To recap: last year the ECB finally began to take action to deal with the acute problems in the sovereign bond market and the banking market, now increasingly and worryingly scrambled together. Through two successive waves of cheap (1% pa) money, a massive trillion euro was pumped into the banks, in what was called — long-term rollover.
Although significantly less in net terms, this injection of liquidity (in November and March) was sufficient to significantly cool the sovereign bond markets. It was also a mechanism, as I have noted previously, to allow the banks to begin to fill some holes in their own balance sheets.
Modern economics absolutely needs banks. They are the pumps that drive money and credit around the rest of the system. In Ireland, these pumps are broken and we see daily the effects of same. What the ECB has done is quite proper, but in mathematical terms it is necessary but not sufficient.
Other factors in the ECB and elsewhere make this policy less likely to succeed than might be hoped.
First, this approach depends on the banks ultimately passing on their money to productive sectors of the economy.
The Bank of International Settlements concluded that individual bank capital positions were crucial to their ability to lend. They also concluded that the key issue was structuring the capital base to allow this to happen. European banks and, in particular, Spanish banks are not yet fixed. We see in Ireland that the next wave of losses from mortgages is beginning to consume political and economic capital.
Second, it is in any case treating the symptom not the cause of the problem. European sovereign states display high borrowing costs because of too much debt. The cost of debt is a function of supply and demand; at present there is a lot of cheap liquidity sloshing around which allows banks to purchase this high yielding debt and make a profit.
But this exacerbates the issue if states consider that the lowering of bond yields indicates that they can take reform slow. European states are on a tightrope: too much austerity and the economy crashes — this is Greece, where real poverty and want are now rampant, and still the debts are unsustainable.
Too little and the markets fear a Greek bailout or worse writedown, this is Portugal or Spain. The circles of austerity-growth- market confidence are unsquarable in my view. We cannot solve too much debt with more debt.
Third there is evidence that the ECB is beginning to adopt a core-periphery approach. In his press conference after the last ECB board meeting the bank’s president Mario Draghi made a number of comments that suggest, to me, that the ECB board was preparing a Plan B.
He restated that where central ECB liquidity operations were not available for banks, then domestic central bank liquidity was available. He also reiterated that this was, however, at the risk (read certainty) of exposure of the domestic sovereign.
We have seen this here. Despite the best spin that the Government has put on it and, notwithstanding that there is another game in town with the final settlement of the banks, the brutal reality is that at the end of March this state did pay €3.1bn to the Central Bank of Ireland to pay down emergency liquidity assistance which it had advanced to prop up Anglo.
When the ECB speaks of emergency liquidity assistance being advanced at local risk this is what they mean. Prop up your banks if you wish but it’s on your own head. Oh, and don’t let them fail. This is a recipe for a Europe populated by Anglo zombie clones.
Fourth, there is a growing theological strain in discourse that debt is not just wrong; it in some ways indicates a moral laxity. This displays a dangerous ignorance of modern macroeconomics. At the same time, we are being asked to vote on a fiscal compact which will not only effectively ban borrowing but, given our debt levels, will require us to run cyclical surpluses. That will, inevitably, lead to more austerity.
There are irreconcilable forces beginning to emerge in the European and national debate. At the heart of these lies the ECB’s insistence that under no circumstances must banks fail, coupled with its abhorrence of any hint of inflation. This is of course counter to the emergent European commission perspective on bank resolution and to the historic reality that debts do get restructured either via inflation or default. Europe will have to choose.
* Brian Lucey is professor of finance at Trinity College Dublin