Monti, The Full Version

The version in question is an interview with the Financial Times. A summary was available here, but now they have gone live with the whole interview. If you can raise it on Google or something then it is well worth a read. For one thing it will offer you a trip down memory lane. Anyone remember this?

“If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”

The reference is, of course, to former U.S. Treasury Secretary Henry Paulson, who famously used the remark in 2008 congressional testimony. But as Republican Senator Bob Corker pointed out in a subsequent hearing:

“I do want to remind you that the theory behind the bazooka was that if you have a bazooka in your pocket and the markets know that you have it, you will never have to use it. I would like to point out that you not only pulled it out of your pocket and used it, huge amounts of ammunition was pulled out of the taxpayer arsenal to solve that. I think you’ve done some very deft things and I compliment you on that, but the point is that things don’t always work out the way people, in their best efforts, think they’re going to work out.”

Well, the idea just surfaced again, this time from the lips of Mario Monti:

“I’m convinced, and the IMF is also convinced, that the more pledges are made [to the rescue fund], the higher the volume of pledges made, the smaller the probability that a single euro of cash will have to be disbursed.”

But, as former IMF Chief Economist Simon Johnson once explained, the latest version of the “bazooka” is unlikely to be any more successful than the previous one.

“Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again. This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used — probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge.”

Fortunately the ECB has deep pockets, and as I argue in this post, these will probably suffice to keep short term bond yields down to acceptable levels, and help the banks fund themselves and recapitalise. What the ECB’s LTRO’s won’t do is get new credit moving (one significant part of the initiative involves banks in the troubled periphery economies not having to write down the asset side too much too quickly, so there will be little room for “creative destruction”). As fund managers Bridgewater put it recently:

“We believe that a) there are logical limitations to the amounts of debt that creditors will choose to lend to debtors, b) at this time numerous debtors have passed their limits, and c) the projected rates of adjustment that policy makers are using, which generally mean slightly slower rates of increase in indebtedness rather than debt reductions, cannot happen. In other words, despite attempts of policy makers to push this debt expansion further, they can’t. Significant funding gaps will remain……. understandably, central banks are now trying to fill the funding gaps with abundant liquidity. At the same time, banks must contract and consolidate as they can’t adequately recapitalize.”

Leaving aside the tricky issue of the extent to which the latest Euro management initiative will work, Monti does have more interesting things to say. He is, for example, quite positive about Standard and Poor’s:

“If I ever dictated anything, it must have been what S&P had to say about domestic Italian economic policy,” he chuckles, before quickly correcting himself: “I never said the three letters BBB,” a reference to Italy’s new S&P rating of triple B plus……..“It’s very interesting when they go through the various factors, and concerning the political risk factor they say there is one negative: ‘The European policymaking and political institutions, with which Italy is closely integrated’,” he says. “And then they go on, saying, ‘Nevertheless, we have not changed our political risk score for Italy. We believe that the weakening policy environment at European level is to a certain degree offset by a strong domestic Italian capacity’. “I think I’m the only one in Europe not to have criticised the rating agencies,” Mr Monti boasts.”

As Peter Spiegel and Guy Dinmore not unreasonably conclude, the reason for this positive tone is clear: “Mr Monti’s 60 days in office have been enough to convince the agency that his government is on a path of reform that could return the country to growth and shrink its debt levels, but that European Union mismanagement of the eurozone debt crisis is dragging down struggling countries, including Italy with its €1,900bn ($2,400bn) debt mountain”.

“Over the course of the 90-minute interview, Mr Monti is careful not to challenge his counterparts directly. Asked whether the S&P analysis is a condemnation of Ms Merkel, who is widely viewed as the driver of the current response to the eurozone crisis, he is diplomatic: “I don’t think we can really single out one country or one person,” he says. Later on, when asked how concerned he is that strikes by taxi drivers and pharmacists could derail his reforms at home, he insists that when he wakes up in the morning, he is more concerned with “European leadership” than domestic unrest. “European leadership – not the German chancellor,” he quickly clarifies.”

