Tuesday, 23 February 2016

Euro-Tarp? Maybe... look at Italy

In the dying days of the Bush administration, then Secretary of the Treasury Hank Paulson introduced a US 1tn program called  the Troubled Asset Relief Program, or TARP for short. Translated into plain words, it was an offer to the banks that the Federal Government would buy the worst stinking pieces of bad loans the banks carried on their balances. And it was clear that not too many questions would be asked.

It was a variation of one of the elements in the famous rescue of the Nordic banking sector in the 1990's. At that time, banks signed up to be rescued, the insolvent ones were taken over by the Finance Ministries, who then combed through the bank balances, hunting for the worst stinking pieces of bad loans. The bad loans were then folded into a company which was floated on the market with a time limited loss guarantee from the government.

In the Nordics, shareholders lost their investments and boards and management lost their jobs. In the US the management largely kept their jobs while the shareholders saw their holdings diluted severely.

However, in both cases, the action contributed to "clean out" the bank balances, meaning that the banks relatively quickly could get back to the core business of a bank: to receive deposits and lend money.

Not so in Europe. 8 years after the onset of the crisis, and two "asset quality reviews" later we are stuck in a situation large European banks are sitting with unrealised losses, which - if they were realised - would lead to the demise of the banks in question. I - and several others with me - have a sneaking suspicion that this state of things holds back European bank lending in a significant way.

Last week, the ECB gave a startling confirmation of the gravity of the situation.

Since 2015, the ECB has tried its own version of quantitative easing or QE. This of course refers to the programs whereby central banks in the US, UK, Japan and Canada have purchased enormous amounts of their own government bonds in the market. Some covered bonds, such as mortgage backed bonds have also been purchased. All in the purpose of forcing down interest rates, particularly in the longer maturities.

ECB faces a particular problem in implementing a QE, since its statutes prevents it from financing the individual governments by buying their government bonds. A compromise was found, whereby government bonds were eligible if bought in proportion with the shareholdings in ECB of the individual countries.

It would of course mean that ECB was forced to buy mostly German Bunds - even if it is a relatively small bond market. There are tons of e.g. Italian bonds on the market, but ECB cannot buy that many of those. Then there is some agency debt out there, but having to buy 60bn EUR worth of bonds each month seems to be a problem.

So ECB has had a brainwave: Let us buy some of the worst stinking pieces of bad loans the banks have been carrying on their balances. In casu the Italian banks, who suddenly admit to have a small sum of 225 bn EUR of bad debts they would really, really like somebody else to buy from them.

Which is possible for ECB if the Italian government is guaranteeing the debt. Once that obstacle is cleared away, we can start guessing which other banks are sitting on a mountain of bad debts.

In other words, the ECB QE program is now morphing into a Euro-Tarp. I am sure that the Germans are shaking their heads or even worse. I do not really care. The TARP program gave the US banks a headstart to recover even if bank regulators had to hold their noses while buying the bad debt.

Here in Europe we have had a very peculiar attitude. We want to punish the banks for doing a dirty on us all, so we want them to recover without any help. But we do not want to punish them so badly that the boards and bank managements were actually kicked out. So the "Swedish solution" was also excluded.

The result has been that it has taken waaay too long time for credit growth to return to Europe. It has held back consumption and investment. When we will be writing the story of the financial crisis in Europe, the lack of dealing properly with the banks will stand out as a monumental error.

So monumental that it will almost be on a par with the German insistence on draconian savings programs to curb government debt creation in an environment of weak consumer demands.

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