Category Archives: European Union

Europe’s problem is monetary, but that’s not all

Lars Christensen has a pretty good post on how Europe’s problems are not fiscal when you compare it to the US. He points out — rightly, I think — that the difference in recovery between the US and Europe is monetary (see Pawelmorski for more). But then there’s this:

The fiscal tightening in the US and the in euro zone have been more or less of the same magnitude over the last four years. So don’t blame ‘austerity’ for the euro zone’s lackluster performance.

But I will, at least partly. The fact that relative difference stems from monetary policy doesn’t exactly mean that the fiscal multiplier is zero now. I think there’s good reason to loosen both where possible.

Luxembourg AAA? Really?

Pictet with the graph:

Debt to gdp and banking size Luxembourg AAA? Really?

And what’s the verdict from the rating agencies for Luxembourg?

Moody’s: Aaa
Fitch: AAA

Err, okay, then. Hat tip Barnejek.

The ECB can deal with bank funding problems

Benoît Cœuré from the ECB is usually the best when it comes to writing (and speaking) about the transmission mechanism and market operations. Since he’s responsible for Market Operations; Payments & Market Infrastructure; and Research that’s probably not too weird.

He gave a speech today in Dublin, which concludes:

In the nearer term, how can the impediments to bank funding of SMEs be addressed? In essence, these impediments are of three types: the banks’ own funding conditions, their perception of the credit risk of their clients, and lack of capital. The ECB does not have a magic wand. The central bank cannot compensate for a shortage, or a misallocation of equity. That is something that has to be addressed, in one form or the other, by other stakeholders. Neither can the central bank alter the credit risk of individual borrowers, although governments can have an impact here through reforms that improve the operating environment of those firms – labour and product market regulation for instance. Where the central bank has a direct role, within its mandate, is primarily with respect to bank funding conditions. Indeed, the ECB has taken and will continue to take appropriate measures to ensure that bank funding is not a source of financial fragmentation or an impediment to bank lending. It is reasonable to think that simultaneous action on all three counts, by the relevant stakeholders in each case, would be mutually reinforcing.

While I’m not entirely convinced that the ECB can’t do more than “continue to take appropriate measures to ensure that bank funding is not a source of financial fragmentation,” I guess he might be using ECB speak to tell us they can. Or maybe not. His slides are important, though. They show some very interesting trends (although not really breaking news): Screen Shot 2013 04 11 at 5.04.21 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.29 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.48 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.59 PM The ECB can deal with bank funding problems

And finally, a chart showing how SMEs fund themselves. This is interesting when thinking about QE in the eurozone as opposed to the EU. The liabilities side of the balance sheet of European corporates is very different:

Screen Shot 2013 04 11 at 5.04.55 PM The ECB can deal with bank funding problems

All slides here.

‘Love letters’

One exam done. So I was reading up on capital controls and a lot of people seem to make the Cyprus-Iceland analogy, which got me thinking about how Icelandic banks used to issue ‘love letters’ to each other. The ‘love letter’ was debt issued by the banks. Then they swapped that debt with other banks, and then used it as collateral for central bank liquidity. Here’s Anne Sibert:

Surprisingly, it was not just the Central Bank of Iceland that was willing to make loans against love letters – the Eurosystem was as well. Between the start of February and the end of April 2008, subsidiaries of the three large Icelandic banks, Kaupthing, Glitnir and Landsbanki, increased their borrowing from the Central Bank of Luxembourg by €2.5 billion. A significant amount of their collateral was in the form of love letters (Hreinsson et al. 2009, p44). It is questionable whether Icelandic bank debt should have been acceptable as collateral in the Eurosystem for any borrower. Given their inter-linkages, the Icelandic banks’ fortunes were far too highly correlated for one Icelandic bank’s debt to be satisfactory collateral against another Icelandic bank’s borrowing.

