Draghi’s force multipliers
By now, everyone who cares about the ECB’s quantitative easing program will have formed their own opinion on the size and structure of the asset purchases, and whether or not they care about “risk sharing” by national central banks — here’s a summary if you want one. Rather than adding to the pile of punditry, though, I thought it might be useful to remind people about a bit of the background institutional context. While these big set piece announcements make the headlines and generate the order flow, it’s important to remember that the European project is mainly one that’s being put together slowly, brick by brick. And so when you’re thinking about QE, it’s very much worth bearing in mind the last few moves made.
Most importantly, it’s worth asking the question “Why now? Why didn’t Draghi launch this program months ago?”. If your answer involves anything to do with “Germany” or politics, I think you’re in danger of missing the wood for the trees.
I spent most of 2014 telling people that there was no chance of ECB QE until early in 2015. My reasoning was that a big intervention program could only have any chance of working if the banking system was able to support it by expanding credit, and that Mario Draghi knew that there was no point in pouring central bank funds into the leaky bucket of the Euroland banking system until the Asset Quality Review was finished. That happened late in October, and nothing happens in November or December, so January was the first possible month. This wasn’t any particular piece of predictive genius on my part, by the way — it was always the plan and he said so, in so many words, in a number of interviews and speeches. The year of 2014 had always been written off by the ECB as far as policy went, as a year in which the underlying problems in the banks had to be dealt with before there was any point starting anything else.
Now we’re in the post-AQR world, though. The way I would look at that is that the really important thing that the system got in October last year was a “certificate of seaworthiness” from their regulators. Before the test results came out, all that bank CEOs knew was a) that a test was coming, b) that it would depend on the ratio of loans to capital, and c) the penalty for failure would be very severe indeed. In that kind of situation, an employee who brings you a load of new small business loans is a pest — he’s raised the denominator of the crucial ratio, and made your key problem worse, not better.
Once you’re past the test, and have an understanding of how much spare capital you have, though, that same guy could look like Employee Of The Month material. The incentive structures facing the banks have changed almost completely, so it’s not surprising that their credit standards, as measured by the ECB lending survey, have moved too.
The power of the ECB’s own intention to start buying up private sector bonds (mainly securitisations) also shouldn’t be ignored. There’s a temptation to downplay it, on the grounds that compared to the USA, Euroland is a very bank-driven system — only about 20% of corporate debt outstanding is in the form of bonds, and comparatively little mortgage debt or consumer credit is securitised. But that’s confusing stocks with flows; if there was an investor base for European securitisations, it wouldn’t be too hard to start the pipelines flowing.
In that context, it’s worth nothing that the European Commission put out its delegated acts under the Solvency II insurance and pensions regime last week. These gave a special status to “high quality securitisations”, basically defined as “normal European securitisations, not your structured and tranched American rubbish”. Up until now, the European securitisation market has been absolutely moribund, largely because insurers didn’t know what capital charge they were going to face under the new rules, but suspected (on reasonable grounds given that most global regulators have been treating all securitisations as being somewhere between GS ABACUS and the devil himself) that it would be punitive.
And now they know, and it won’t be. So there has, once more, been a step change in the incentive structures facing a key group of finance providers in Euroland.
This is the way that the “expectations channel” works in monetary policy. It is uncomfortably redolent of “animal spirits”, but the idea is to create a climate of confidence in which the business community feels comfortable in carrying out investment spending and the financial community feels comfortable in financing it. In that context, the careful unpicking of institutional problems matters just as much as the big showy announcements of trillions of Euros of asset purchases.
So my piece of advice here would be to be very careful about extrapolating from past failures of European monetary policy to the near future. For the last few years, the ECB has been trying to carry out monetary policy via the channel of a basically broken intermediation system. This time, that system looks like it might be significantly more viable. It’s not the “big bazooka” that really matters — it’s the fact that for the first time in a while, most of Europe’s guns are pointing in the same direction.