This entry was posted in A Fistful Of Euros, Economics, Economics: Country briefings by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

6 thoughts on “Monti, The Full Version

  1. What prevents a central bank from making new loans a requirement for further financing? Or why can’t it accept corporate bonds as collateral?

  2. Hi again Oliver,

    “Or why can’t it accept corporate bonds as collateral?”

    No reason at all, although it depends on the rating, but the banks would need to hold the corporate bonds, and I’m not sure why they would do this? I mean, corporates who can issue bonds do, and those who can’t are probably the ones you don’t want to extend lending to.

    “What prevents a central bank from making new loans a requirement for further financing?”

    Well look, if life were ever so easy.

    Basically this issue is that most of the economies on the Euro Area periphery are over leveraged. That is to say the proportion of their TOTAL debt (public and private) to GDP is too high relative to their future capacity to pay, and this is really why we have the global financial crisis in the first place (including in the US), so if 4 years into the crisis people haven’t gotten thru to this, then they haven’t been reading the right kind of material.It is important to understand that from this point of view it doesn’t matter whether the debt is public or private.

    Now, and here comes the issue where there is debate, if you have too high a debt ratio (overleveraged) you can reduce it either by growing GDP (nominal GDP) or by reducing the debt. Now, here comes the rub, the countries on the periphery can’t get growth until after they have deleveraged, since getting more credit will only make them even more leveraged (Bridgewater’s point) and they have a competitiveness issue which makes it hard for them to expand their export sectors.

    Once they have deleveraged, which means the banks will have less credit on their balance sheets, then the banks can leverage again and offer new credit. This kind of deleveraging also produces deflation (economies contract along with credit) and with time competitiveness is restored (say a decade).

    The other alternative is to write off bad loans, but this means accepting losses, and government intervention in the financial sector. So banks and governments are reluctant to do this, since it balloons the deficit (see Ireland), and prefer the slow process.

    In other words what I am saying is not that no new loans are possible, but that new loans can only be issued after old ones are paid or written off, and after the balance sheet has been reduced to deleverage a bit. Which means the quantity of new loans is not sufficient to produce growth or (in Spain’s case) stop unemployment rising.

    This issue is deep structural (if complex) and there is no simple rule from a central bank which can produce new credit.

  3. Incidentally, I was only refering to corporate bonds at the start of the last comment, not bilateral loans from banks, which, of course, Mario Draghi has decided the ECB will accept as collateral. The bonds are issued by corporates themselves, and the banks only act as intermediaries to secure placement. Naturally banks who do a failed placement may end up having to eat the corporate bonds themselves, and then use them as collateral.

  4. Basically Oliver, they have to control the rate at which non performing loans appear in their returns, so they have to keep financing a large number to slow down the rate of impairment. This is what makes it hard to generate additional new loans when you are “deleveraging”. Below I reproduce the latest data on Spanish banks from the WSJ. Note this:

    “As of November, Spain’s banks had a total of €1.79 trillion in loans outstanding, down from €1.84 trillion a year earlier”.

    When you are collectively reducing your balance sheet exposure to credit in this way, and holding a lot of questionable loans to slow down the rate of increase in impairment, well basically it is hard for economies to grow. Getting growth has become a secondary issue, and that is why S&Ps downgraded.

    MADRID—The bad debt ratio of Spain’s banking sector rose for the eighth consecutive month in November to a new 17-year high, data released Wednesday by the Bank of Spain showed.

    According to the data, 7.51% of loans held by banks were more than three months overdue for repayment in November, up from 7.42% in October. It’s the highest percentage recorded since November 1994, and contrasts with bad debt levels below 1% of all loans in the years prior to the collapse in 2008 of the country’s property sector.

    Overall, €134.1 billion ($170 billion) in loans were non-performing in November, up from €131.9 billion in October and €104.7 billion a year earlier.

    As of November, Spain’s banks had a total of €1.79 trillion in loans outstanding, down from €1.84 trillion a year earlier.

    Lenders have been struggling to cope with steep losses on loans extended to the real-estate and construction sectors, as the country tackles the deepest economic downturn in decades and an escalating debt crisis in the euro zone.

  5. Pingback: Falling beneath the threshold [The Economist] | DreamInn

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