By late April 2008, the ECB had become concerned about its loans to Icelandic banks and on 25 April, the ECB President, Jean-Claude Trichet, phoned Icelandic central bank governor Davíð Oddsson and demanded a meeting with Icelandic banks and monetary and regulatory authorities (Hreinsson et al. 2009, p44). As a result, an informal agreement was made in Luxembourg on 28th and 29th April to limit the use of love letters as collateral. This proved ineffective. By the end of June, loans to the Icelandic banks had risen sharply to €4.5 billion. At the end of July, the Central Bank of Luxembourg finally prohibited the further use of love letters altogether and lending to Icelandic banks fell back to around €3.5 billion. In the autumn of 2008, five counterparties defaulted on their Eurosystem loans and three of these were subsidiaries of the large Icelandic banks (European Central Bank 2009).

From the ‘Causes of the Collapse of the Icelandic Banks‘ chapter from the Report of the Special Investigation Commission, we have the following tidbit from what happened there (p. 45):

The problem now was not only the unprotected „love letters“ being put forth as collateral for the loans at the ECB but also the currency swap agreements that were in force inside of the asset backed securities. It is clear that the Icelandic banks had angered the governors of the Central Bank of Luxembourg and the European Central Bank. At the end of July the three banks were in fact prohibited from using each others securities as collateral for loans from the European Central Bank which was effective. In general, the conduct of the Icelandic banks which has been described here, can be thought to have played a part in the fact that Iceland became eliminated from the scene of European Central Banks, but this, in return, made it more difficult for the CBI and the Icelandic government to raise liquid funds, see a more detailed discussion later in this chapter.

Also we have these graphs:

Screen Shot 2013 03 29 at 10.16.45 AM Love lettersScreen Shot 2013 03 29 at 10.11.46 AM Love lettersScreen Shot 2013 03 29 at 10.16.43 AM Love lettersScreen Shot 2013 03 29 at 10.16.27 AM Love letters

Which leads us to this announcement from the ECB:

On 20 March 2013 the Governing Council adopted Decision ECB/2013/6 on the rules concerning the use as collateral for Eurosystem monetary policy operations of own-use uncovered government-guaranteed bank bonds. Under this Decision, from 1 March 2015, the use of such bonds issued by the counterparty using them or an entity closely linked to that counterparty as collateral in Eurosystem monetary policy operations will be prevented. The Governing Council also decided to amend the rules on the use of uncovered government-guaranteed bank bonds for the period ending on 28 February 2015. To this end, the Governing Council adopted Guideline ECB/2013/4 on additional temporary measures relating to Eurosystem refinancing operations and eligibility of collateral and amending Guideline ECB/2007/9 (recast), the provisions of which encompass several existing legal acts on temporary measures. Finally, in order to clarify the overall framework, the Governing Council adopted Decision ECB/2013/5 repealing Decisions ECB/2011/4, ECB/2011/10, ECB/2012/32 and ECB/2012/34.

So everything is fine until March 1, 2015. This is — it seems to me — some housekeeping post-financial crisis. In the case of Cyprus, this bit is relevant from the original press release:

As a result, the national central banks of the Eurosystem will now only be allowed to reject eligible uncovered government-guaranteed bank bonds as collateral if they have been issued by the counterparty itself and do not comply with the Eurosystem’s minimum credit rating threshold.

Unlimited liquidity in other words, unless the ECB decide to go all nuclear again.

[And no -- this is not a perfect analogy, but it's kind of interesting since there are a few similarities. Don't over-interpret it.]

Two-tiered Europe, redux

Relatively silence from this end as of late, given other commitments (mostly exams.) I did stump upon this paper from the ECB yesterday, though, which elaborates on the discussion of the two-tiered Europe. A couple of nice graphs:

Screen Shot 2013 03 26 at 1.01.11 AM Two tiered Europe, redux

Screen Shot 2013 03 26 at 1.01.13 AM Two tiered Europe, reduxAbstract:

The Euro area economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse how financial fragility has affected the transmission mechanism of the single Euro area monetary policy during the crisis until the end of 2011. The analysis shows that the monetary transmission mechanism has been time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates mainly through the credit channel, both the bank lending and the non-financial borrower balance-sheet channel. Our results suggest that the bank-lending channel has been partly mitigated by the ECB nonstandard monetary policy interventions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SME, we infer that the policies adopted until the end of 2011 might have fallen short of reducing credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress.

