Notes From Underground: The ECB Is On the Horns of a Dilemma … Again

Let us continue where last night’s blog ended. This week’s move by the French President Hollande to reshuffle the government’s cabinet should be perceived as a way for France to negotiate for a depreciation in the EURO and an end to the German-imposed conditions of growth through austerity. Prime Minister Valls cast out previous Economic Minister Arnaud Montebourg because his continuous attacks on the Germans’ push for austerity wasn’t appreciated by Chancellor Merkel. Montebourg is a beloved leader of the Socialist Party and has been a close confidant of President Hollande. The change in the cabinet can be disastrous for Hollande’s socialist standing so we must examine Hollande’s political maneuvering as representative of something bigger.

Emmanuel Macron, a former investment banker, replaced Montebourg as economic minister. Macron is very young and it is hoped that his profile will lead to a pivot by President Hollande toward a more capitalist growth-oriented policy. When a long-time socialist tosses aside his friends and colleagues it is a measure of panic by a leader searching for an end to the economy’s slide. What will be the quid pro quo for Hollande’s efforts? European support for downward pressure on the euro?

The ECB is also under pressure to implement aggressive QE as the talking heads reported that Draghi was prepared to move aggressively to do “whatever it takes” to jumpstart EU-wide job growth. In my opinion, Draghi’s Jackson Hole speech was just a reiteration of previous speeches and press conferences except that it reflected President Draghi’s frustration and exhaustion with the politics of the European Union. Monetary policy in the EU is handcuffed by the Maastricht Treaty and its Growth and Stability Pact. The ECB president didn’t plead for monetary policy but a softening in the fiscal requirements pushed by the German alliance of budget austerians. He enumerated his views:

  1. “Aggregate demand policies have to be accompanied by national structural policies”;
  2. “… engineering a higher level and trend of potential growth–and thereby also government income–can help recover a margin for manoeuvre and allow both policies regain traction over the economic cycle”;
  3. Find a way to lower the tax burden in a revenue neutral way–cut taxes and expenditures;
  4. “Stronger coordination among the different national fiscal stances should in principle allow us to achieve a more growth-friendly overall fiscal stance for the euro area.” Thus, it is tax harmonization that is needed but as the French have maintained since the euro’s inception, tax harmonization is a no-go as it is a surrender of national sovereignty

Draghi has the unenviable of task of managing monetary policy in a UNION devoid of political authority. A lack of fiscal policy tools to generate growth leaves President Draghi left with quantitative easing, or, more importantly, the creation of asset-backed securities, which is a way to circumvent the lack of banking and fiscal union.

Why is the need to resuscitate a comatose ABS market so important to President Draghi? The answer is that it unclogs the plumbing of the European financial system. Again, European banks are the backbone of the EU system and with so many nonperforming loans preventing banks from creating new loans, Draghi needs to relieve banks of the problem loans by bundling them into a financial instrument that global investors may be willing to buy. The initial buyer will be the ECB as it swaps cash euros for the troubled loans. Then as the European economy begins to grow the ECB will hopefully unload the ABS at discounted levels to hedge funds, private equity groups and sovereign wealth  funds.

This idea President Draghi floated almost a year ago may be able to elude the German Constitutional Court as it won’t involve the ECB directly buying sovereign debt since the ABS will be private loans and the debt of small and medium enterprises. The ECB announced that Blackrock will be its consultant on this project but the operative questions will be how long will it take to enact and will the Bundesbank and others provide support for the plan. Remember, the ECB needs a creditor and the German’s know it is their signature as co-signer. The markets will view the actual announcement of a genuine ABS plan as a positive but the French and Italians will continue to push for a weaker EURO. If Draghi is to be believed he is also in the camp of a weaker euro to help aid European growth.

***I want to add the work of a blog reader, Tom Mazza, as he has done significant  work on the Bank Rankings Aug 2014 (Top 65) [click link for the list]. Pay particular attention to the column on nonperforming assets as a percentage of total assets. Thanks Tom et al!


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9 Responses to “Notes From Underground: The ECB Is On the Horns of a Dilemma … Again”

  1. Joe Says:

    I wish to add my thanks to Tom Mazza for Bank rankings 2014.

  2. ShockedToFindGambling Says:

    Yra- Good to have you back.

    Any idea on what % of face the ECB would pay for the ABS assets?

    I would guess most of what the banks will want to give them is worthless.

  3. yra Says:

    shocked–that is always going to be the operative question in any type of massive bailout by the authorities—remember that Geithner et al paid Goldman a 100% for the AIG paper and there is no reason to stop there—if the assets are not priced high enough the entire ABS plan fails—the question is again who will pay the bill if it all collapses

  4. arthur Says:

    The Trilemma:

    1. Mario Draghi: “wathever it takes”
    2. Angela Merkel: “if the euro fails, Europe also fails”
    3. George Soros: “jettisoning the euro may be necessary to save the EU itself”

    Who pays the bill? As Benjamin Franklin said, “Creditors have better memories than debtors.” So, Wolfgang Schaeuble, Germany’s finance minister, says the ECB has gone as far as it can in supporting the economy.

  5. ShockedToFindGambling Says:

    Yra- I would guess the ABS program will just be a giveaway to banks, disguised as a “program”.

    They will probably pay 80 cents for assets worth 10 cents (or something like that). With Europe possibly heading into a recession, the “assets” won’t be worth much (and probably won’t be, even if the economy recovers).The banks will hold onto any assets that have a reasonable chance to recover.

  6. yra Says:

    Shocked–they will do exactly as you suggest in my analysis.Which raises the question if they phony up the AQR to be a worse result so they can pressure the authorities to do more—worse is better for Draghi

  7. Chicken Says:

    Who’s working for whom?

    Wasn’t BAC 2nd worst next to C not so long ago with C having more shares issued than human numbers living on Earth?

    This is all about stealing from savers for the benefit of special interest groups so the special interest groups can continue outsourcing into infinity.

    Does Germany really intend on pulling the plug on this hot tub party complete with rubber duckies, given their banks are among the worst offenders?

    I don’t guess it takes much cream off the latte’ to hire a few of these special interests to sell re-renumerated PMs that will never be delivered regardless, the cornerstone of precedent is set.

  8. Alex F Says:

    The ECJ’s judgement on the OMT is still pending. Given that there are substantial legal and operational difficulties in getting QE done, there is perhaps an excessive amount priced into markets here.

  9. yra Says:

    Alex–see the new blog and I agree with you wholeheartedly on the legality of QE

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