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The New World Ordoliberalism Part 5: The TLTRO and Waiting for Godot. And Sanity.

With European Union continuing its slow steady fall into deflation, the question of “what’s to be done?” has becoming a permanent fixture for European policy-makers. But for the eurozone, with it’s shared monetary system, the question is a much more complicated “what should we all be doing together?”. The answer to that latter question, unfortunately, has consistently been “not enough”, despite prior promises [1].

This is not to say that there have no attempts to stimulate the eurozone economies. On the contrary, for the past three years, the ECB has been offering hundreds billions of euros in low interest [2] loans out to eurozone banks and for the past three years banks have been accepting those loans [3]. Accepting those loans and then paying them back. But not lending those loans. And when you factor in the seemingly permanent austerity regimes imposed across the eurozone, that lack of lending is no surprise.

Still, the ECB hasn’t given up entirely in its attempts to reflate the eurozone. Back in June [4], the ECB decided to inject another 400 billion euros into the eurozone banking system in a two-phase loan program. And as we’ll see below, in both phases the eurozone banks wanted far [5] less [6] than what was offered while continuing to pay back their previous loans. In other words, while the ECB has been trying the expand the monetary base in the eurozone’s financial markets that monetary base has continued to shrink. As the excerpt below puts it, it’s like ‘Waiting for Godot‘. And as we’ll see at the end, it really IS like Waiting for Godot, theatrics [7] and all [8].

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There was a recent Ernst & Young report on the amount of lending by Spanish banks that painted a glass-is-half-full picture for Spain’s banks: while loans to corporations and businesses by Spanish banks fell 5.7 percent in 2014 (and 1.5 percent across the EU), a recent Ernst and Young report projects a 1.8 percent rebound in Spanish bank lending next year and another 5.4 percent rise in lending in 2016 [9]. In other words, Spain’s economic dead cat might start bouncing soon, and after a year or so the cat shall rise again! At least that’s the projection from the Ernst & Young report. And who knows, maybe that’s what will happen.

But keep in mind that it’s still a rather significant and ominous phenomena that EU bank lending has fallen at all in 2014 since the European Central Bank has been driving borrowing costs down significantly and basically giving banks nearly free money to lend via the “Targeted Long-Term Refinancing Operations” (TLTROs) and yet lending has fallen. It’s almost as if waiting for the stimulative effects of the free ‘TLTRO’ cash is like Waiting for Godot [10].

Except under the ECB’s ‘Godot scenario’, the ECB keeps promising the arrival of Godot while the ECB’s pro-austerity allies leave Godot tied up in an attic somewhere [11]. And the wait continues… [5]:

TLTRO effect is the ECB’s Waiting for Godot
By Ross Finley
September 23, 2014

When banks are offered hundreds of billions of euros worth of what is essentially free money and they don’t take everything they can get, something has gone seriously wrong.

The European Central Bank’s latest offer of cheap cash to banks — only this time tied to loans they provide to private sector businesses rather than with no strings attached — has gotten off to a weak start.

That suggests not only that temporary liquidity for lending may be the wrong approach to boost a flat-lining euro zone economy that is barely generating any inflation, but it also underscores the much more serious lack of demand in the economy.

With only 82.6 billion euros taken up in the first of two tranches it is now clear that the ECB will not be able to find enough takers for the 400 billion euros it has put on offer.

The latest Reuters poll of euro zone money market traders predicts that banks will take up 175 billion in the December auction, leaving one-third of the cash untapped.

To put that number in perspective, when the ECB last offered money like this in the depths of the euro zone debt crisis a few years ago banks swallowed up more than one trillion euros. That made for explosive results on asset prices [12] but also did very little to spur lending [13].

Now ECB President Mario Draghi, who is running an institution that appears programmed to do everything in its power to avoid outright purchases of sovereign bonds as a policy option, is running out of room for manoeuvre.

Part of the problem is he’s spinning a lot of policy plates at the same time.

The latest round of cheap cash — dubbed Targeted Long-Term Refinancing Operations (TLTROs) — comes along with record low interest rates and an even more-negative deposit rate, which in theory should drive banks to take the cash and lend.

The ECB also plans to build up the Asset-Backed Securities (ABS) market in Europe in order for the central bank to swoop in and purchase vast swathes of it.

That will be lucrative for those who want to sell on those securities, and some traders have suggested that waiting for details on ABS purchases has interfered with the TLTRO.