Cyprus deposit tax reading [updated]

Much has been written today on the deal from last night, and I don’t have anything to add, except to say that the deposit tax on small depositors is a very, very dangerous route to take… Here are the best links to explain why:

Will update. Links in ~chronological order. In pictures [hat tips Mark Dow and Aurelija Augulyte]:Graphed Cyprus deposit tax reading [updated]   Learn to swim Cyprus deposit tax reading [updated]

Borrowing in Spain and Italy is expensive — let’s securitize it away

One of the main problems for Europe is the broken transmission mechanism. It’s been a problem for quite some time.

When the ECB cut its rate, it won’t pass through to the areas of Europe that need it: the periphery. There is thus a world in which it is easy to get cheap credit (the core) and a world in which it is expensive (the periphery) — no matter how low the refi rate is.

With that in mind, here’s a Goldman Sachs graph from an excellent note by Huw Piil:

Lending rates in Europe GS Borrowing in Spain and Italy is expensive    lets securitize it away

Here’s Goldman’s explanation of the graph (their emphasis):

Exhibit 1 illustrates the latest data, demonstrating the persistence of the gap between lending rates in the ‘core’ countries (Germany and France) that remain well integrated into Euro financial markets and the ‘peripheral’ countries (Spain and Italy). Indeed, in the January data, this specific measure points to a widening of the gap, despite the success of the ECB’s OMT programme in stabilising government debt markets and narrowing sovereign spreads.

Taking a somewhat longer perspective, it is apparent that the ECB’s easing actions over the past 18 months (the rate cuts in November 2011 and July 2012; the implementation of 3-year LTROs in December 2011 and February 2012; and the announcement of the OMT in September 2012) have passed through to lower bank lending rates in Germany and France, whereas, at best, these measures have only served contain the rise in bank lending rates in Spain and Italy.

The problem summarised by Piil:

Given the weak macroeconomic situation in the periphery, there is a concern that monetary stimulus is not being transmitted to the countries where it is most needed — this is the essence of the impairment to monetary policy transmission that so consumes ECB policymakers. And there is an important sectoral dimension to this impairment, in addition to the cross-country element that has been emphasised thus far: larger companies with access to capital markets are able to issue debt at narrow spreads to sovereigns (and therefore now at reasonable rates even in the periphery), but SMEs are dependent on banks and thus face the elevated rates shown in Exhibit 1. These two dimensions interact and amplify each other: the Spanish and Italian corporate sectors are both dominated by the SME sector.

There are thus two reasons: 1) peripheral countries are more risky and banks (and companies) are increasingly trying to match assets and liabilities on a state-line instead of on a euro zone basis, and 2) the sectoral composition of companies who need credit, where the peripheral have more SMEs without access to capital markets.

So how to ease? As Piil suggests, the ECB could use its collateral framework to support financial innovation. By now, most will probably react like this guy when they hear ‘financial innovation’, but the idea is quite good.

By relaxing the collateral the ECB accepts to include asset-backed securities where the underlying is loans from SMEs in the peripheral, the securitization could start to work.

If the loans could be packed into ABS that could be pledged at the ECB as collateral, it might increase the amount of lending in the peripheral at rates closer to the core. Obviously haircuts would have to be low enough to make it worthwhile, but not so low as to make Weidmann go crazy.

To make ABS backed by peripheral SME loans eligible as collateral might be a way for the ECB to alleviate the problems of structural differences across the monetary zone.

For reference, here’s the ECB’s website on collateral eligibility; and their website on their newly established ABS loan-level initiative.

Debt strategy of Denmark

The Danish Government Borrowing and Debt, 2012 report is out of the central bank. Not much new in there, but there are a few good graphs worth reposting.

Screen Shot 2013 02 24 at 12.50.10 AM Debt strategy of Denmark

The next one is of bids and sales of government bonds at auctions. Can you spot when the euro crisis was in full swing?

Screen Shot 2013 02 24 at 12.51.08 AM Debt strategy of Denmark

Ownership structure of the domestic debt securities:

Screen Shot 2013 02 24 at 12.53.02 AM Debt strategy of Denmark

A quick comment to the strategy of issuing in euros (not much there):

The strategy for the central government’s foreign borrowing in 2013 is to raise a loan of 1-2 billion euro with final exposure in euro. The loan will be issued in the 2-5-year segment and denominated in euro or dollars. Foreign loans with a term to maturity of up to 1 year (Commercial Paper) will be issued to maintain investor interest and market access.

