The ECB Is On The Right Track, The Bundesbank President Is Not

by: Martin Lowy

To an American student of bank regulation, Bundesbank President Jens Weidmann is a European throwback. He is demanding that the ECB formulate an "exit strategy" from the liquidity that it has been supplying to European banks. This demand shows how old-style European Mr. Weidmann is in his approach to banking. Apparently, he still believes that liquidity is a separate subject from capital. He does not seem to understand that the exit strategy is already in place in the form of capital requirements that must be met by June of this year. Apparently, he does not understand that well capitalized banks can fund themselves in the capital markets, and therefore that compliance with the new capital requirements is itself a sufficient exit strategy that will play out over the next three years, as LTRO and other liquidity facilities get paid down. As the market becomes ready to supply liquidity, the ECB will raise the price of credit to make it more desirable for banks to turn to the capital markets.

In the meantime, many of the banks are shrinking, which will, by definition, also reduce the amount of funding they will need.

In a way, Mr. Weidmann's recent remarks are rather scary. One of the commenters on my article the other day that recommended buying a package of European bank stocks (DB, CRARY.PK and SCGL.PK) crowed that I was rather late to the party-that he had bought a European bank stock six months ago "when there was blood in the streets" and had done very well. Indeed, there was figurative blood in the financial streets of Europe six months ago, and this man was very brave. But reading Mr. Weidmann suggests to me that our investor friend also was very lucky because if Mr. Weidmann had become ECB President, as he would like to have done, it is likely that Europe's banks would still be in the soup. It is only Mario Draghi's far-sighted understanding of the relationships between liquidity, capital, structural reform, and the sovereign debt markets that has given the Eurozone an opportunity to come out of the crisis without a disaster. (It still has a long way to go. The sovereign debt crisis is not going to go away. But ex-the-sovereign-debt-crisis-a big ex, I agree), the banks will, a year from now, be ready to play a productive role.)

Will Mr. Weidmann's backsliding, backstabbing bluster derail the European train now that it is back on the tracks and chugging along, albeit at a slow speed? I think it will not. I think it more likely that Mr. Weidmann will become more isolated in the European banking and bank regulatory community that is beginning to seethat there may be light at the end of the long tunnel in the midst of which they still remain.

Yes, next up is Portugal, and anything can happen.

But I am sticking by my calls for the near term.

Disclosure: I am long OTCPK:CRARY, OTCPK:SCGLY, DB.