Either way, banks will need to expand credit in order to usher in a climate where securitisation — which involves parceling together new securities backed by loans against assets — takes place. The idea is to connect small and mid-size businesses with the broader capital markets, where large companies tend to go first to borrow.

But that underlying lending does not appear to be happening.

Lena Komileva, chief economist at G+ Economics, wrote:

In market psychology terms, it creates a dangerous market co-ordination loop between ‘buying’ the ECB announcement and ‘selling’ policy action, which threatens to disrupt the core channel of policy transmission into real economies – confidence.

In other words, so long as markets are just trading the effect from policy announcements but not actually responding to the policy, nothing will ever happen to real lending.

The ECB also is close to wrapping up a lengthy assessment of euro zone bank balance sheets and will have to walk a fine line reporting the results in order not to create havoc if they contain any ugly surprises.

So why won’t banks take free money in the meantime?

Komileva explains it this way:

The big difference between bank activities in financial markets and in real economies is the financial incentives and risk aversion. Lenders manage their cost of credit and capital more efficiently by selling securities to other investors and by borrowing from the ECB, whereas when a loan is made in the real economy it stays on the bank’s books until it matures. This is an expensive diet for capital-constrained banks.

Lending to the private sector has been in decline for the better part of two years [14] and shows no signs of abating since the TLTROs were launched in June.

The latest data from the ECB due on Thursday are expected to show a 1.5 percent annual decline in lending, according to the latest Reuters poll, barely changed from the month before.

Economists appear to be paying very little attention to this data series, making no visible attempts to establish the link [15] between whether a revival in private sector lending might generate any significant amount of inflation.

There’s a lot to absorb there, and the part at the end about the utility of just giving peopbut note this key point made in the article:


Either way, banks will need to expand credit in order to usher in a climate where securitisation — which involves parceling together new securities backed by loans against assets — takes place. The idea is to connect small and mid-size businesses with the broader capital markets, where large companies tend to go first to borrow.

But that underlying lending does not appear to be happening.

Lena Komileva, chief economist at G+ Economics, wrote:

In market psychology terms, it creates a dangerous market co-ordination loop between ‘buying’ the ECB announcement and ‘selling’ policy action, which threatens to disrupt the core channel of policy transmission into real economies – confidence.

In other words, so long as markets are just trading the effect from policy announcements but not actually responding to the policy, nothing will ever happen to real lending.

As the article points out, while the Draghi-wing of the ECB continues to fight with the Bundesbank and its austerity coalition over how strongly to back the proposed monetary stimulus programs like quantitative easing (QE), it’s all moot if the banks don’t take that central bank cash and loan it out.

That’s part of the reason it’s so ominous that bank lending fell across the EU in 2014: it’s not just a bad sign that economic demand is so tepid that banks lack the customers looking for a loan. The shrinking EU credit market also threatens the entire mechanism by which a QE stimulus plan would even operate in a useful way.

Solely relying on QE and other forms of monetary stimulus might be useful if consumer demand hasn’t already collapsed and interest rates aren’t close to zero. But when that economic collapse has already taken place, interest rates are already near nothing, and consumer demand is far below what it used to be, even handing out free cash to banks isn’t necessarily going to be enough to reverse the condition. Those banks have to have someone to lend to if the stimulus is going to work.

Still Waiting For Godot…
Now, if fiscal stimulus was actually allowed in the EU this could be dealt with. But since fiscal stimulus isn’t allowed, it’s exclusively up to the ECB’s underwhelming monetary measures, like the ‘free money’ TLTROs, to carry the day. It’s one more reminder of why relying exclusively on monetary stimulus and abandoning fiscal stimulus is so insane when you’re facing Depression-like conditions and shrinking crdit: the chicken-and-egg problem can be solved pretty easily as long as fiscal stimulus is allowed. Otherwise, it’s just more ‘waiting for Godot’, with the additional hope that Godot knows how to solve the chicken-and-egg puzzle [6]:

The Wall Street Journal
Money Beat blog
Europe’s Banks Are Reluctant Borrowers
11:36 am ET
Dec 12, 2014
By Alen Mattich

The European Central Bank is swimming against a very strong liquidity tide.

Quite how strong is evident in this week’s bank refinancing operations. On Thursday, the ECB reported that the region’s commercial banks are taking up some €130 billion of super cheap central bank funding in the second installment of its Targeted Longer-Term Refinancing Operation (TLTRO). That level of demand verged on disappointing–earlier forecasts had figured on a €170 billion flow to banks.