And, as previously mention, the central bank is to post collateral on swaps:

The current agreements with the central government’s swap counterparties entail pledging of one-way collateral for the market value of the swaps. Consequently, the counterparties pledge collateral when the market value of the swap portfolio is positive for the central government, while the government does not pledge collateral when the market value is positive for the counterparty.

In 2013, the central government will start negotiating new bilateral collateral agreements with cash as eligible collateral. The switch to two-way collateral agreements is expected to provide for more favourable terms for the central government when concluding new swaps. This reflects that two-way collateral agreements reduce the liquidity requirements of the counterparties compared with one-way collateral agreements. The negotiations with the counterparties on new bilateral collateral agreements are expected to be finalised during 2013.

Don’t we deserve better than Olli Rehn?

Yes, we do. Jonathan Portes puts it better than I possibly could, so here’s his post on Olli Rehn’s letter:

pointed out late last year that European Commission Vice President Olli Rehn has been predicting for at least two years that, thanks to the excellent policies recommended by the Commission and the European Central Bank, economic recovery in the crisis economies of the eurozone is imminent.

However, this week – perhaps noting that outside the financial markets, the light at the end of the tunnel that he is fond of referring to appears to be receding - he’s tried a different tack. Blame the economists – and in particular, economists who want actually to use proper, theoretically based and empirically grounded analysis to critique the Commission’s policies.  Mr Rehn, in a letter to European Finance Ministers, copied to other international financial luminaries like Christine Lagarde, says:

“I would like to make a few points about a debate which has not been helpful and which has risked to erode the confidence we have painstakingly built up over the last years in late night meetings. I refer to the debate about fiscal multipliers, ie the marginal impact that a change in fiscal policy has on economic growth.  The debate in general has not brought us much new insight.”

Much of the rest of the letter is devoted to Mr Rehn’s (and presumably the Commission’s economists) attempt to debunk the findings of IMF Chief Economist Olivier Blanchard, who found, to no-one’s great surprise, that the adverse impacts of fiscal consolidation were indeed much greater than that forecast by the Fund or the Commission.

I won’t attempt a point by point rebuttal, but would note the following:

  • as I said here, it is quite true that on its own the Fund analysis doesn’t demonstrate that the Commission and Mr Rehn (and here the Treasury, Bank and OBR) are wrong.  But the whole weight of the evidence, both theoretical and empirical, does.  Our estimates of the impact of self-defeating austerity are here.
  • while Blanchard’s analysis is far from the end of the story, it is a professional piece of work by one of the world’s leading empirical macroeconomists.  The Commission’srebuttal, by contrast, would, as I say here, shame a first-year Masters’ student. [Briefly, for nerds, including sovereign yields as a "control variable" for growth outcomes is so obviously misspecified - yields are an outcome, not an exogeneous independent variable - as to be a straight fail.]

But of course the really surprising thing is that Mr Rehn should be writing to Finance Ministers, and the IMF Managing Director, complaining that an academic paper on a very policy-relevant, but highly technical issue of empirical macroeconomics, represented “debate which has not been helpful”.  I’m not trying to get on any high horse about academic freedom; it just seems bizarre.

The optimistic conclusion is that Mr Rehn recognises that the economic justification, tenuous at the best of times, for the self-defeating austerity policies pursued by eurozone policymakers is crumbling – and that, if authored by the IMF Chief Economist, even quite a technical paper (and, who knows, even blogs like mine) can make a major contribution to undermining it and, maybe, lead to pressure for more sensible policies. Let’s hope so.

Swedish central bank says, “stay” and currency rises instantly

From the FT’s Alice Ross and Richard Milne:

Sweden has indicated it is likely to stay on the sidelines of any fresh round of global “currency wars” after its top central banker said that the krona was at an appropriate level, throwing Sweden into stark contrast with other developed nations that have signalled they are concerned about the strength of their currency.

The Swedish krona rose sharply against other currencies to hit multi-month highs after Stefan Ingves, governor of Sweden’s Riksbank, said at a press conference that the krona was at a good level and that the central bank was not concerned about its recent strength. The central bank kept interest rates on hold at 1 per cent.

Ah well…