Sunday, November 23, 2014

Saving Europe’s Real Hegemon

MUNICH – Last June, the European Commission announced its about-face on bank restructuring. The money for recapitalizing distressed banks would now come primarily from creditors, not European taxpayers, with a pecking order to specify which lenders would be repaid first. All of this is welcome, at least in principle. In practice, however, the scheme leaves much to be desired.

The problem is that a very long list of exceptions reduces the recoverable assets to such an extent that in many cases it will still be impossible to make do without public money. The long-term plan is that this money should come from a fund created by European banks themselves. But the Eurogroup (a meeting of eurozone finance ministers attended by the European Union’s economic and monetary affairs commissioner and the European Central Bank president) is suggesting that, until then, the European Stability Mechanism (ESM) – and thus the taxpayers – will fill the gap.

Given that taxpayers are thus supposed to finance guarantees for deposits up to €100,000 ($133,000) – the median level of Dutch household wealth and twice the German median – the Eurogroup’s proposal boils down to a massive redistribution of wealth in Europe, the dimensions of which are not understood by the public.

The idea of exempting banks’ secured debt from the pecking order for repayment is extremely problematic as well. While this proposal may sound harmless and almost self-evident, it is not; secured debt needs no further protection, because it is already secured. Viewed from this perspective, the additional protection afforded by the exemption is highly surprising.

The exemption for secured debt undoubtedly concerns mainly the refinancing loans that the ECB has extended to commercial banks against increasingly weak collateral. For the eurozone’s crisis-ridden economies (Cyprus, Greece, Ireland, Italy, Portugal, and Spain), the combined total is €732 billion. These loans extend far beyond providing the liquidity that these countries need for internal circulation, for which a maximum of €335 billion – their available stock of central-bank money – would have sufficed. Instead, by weakening safety standards, bailing out foreign investors, and financing current-account deficits, the ECB has undercut and replaced the private European interbank market.

With several banks in the crisis countries on the verge of bankruptcy, many of these loans have now turned toxic. After all, if one takes the average of estimates reported by reputable sources, the write-off losses of the six crisis countries’ banks amount to about €670 billion. Participating in these write-offs would put huge strain on the Eurosystem (the ECB and the central banks of the eurozone member states), which has only around €500 billion in equity capital. The riskiness of the ECB’s strategy of using the printing press to bail out banks, including their public and private clients, would become apparent to everyone.

Thus, it is clear how the losses incurred by the ECB’s de facto regional fiscal policy are to be avoided: the write-off costs will be transferred from the ECB to the ESM. This makes no difference to taxpayers, who will have to pay for both institutions’ losses in the same manner. But it has the advantage of allowing the ECB to present itself as having a clean balance sheet, thereby enabling it to maintain its current policy.

Ultimately, this is merely a new round of the eurozone’s old game of financial hide-and-seek, whereby losses are obscured by distributing them among different institutions and time horizons. The game started with the bailout fund for Greece, which was followed by the European Financial Stability Facility, the European Financial Stability Mechanism, and the International Monetary Fund, which in turn were relieved by the ESM. In each case, a major objective was to reduce the burden on the ECB, which had advanced the money by printing it and would have run into serious difficulties without help.

The entire arrangement is highly problematic from the standpoint of democracy, because the initial decisions about undercutting the capital markets by means of public credit were taken by the ECB’s Governing Council, in which large countries like France or Germany have the same voting power as Cyprus or Malta. Indeed, the national central banks’ allocation of emergency liquidity assistance required approval by only one-third of the Governing Council’s members, and the six crisis countries had these votes. According to the Eurogroup’s proposal, these self-awarded loans, too, are now to be secured by ESM funds.

While the European Union’s national parliaments must still decide on the scheme, they essentially have no option but to assent, because to do otherwise would severely harm the ECB. When they finally get to vote on the matter – years after the ECB’s risky credit maneuvers – they will have no choice but to bail out the ECB, the true hegemon of the eurozone.

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    1. CommentedGianluca Cerritelli

      Professor Sinn arguments seem very sensible at first look. Where I start having problems though is when he says: "The riskiness of the ECB’s strategy of using the printing press to bail out banks, including their public and private clients, would become apparent to everyone". I don't think this is as self-evident as implied.
      First: what would be the risk of NOT using the printing press (which is not what actually happened, but let's accept it for the moment)? What of the 2 outcomes is the worse one?
      Second: I don't understand if Professor Sinn doesn't believe at all that monetary policies can have real effects. If he believes that they can't, this means that he doesn't see the use of a central bank at all, I suppose?