But even the resulting take-up overstated the situation. On Friday the ECB reported banks are paying back a shade under €40 billion of its previous LTRO funding scheme, leaving the net infusion at a mere €90 billion.

The eurozone’s banks just aren’t that interested in holding onto the ECB’s largesse.

In February 2013, there was nearly €850 billion of LTRO funds outstanding. By this September, in the absence of any further ECB operations and a steady flow of bank repayments, that total had shrunk to under €350 billion.

These bank sector repayments have been a major factor in the shrinkage of the ECB’s balance sheet during the past couple of years. In early 2012 the ECB’s balance sheet was more than €3 trillion. By the end of this summer it was only just above EUR2 trillion.

Banks haven’t wanted cheap ECB funding because they haven’t wanted to lend the money out. Instead, they’ve focused on rebuilding their balance sheets to make up losses incurred during the crisis and to meet more stringent capital requirements. Lending to the private sector has consistently shrunk during the past couple of years.

So following the tepid 82.6 billion euros in TLTRO borrowing back in September, the eurozone banks took only took 130 billion euros in December, far less free “TLTRO” cash than was offered or even expected. And, of course, it’s even worse because…:

In February 2013, there was nearly €850 billion of LTRO funds outstanding. By this September, in the absence of any further ECB operations and a steady flow of bank repayments, that total had shrunk to under €350 billion.

Banks haven’t wanted cheap ECB funding because they haven’t wanted to lend the money out. Instead, they’ve focused on rebuilding their balance sheets to make up losses incurred during the crisis and to meet more stringent capital requirements. Lending to the private sector has consistently shrunk during the past couple of years.


while the ECB’s pro-austerity allies leave Godot tied up in an attic somewhere

That pretty much encapsulates the situation from a bank balance sheet standpoint. Banks will take some of the free ECB cash because it’s useful even if they aren’t planning on lending it out (like for rebuilding balance sheets), but that lack of lending also means any sort of sustainable banks-borrowing-from-the-ECB-lend-it-out-and-jump-start-the-economy virtuous cycle is simply not going to happen. And as a consequence of all this, eurozone banks’ balance sheets have been shrinking for the past two years as the world watches Europe descend into a deflationary death spiral.

Is Godot’s Absence a Source of Strength?
Bad news abounds! Or does it? After all, the worse the economic news, the stronger the ECB’s pro-stimulus stances become. At least, that’s what one might assume if one also assumes the proponents of austerity actually care about ending Europe’s near depression. Waiting for Godot can lead to a lot wishful thinking [16]:

Forbes
The Weaker The Eurozone, The Stronger The ECB?
12/12/2014 @ 3:18PM

Jeremy Hill

Yesterday (Thursday), Eurozone banks were offered virtually free money from the European Central Bank through the Targeted Long Term Refinancing Offering (“TLTRO”). Guess what happened? An almost universal “non/nein/no/não/geen/óxi thank you,” Mr. Draghi! OK, if we must, we will take just €130 billion of your free money because honestly…, we have no one to lend it to. In total, 306 Eurozone banks took in the TLTRO funds. That’s a bit less than €2.6 billion per bank on an average basis with about 25% of the total amount going to core Eurozone country banks. Ultimately, the weak showing of this tranche of the TLTRO may make it easier for the ECB to convince the Germans to go along with a US style quantitative easing notwithstanding the Maastricht Treaty’s prohibition on monetizing fiscal deficits (a very big NEIN! According to Angela Merkel and Jens Weidmann).

Banks not wanting free money speaks volumes to the very weak level of European loan demand. Except for refinancing, there is no impetus for Eurozone businesses to request new loans from their banks. The fundamentals of the Eurozone economy do not warrant capital expenditures or risky research & development programs funded by bank loans. At the same time, the very low interest rates and inflation expectations do not create the feeling of urgency for companies to take on additional capital.

For the Eurozone to get fiscally healthy, aggressive monetary policy will need to play a role. However, what ails the Eurozone has never been about monetary policy. Monetary policy is merely a salve and the ECB is a temporary savior. The Eurozone’s problems are structural in nature and include balance of payments, labor costs, regulatory/employment inflexifbility, demographics, fiscal deficits/debt and above all, very low final demand for goods and services. Hence, the current Eurozone economic malaise which includes low-flation, disinflation or deflation and simply stultifying complacency of investment animal spirits. In this context, the job of monetary policy is to provide cover and time for the more difficult political and policy changes that realign economies and trade. We don’t dare to hope that these changes will be anything other than incremental and allow for further muddling through. What the ECB’s liquidity injections have done is prevent the Eurozone from lurching from crisis to crisis. That is a temporary state that cannot be indefinitely maintained, no matter the size of the potential liquidity injections or the verbal skills of Draghi.

