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Monday, 2 December 2013

Süddeutsche Zeitung: ECB wants to lend money for special purposes, like industrial and small & medium enterprises. Here is why this won’t help the economies in Europe to recover anyway.

This story is a little bit older, as it is from Wednesday, 27 November 2013, but it is nevertheless very interesting. That is the reason that I print it here:

The German daily newspaper ‘Süddeutsche Zeitung’ reports that the ECB council, chaired by President Mario Draghi, is interested in opening a special purpose, long-term lending facility.

The goal of this lending facility would be to enable commercial bank loans to industrial and SME companies (Small and Medium Enterprise), all over Europe.

Here are the pertinent snips from the article in the 'Süddeutsche', translated by me:

The interest could hardly be lower than today. Now, the ECB council is discussing what other means are yet available, in order to stop the euro-crisis. 

One of the solutions could be, that new creditlines will only be enabled by the ECB, when the receiving banks agree to use the money for financing industrial companies and small and medium enterprises.

The Süddeutsche Zeitung has learned from insiders in the matter, that the ECB council is considering to deploy another massive lending facility with a long maturity rate – a so-called LTRO. 

The big difference of this LTRO with previous ones would be, that only banks would receive money, which forward this money as a loan to industrial and small and medium enterprise companies. This would be the first time that the ECB would enable such a special purpose lending facility: a possibility that has been explicitely allowed in the statutes of the ECB.

Among European politicians, as well as among the executives of the ECB itself, there are many opponents against this particular plan. These people point at the fact that the ECB would enter dark territory. ‘When you start such a facility, where will it end? Would the ECB eventually subscribe that the money could be lended to hairstylists, but not to solar studios?” 

Earlier experiences have also not been really encouraging. The Bank of England earlier established a comparable program with the name ‘funding for lending’. Most merchant banks said “thanks, but no thanks!”.

ECB officials, on their behalf, pointed at the fact that two earlier LTRO’s from the ECB hardly ended in the real economy, like they should have. The almost one billion euro of these LTRO’s had been used for other, more lucrative investments. Especially south-European banks used these inexpensive loans to buy domestic sovereign bonds and cash the difference in interest-rates between the ECB and the sovereigns: a so-called carry trade.

According to an investigation of the DZ-Bank, Spanish financial institutes currently hold approximately 34% of all Spanish sovereigns bonds, while Italian banks increased the volume of domestic sovereigns to €415 billion, from €240 billion in 2011. Irish (60+%) and Portuguese (51+%) banks executed the same carry trade. 

This business in particular is very rewarding, as banks don’t need equity capital as a financial risk buffer for these state loans, in contrary to loans for industrial and SME companies, which do require such a buffer. Many banks therefore diminished their corporate and SME loans, in order to lend their money to the European countries.

This whole article is a must-read for everybody, who either can read German or uses Google Translate.

This article proves the perversity of the so-called carry-trades, which banks in many European countries have executed. 

These banks received virtually free money from the ECB, through the LTRO’s. Instead of investing this borrowed money there, where it would really help the European economy, the banks have been spurred by the big, virtually “risk-free”  profits, to fill the financial potholes of governments in the South of Europe.

These governments have used this borrowed money from the commercial banks to kick the can down the road and postpone the inevitable changes, as far as economic reforms are concerned.

So instead that this LTRO money from the ECB helped to reinforce the European economies and industries, thus bringing back growth, it led to further economic stagnation and prolongation of the current ‘status quo’. 

Just like with many other European plans and ‘good deeds’, the negative side-effects have surpassed the original positive cause. And that is what probably will happen with this news ECB LTRO plan too, when it will ever be executed at all:
  • First, the number of financially rock-solid, industrial and SME companies is very low. Companies that are financially sound mostly don’t need the money, while companies that do need the money are often not financially sound.
  • Second, banks don’t want to invest at all in (especially) SME companies. The profits are still very low, in comparison with the administrative expenses for handing out these loans safely and the substantial risk for defaulting customers, that the banks run with every loan. This will hardly change with the arrival of “free” ECB money;
    • The risk buffers and collateral that are needed in order to hand out such loans are just too expensive, to make these loans really profitable;
    • Banks reinforced their approval process to absurd levels, in order to diminish the number of defaults on bank loans;
    • Banks therefore will just 'go through the motions', when it comes to handing out loans to industrial and SME companies and will use the rest of the money in much more lucrative carry trades after all.
  • Third, spurring the supply of goods and services does not do anything about the demand for these goods and services, except for enabling some new jobs;
    • Although there are some green shoots all over Europe, there is still a consumer strike in many European countries;
    • Even when the money would be used to spur exports to countries outside Europe, the success rate would be questionable: the US economic revival seems to stall currently, while the situation in the BRIC’s seems to have deteriorated over the last few months;
  • Fourth, the German government and the German constitutional court in Karlsruhe seem to be totally against every action of the ECB, which takes place beyond their grasp.
    • Both institues want to have the ECB at the shortest possible leash and they will probably find ways to sabotage this plan.

Summarizing, this plan by the ECB seems to be a ‘nice’ and ‘sympathetic’ idea, but I’m afraid that it’s ‘dead on arrival’, before the first euro has been handed out by the ECB.

On top of that, is seems useless  to these eyes, to sponsor the supply side (i.e. companies producing goods and services) with cheap loans, without doing anything about the demand side (the European consumers, who have virtually stopped consuming).

It would be a shame when this third LTRO would end, being ‘wasted money’ again, just like the previous two LTRO’s seem to have been.

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