The delusion of State guarantees
European policymakers are currently busy addressing two issues: moribund investment and banks on extended sick leave. Some observers might be tempted to segregate these issues. While investment would be in the remit of States, the financial health of our economies would be under the responsibility of the ECB alone.Par Natacha Valla
Billet du 3 octobre 2014
The first issue (how to revive investment) has made it to the top of the political agenda. It belongs to the key priorities set by Italy within its EU Presidency, running until the end of 2014. Jean-Claude Juncker, head of the new European Commission, hit headlines with his €300bn plan – the details of which are still unclear – to restart investment in Europe. In September, Poland put an even higher bid at €700bn for similar purposes. Revamping EU Structural Funds, rejuvenating the European Investment Bank, creating a network of national public investment banks… the debate is open.
Likewise, the second issue (refocusing banks on the real economy) has been actively taken care of by the ECB via a sophisticated arsenal. Monetary policy tools are now many: historically low interest rates, long and cheap liquidity injections, ABS purchases (that, as we just learnt through the publication of the programme’s technical details, will virtually write a blank check on senior tranches in the loan portfolios of Greek and Cypriot banks) – and tomorrow perhaps, purchases of sovereign debt.
But in fact, the objectives of European States (investment) and of the ECB (financing the real economy) are not only complementary: they are also deeply intertwined. When unfolding its unconventional toolkit, the ECB also smoothens the long and painful deleveraging of our economies, thereby mitigating the risk of secular stagnation. Governments do not seek anything else when designing structural and fiscal schemes to revive investment. Their aim is to bolster potential growth and act for a sustainable and innovative economy. But doing so, investment-enhancing policies can also become a trigger for economic and financial re-integration in Europe.
If unconventional monetary and pro-investment policies are woven together, should we worry? Not necessarily. But for this tripartite (monetary, structural and fiscal) strategy to work, monetary policy should avoid becoming a fiscal bailout. And investment policies should not become fiscal sloppiness in disguise.
Respecting a handful of principles could help avoiding that lose-lose trap:
First principle: a pro-equity ECB. The ECB monetary policy is very much geared towards banks and towards debt. However, banks are big and outstanding stocks of debt are already too large in the euro area. By exclusively focusing on debt-related instruments to implement its monetary policy, the ECB might miss an important point. Restarting European investment and defragmenting financial markets will also depend on non-bank financing and on the development of pan-European markets for other sources of financing. The ECB might therefore consider an equity-based collateral policy or even outright purchases of equity and other forms of financing that are still marginal today. Some might argue that equity markets are way too small to be seriously considered in the implementation of monetary policy. But the ECB has rightly committed to support the development of securitization, so why not also support the financing of innovative and long-term growth enhancing projects by other means? If securitization can be boosted Deus Ex Machina by the central bank, so could pan-european equity instruments. Of course, appropriate haircuts would need to be applied, and a strict margin policy would be warranted.
Second principle: an ECB that ‘elects’ innovative debt. The Eurosystem has widely exploited the flexibility of its operational framework by softening the eligibility criteria it applies to the assets eligible to its refinancing operations. But then, why not adopt an even more pro-active policy by including new instruments, even some that do not exist yet –such as low carbon assets or human capital bonds? What is better for the list of eligible collateral to ECB open market operations: under-margined Greek bonds, or low-carbon assets with adequate haircut?
Third principle: a moderate dose of State guarantees. The use of State guarantees has intensified with the crisis, and it now seems to be flourishing even more. They are frequently mentioned as a way to support investment by reducing funding costs. Or as a sesame that would allow the ECB to finance anything with closed eyes, provided that the security is guaranteed. But nobody should forget that a State guarantee is and will always remain a contingent liability. And considering that a hypothetical or off-balance sheet liability is not a genuine commitment is a fatal error. In 2009, the Austrian federal government nationalised Hypo Alpe Adria, a bank. It was deemed necessary to avoid its failure because its liabilities were guaranteed by the State of Carinthia. In 2014, after repeated capital injections by the government, the bad assets of the bank were transferred to a ‘public’ SPV for a value of €12bn, that is… 4% of Austrian GDP! Beware, State guarantees are no panacea.
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