Note that when the article says “For the Eurozone to get fiscally healthy, aggressive monetary policy will need to play a role. However, what ails the Eurozone has never been about monetary policy. Monetary policy is merely a salve and the ECB is a temporary savior. The Eurozone’s problems are structural in nature and include balance of payments, labor costs, regulatory/employment inflexifbility, demographics, fiscal deficits/debt and above all, very low final demand for goods and services,” the kinds of “structural” adjustments to the rules of business and the economy that are generally implied by such statements include things like lowering wages, cutting pensions, gutting the safety net, making it “easier it hire and fire” during a time when mass firings would probably result, and just generally enact exactly the kind of “structural reforms” that will kill demand and remove the need for banks to make new loans, short-circuuiting the stimulative power of monetary measures like QE.

Of course, this doesn’t mean EU members can’s benefit from “structural reform”. Just not those reforms. There could be non-supply-side reforms like strengthening the safety or making government the employer of last resort. Afterall, creative destruction [17] is far less destruction when you aren’t destroying lives in the process. And, of course, the kinds of “stuctural reforms” that protect those lives during the process of ‘creative destruction’ are slated to be destroyed under an austerity agend. So why not develop “structural reforms” that enable “creative destruction” without destroyed lives? It’s an option. But since the idea of New Deal-style “structural reforms” is in the process of being unpersoned [18], it’s an easy to forget option.

Skipping down…

With the feeble take up of the latest TLTRO tranche, the ECB might just be forced to actually buy bonds. Not now, but eventually. The other piece of bad news from the Eurozone yesterday was the fact that French inflation went negative for the month of November. That is the first time that French core CPI has been negative since 1990 which is when this economic indicator was first collected by France.

Did you catch that? France’s inflation rate went negative for the month of November [19].

Continuing…

It may be that the US has exported to the Eurozone our previous central banking mantra: good news is bad; and, bad news is good. That is, the worse the micro economic data becomes in Europe, the easier it is for the ECB to press their case for further monetary stimulus. The caveat is that the market has already essentially front run further ECB liquidity. That may mean that the ECB has a very short and defined window for attempting QE or some other non-traditional liquidity injecting policy. If they wait any longer, the risk tilts toward changing risk-to-reward dynamics, creating asset bubbles and denigrating financial stability.

The TLTRO may eventually prove more robust in later tranches. That is not likely to happen in the near term however as there is too much uncertainty in Eurozone over the state of politics and the upcoming election cycles in Greece, Spain and France. At some point Draghi will need to succinctly command that the Germans cease and desist in their trepidation to stimuli. Should Eurozone asset price volatility increase, it will be his opening for implementing other monetary policy solutions. The fact that the German Bundesbank downgraded its own forecast for German growth next year to a mere 1% is not immaterial. All of these negatives are adding up, but the ECB is still a ways off from seamlessly pushing another €1 trillion of liquidity into the system.

The last sentence really covers it: “All of these negatives are adding up, but the ECB is still a ways off from seamlessly pushing another €1 trillion of liquidity into the system.” And the negatives sure are piling up:
Germany’s economy is stalling while France is falling into outright deflation. At the same time, EU banks are are turning down free money! Why? Because there’s no one willing to borrow because everyone expects things to stay bad or get worse. And what’s the light at the end of the tunnel?! The fact that things are so bad that investors still willing to scoop up sovereign debt and drive government borrowing costs to record lows in part because investors are assuming that the ECB will be forced to eventually by sovereign bonds in order to prevent the eurozone economy from imploding because everything else it’s doing isn’t working.

That expectation of future action by the ECB has been the underlying driver for a rally in the eurozone’s sovereign bonds that’s over two-years old [20] and that rally [21] is still going strong with no end in sight for either the EU-wide depression or an end to the Bundesbank’s opposition to ECB sovereign bond purchases or anything resembling a fiscal stimulus.

It’s a grimly fascinating dynamic: the primarily element of the market psychology holding the eurozone (and larger EU) together is faith that the ECB will eventually be allowed to do something its most powerful members deeply oppose and find ideologically threatening. And yet it’s a faith that is objectively grounded in the apparent economic hopelessness of the current situation. The markets are playing chicken with the Bundesbank and its austerian allies [22] that the ECB will eventually be allowed to purchase sovereign bonds simply to avoid an eventual financial/socioeconomic meltdown. And as long as the markets are convinced thatrobably continue to find plenty of buyers.