    2. Commentedhari naidu

      As lender of last resort, ECB has no other technical choice but to facilitate and transform the EZ macro prudential oversight.

      Berlin has officially saved some E40B during current budget cycle on accrued interests principally due to ECB policy.

      Moreover, EP is sovereign. And, as ECB begins structuring Banking Union and its supervision, including so-called *zombie banks*, EP will become the most critical sovereign oversight entity.

    3. CommentedLennart fredrikson

      "Eurozone at Critical Juncture"
      Prof. Sinn points very well out the smoke screen of liabilities and Funds like the PIGS selfapproved ELA loans.
      Further costs for Bank Bailouts of ZOMBIE BANKS to be backed by taxpayers! Now clear Eurozone management not better than JPM or GS in thifty hide and seek of Public money. This obviously undemocratic process unseen to BIG PUBLIC make credibility in present EU leaders&Institutions policies alarming! Constant new TREATY violations without any sanctions! This PUBLIC MONEY POKER GAME have passed into POLITICIANS suffering same excuberant feeling as BIG BANKERS "I AM TOO BIG TO FAIL" The deck of cards will fall apart! Time declare a NO to unresponsable game with TAXPAYERS MONEY!The HOLY COW "EURO" at a very CRITICAL JUNCTURE!

    4. CommentedJavier Sanchez

      Oh man, here we go again. In a fiat money system with a currency (the Euro) not backed by gold or any other asset floating freely against other currencies, what exactly does it mean to have the Eurosystem with negative equity? Hmmm... not much.

        CommentedGerin T.

        You can have negative equity as long as the people's trust in the stability of the money remains, however the point I believe Mr. Sinn is making, is that this amounts to a redistribution. The money is being taken from the State (i.e. the taxpayers) and given to wealthy capital owners (not even necessarily European), because they are bailed out with ECB money while the ECB's capital that the State payed in as well as some future profits of the ECB that would've gone to the state are "lost".

        Now even if one were to say that the policy of "save first, distribute losses later" or "use Central Bank balance sheet because it's not real anyways" is the right (or least bad) one, one still has to consider the special case of the Eurozone, were the losses (or forgone profits) of the ECB touch all European taxpayers, whereas the addressees of the ECB bailout money are all in the periphery, thus redistributing within the EZ without parliamentary control.

        As for the argument that the ECB needs to be expansionary, I strongly support this. However, the ECB can be expansionary, without redistributing. For example, the ECB could easily buy sovereign bonds of ALL EZ countries on the secondary markets.. akin to QE of the Fed or BoE.

        CommentedArmin Haas

        @ Gianluca Cerritelli

        Gold is a good store of value because it does not corrode. Moreover, because you do not need it for anything, its amount is rather invariant on small time steps, i.e.within years to decades, depending on contemporary mining technology.

        When used as currency base (whether as redeemable gold in a backing scheme or by pegging a currency to the price of gold), it serves as a means for anchoring human expectations and as an attenuator of social (monetary) dynamics. Fiat money, in contrast, can rather easily be manipulated by changing the rules of the game.

        CommentedGianluca Cerritelli

        Sorry, but this I really don't understand. Why gold has any value in itself? Food... if one doesn't dispose of it he will starve and die; water... again if one can't drink a given quantity constantly he will die. But gold? You don't need any quantity of gold, big or small, to live.
        As I understand it, gold has value for the simple fact that we believe it has value. Same as Money! The way I see it the only reason why gold has this halo of preciousness over money is historical: our ancestor started to use gold to exchange assets about 10,000 years ago and money only about 3,000 years ago. Apart from that, what's the difference?

        CommentedArmin Haas

        @Javier Sanchez

        This is the crucial question, heavily debated among theoreticians, and practitioners. In my opinion, this boils down to a co-ordination exercise: If sufficiently many people (whatever this may mean in numbers) believe that it won't mean much, then it will indeed not mean much. If, however, sufficiently many people think otherwise, it will matter a lot.