Copy-pasting Mario Draghi: ‘There is no plan B’

On the website of the ECB Mario Draghi’s recent Introductory statement to the press conference (with Q&A) can be found. I disagree with mister Draghi: in the Eurozone, not the banking system but unemployment is the main problem. Draghi doesn’t even mention the record breaking, historical unique levels unemployment… (more on that soon). With that in mind and as banks indeed are a problem, I copy-pasted and scrambled the text of his answers to the press conference questions a little bit and added some remarks to obtain a more homogenous text (only the very first quote is a little out of context). His analysis of the Eurozone banking system is alarming:

What is not going well?

1. The Euro does not work the way it is supposed to work (and banks are a problem):

We have fully addressed the funding issue through a variety of instruments – non-standard measures, predominantly. And one of these allowed banks to lend to firms and use the loans extended to firms as collateral for their borrowing from the ECB, from the Eurosystem. Now, it so happens that this measure works beautifully in some countries but does not work at all in other countries. So, the issue now is to understand why it does not work in certain countries. What is not going well? That is one issue that we will have to look at.

2. Stimulus works (and governments are a problem but banks are a problem, too)

Another point is that I think one should always be mindful of what the ECB can do and what it cannot do. We cannot replace capital that is lacking in the banking system. That is quite clear. We cannot compensate for lack of action by governments – for example, in some countries the most powerful stimulative measure that the government can undertake is to pay back the arrears, which in some cases amount to several percentage points of GDP.

3. Banks are a problem

Finally, when we look at measures undertaken by other countries, or by other monetary policy jurisdictions – always keeping in mind that our institutional set-up is different, and we have to act within that set-up – we see that, first of all, not all experiences are encouraging. We see that some of these measures have been taken but with very little reaction on the credit side. In other cases, the measures were suited to the specific financial market set-ups. In other words, when you have a very important share of financial intermediation taking place through capital markets, then you have assets that, potentially, the central bank may decide to buy. These assets have a price, have a rating. In the euro area we have only a small share of financial intermediation taking place via capital markets, and a large share, roughly 80%, taking place via the banking system. So in the specific case of the euro area, all these initiatives are much more difficult.

4. We’re all in this crisis together

We can now see that this weakness is extending to countries in which fragmentation is not an issue.

5. Cyprus: Draghi was outraged about bailing in small depositors (but the ECB was there and was part of the problem).

The ECB had presented a proposal that did not foresee any bail-in of insured depositors. And let me also tell you that this was exactly the same for all the other proposals – the proposals by the Commission and the IMF had exactly the same feature. Then there were prolonged negotiations with the Cypriot authorities, represented at that meeting, the outcome of which was what you know, namely a levy also on insured depositors. That was not smart, to say the least, and it was quickly corrected in a Eurogroup teleconference on the next day. But that is what is past.

6. Cyprus: we were not knowing what we were doing, as we did not have a template and it is no template but we really need a template and we will have a template which will look quite a bit like it (and banks are a problem). Aside: the ugliest english word I’ve come across in quite some time is introduced, too.

Third, let me stress that Cyprus is not a template! I have not had chance to talk to the President of the Eurogroup, but I am absolutely sure that he has been misunderstood. After all, the bail-out of the Dutch bank SNS REAAL, which involved the bail-in of only shareholders and junior debtors to the tune of €4 billion, had been agreed only a few days earlier. And that is no template either….

A bail-in in itself is not a problem: it is the lack of ex ante rules known to all parties and the lack of capital buffers or other “bail-inable” assets that may make a bail-in a disorderly event. The existence of buffers of “bail-inable” assets is therefore essential. In the case of Cyprus, one peculiarity was the fact that these assets were actually quite limited by comparison with the size of the banks… A draft directive is now under discussion in the European Council and the European Parliament that specifies a pecking order of the categories of asset holders that could be bailed-in. In this context, we would really like to see these rules enter into force, not in 2018 or 2019 as is envisaged, but much earlier, for example in 2015… The Single Supervisory Mechanism (SSM) would not actually call for a mutualisation of losses… Banks should not only be properly supervised – with a view to them not outsizing the economy in which they reside – there should also be enough buffers, be they of capital, be they of other “bail-inable” bonds or of other sorts of “bail-inable” liabilities.

7. Banks in Luxembourg and the Netherlands are a problem, too. And governments need a surplus because banks are a problem.

Recent experience shows that countries where the banking sector is several times larger than the economy are, on average, more vulnerable. Financial shocks hit these countries harder – simply because of the size of their banking sector – than countries where the banking sector is a smaller component of the economy. We have seen this everywhere, really, beginning with the United Kingdom. So, what to do? Well, one thing is to downsize, but other things can be done. You have to run your country and your banking system in a more conservative way than you would do normally. Namely, do not have budget deficits, and maintain large capital buffers or large buffers of “bail‑inable” assets. That is the sort of advice one could give. It is very difficult to choose, ex ante, what your business model is; in fact you only realise that your country’s business model is wrong when a crisis arrives. But I think people ought to learn from what we are currently experiencing and follow this advice – namely, run both the country and the banking system much more conservatively.

8. We’re still not doing what we should have done a long time ago

The entering into force and implementation of the Single Supervisory Mechanism (SSM) is absolutely essential. There is no better way to prevent such crises than to shed light on the situation of the national banking systems through the sort of international oversight that would be provided by the SSM. This applies to Ireland, Spain, Greece and now Cyprus. Any delay on this front is therefore extremely disappointing.

9. Austerity kills the confidence fairy which disables Ricardian equivalence which means that real life fiscal multipliers are larger than assumed in many economic models.

I don’t think fiscal multipliers have been underestimated. Domestic demand turned out to be weaker than expected, essentially because of the heightened uncertainty and lack of confidence.

10. All debt is created equal – but some debt is more equal than other debt

As for the second question, there is nothing in the market that says that the ELA is senior, but if you want to remain as a counterparty in the ECB’s monetary policy operations, it should certainly be treated as such.

11. There is no plan B

There is no plan B.