But until that game of chicken is resolved, the other kind of monetary stimulus poliicies being debated, like the QE targeting Asset Backed Securities (ABS) [23] aren’t going to be of any help because the existing austerity policies kill the consumer demand required to avoid a short-circuiting of the ABS QE.

Wait, Is That Godot Coming Towards Us From The End Of The Tunnel? No. It’s That Austerity Train
But wait, could it be that the even Jens Weidmann and the Bundesbank are finally getting behind the ECB’s plans for QE involving both sovereign debt and asset backed securities? Well, there was a recent Reuters article suggesting exactly that, although it was later withdrawn as erroneously based on an ECB report an not a Bundesbank report [24].

Here’s the actual update [8]:

Exclusive: ECB considers making weaker euro zone states bear more quantitative easing risk – sources

By John O’Donnell and Paul Carrel

FRANKFURT Fri Dec 19, 2014 7:08am EST

(Reuters) – European Central Bank officials are considering ways to ensure weak countries that stand to gain most from a fresh round of money printing bear more of the risk and cost.

Officials, who spoke on condition of anonymity, have told Reuters that the ECB could require central banks in countries such as Greece or Portugal to set aside extra money or provisions to cover potential losses from any bond-buying, reflecting the riskiness of their bonds.

Such a move could help persuade a reluctant Germany to back plans to buy state bonds.

There is currently a stand off between the ECB and Germany’s Bundesbank over ECB preparations to buy sovereign bonds, so-called quantitative easing (QE), to shore up the flagging euro zone economy.

But while the idea may help overcome opposition in Germany, which is worried that fresh money printing could encourage reckless spending and leave it to pick up the tab, critics will argue that any such conditions curtail its scope and impact.

Although a release of new money to buy state bonds appears all but certain, how it will happen remains fluid. The ECB’s Governing Council holds its next monetary policy meeting on Jan. 22., with market expectations high for fresh stimulus.

Requiring weaker countries to set aside extra provisions would signal that more of the risk of potential losses would rest with national central banks, rather than the ECB in Frankfurt.

“Losses are taken … by the nation states,” said one official.

The ECB declined to comment.

CHANGING SHAPE

Lobbying by the small group of countries opposed to fresh money printing is now gradually shifting towards changing the shape of quantitative easing rather than try to block it altogether.

The Bundesbank is demanding that any new round of bond buying be subject to strict limitations.

Its president, Jens Weidmann, this week outlined two such possibilities – restricting ECB buys to bonds of countries with a top-notch credit rating or allowing each central bank to buy their country’s bonds at their own risk.

“Even if you say it’s not too early for QE, there is still something to be said about how you set it up,” said one euro zone central bank official.

“If the central bank would only buy bonds from its own country, then the chances and risks would go to that central bank. What happens if there is a loss? It would be good if the central banks have made adequate provisions.”

But while setting such a precondition for any resulting losses would help win over Germany, it threatens to further undermine the notion that all 18 countries of the euro bloc are on an equal footing.

As the article points out “Lobbying by the small group of countries opposed to fresh money printing is now gradually shifting towards changing the shape of quantitative easing rather than try to block it altogether.”. In other words, a compromise. And now behold the Bundesbank’s compromises: either forcing the weakest economies to shoulder the greatest risks for any quantitative easing program, and that’s just one compromise put forth by Weidmann. or limiting the QE to only those nations with a ‘top-notch’ credit rating (QE for all the countries except those that need it).

So let’s assume the ECB really does end up accepting Weidmann’s first option of forcing the weakest economies to shoulder the greatest risk of the QE doesn’t end up turning turning the their economies around. Wouldn’t that mean that, if the QE doesn’t work out as hoped, the weakest economies will presumably end up even weaker and require even more austerity to make up for the lost ground?

Which raises an obvious question: wouldn’t the Bundesbank’s compromise mean that Berlin and its austerian allies [25] will have an incentive to derail any QE program in order to ensure a continuation of the austerity? It’s a alarming possibility, and yet, here we are. All austerity, a fizzling TLTRO, and no Godot.

So let the waiting continue. But it’s not just waiting for a mythical person to arrive. Sometimes [26] you’re waiting for them to leave [27].