limitations, the idea to buy ABS has provoked resistance from Germany's minister of finance, Wolfgang Schäuble. As Der Spiegel informs us (emphasis added):

German Finance Minister Wolfgang Schäuble and European Central Bank head Mario Draghi have never seemed particularly eager to avoid conflict with one another. Just in January, the two got into a mini war-of-words over the need to bail out Cyprus, with Schäuble openly questioning whether the country was systemically relevant.

Now, the two are at odds again. SPIEGEL has learned that Schäuble is deeply critical of an ECB idea to purchase asset-backed securities, fearing that the plan could be little more than 'obscured state financing,' a no-no for the ECB. Schäuble made his remarks at a breakfast of conservative lawmakers last Wednesday, according to sources present. Schäuble said that such a plan would violate European Union treaties.

The motivation for considering such a move is clear. The ECB is eager to stimulate bank lending, particularly in Southern European countries where the debt crisis has made banks wary of issuing loans. But Schäuble is concerned that an ECB program of buying asset-backed securities could amount to the bank taking over some €70 billion in debt owed by Italy to private creditors.

Schäuble was backed on Monday by Hans Michelbach, the top conservative in the Finance Committee in parliament. 'After the extremely questionable ECB purchase of sovereign bonds, this would be a clear violation of European treaties,' Michelbach said, according to German news agency DPA. There are, he said, apparently some people in the ECB leadership 'who consider the ECB to be the Bad Bank of Southern Europe.'

Not only did Schäuble detect that there was a possibility of covert government funding by the ECB through the ABS back door, so to speak, he also poured cold water on the banking union, which he thinks may be in violation of the treaties as well. Draghi had admonished EU governments to hurry up with the banking union in his press conference. Note that the current sanguine mood in the financial markets is largely based on the idea that all these things -- OMT, the banking union, further ECB easing measures -- are basically a done deal. They are not, at least not yet. A renewed flare-up of the crisis may change that again, but right now Schäuble (and Jens Weidmann of the BuBa) are finding fault with practically everything Draghi has proposed (emphasis added):

Schäuble, however, is not just concerned about the threat Draghi might pose to EU treaties. He also on Monday voiced his concern that efforts to push ahead a bloc-wide banking union could be in violation of EU rules. In a contribution for the Financial Times, Schäuble proposes a 'two-step approach' that would leave bank bailouts in the hands of national authorities for now. The plan of having a super-national authority for the entire eurozone, he writes, require treaty changes before the have the necessary legal foundation.

Germany has long been pursuing a 'banking union' as a way to prevent a repeat of the euro crisis in the future. Eurozone leaders would like a separate bank bailout fund, the ability to wind down banks that run into significant difficulties and clear rules regarding when and if taxpayers must be responsible for a bailout.

As we have pointed out previously, Germany's banks and politicians are dead set against the banking union, at least insofar as it involves a communal deposit insurance scheme. Without such a scheme however, the risk posed to depositors by banks in the periphery remain quite large as Cyprus has demonstrated.
We guess that the fat lady has probably more singing to look forward to in euro-land.

The Euro-Stoxx bank index -- via BigCharts -- is still retaining most of its gains from last year's low. This is a barometer everyone should watch.

Click to enlarge