Draghi’s Asset-Backed Drive Rouses Academic SkepticsJeff Black and Alessandro Speciale
Mario Draghi’s plans for credit easing may not turn out to be all that easy.
In seeking to unblock the supply of loans to the economy by reviving the European market for asset-backed securities, the European Central Bank president risks an unprecedented reach into the functioning of the financial system that could backfire, according to academics including former Bank of England Deputy Governor Paul Tucker.
Just over a week before the ECB’s next policy meeting, where it is predicted to cut interest rates to stoke inflation, central-bank officials and researchers are meeting in Sintra, Portugal, to discuss current monetary thinking. Draghi, who has shown support for measures from negative rates to liquidity injections and large-scale asset purchases, said yesterday that buying packaged loans could reduce the “drag” on the economy.
“It seems to be a kind of structural thing for a temporary problem,” said Mathias Dewatripont, professor of economics at the Universite Libre de Bruxelles and a member of the ECB’s new Supervisory Board. “We should find ways to make sure that this thing does not get out of hand.”
The ECB is seeking ways to help companies and households access credit to boost prices and sustain the euro area’s gradual economic recovery. While the central bank’s lending survey showed conditions for new loans stabilized in the first quarter, lending to companies and households has been contracting for almost two years.
Policy makers working on a package of measures to prevent inflation staying too low for too long have looked to the ABS market as a way of encouraging banks to lend to smaller companies that are often shunned by risk-averse lenders.
The market involves packaging individual loans such as mortgages, auto credit or credit-card debt and selling them on to investors. That allows banks to share the risk of default by borrowers, encouraging them to offer more credit.
Draghi voiced optimism that there could be a revived market for ABS in Europe in a year’s time, provided regulators move to reduce the risk capital that banks need to have if they hold such assets on their balance sheet.
“Certain legislative changes need to be done,” Draghi said at a panel discussion today. “Depending on how fast the other actors move forward, why not.”
The ECB president didn’t say how or when the ECB could itself intervene.
The ECB and Bank of England will publish a joint paper on securitization on May 30. The document will expand on a previous paper in April that called on regulators including the Basel Committee on Banking Supervision to relax rules that currently impair the market for “high-quality” securitized assets. The central banks said rules agreed on in recent years to safeguard the financial system shouldn’t kill a means of stimulating credit.
European Union regulators have been wary of the downsides as the complicated structure of some products can obscure the true riskiness of the underlying assets. That happened with securities backed by the U.S. sub-prime mortgage market, which led to them being blamed by politicians and rule-setters for sparking the financial crisis.
Even if the ECB were to stand behind an ABS market linked to loans to smaller firms, the due diligence required on the part of investors in order to be able to buy the products may be prohibitive, according to Sharon Bowles, outgoing chair of the Economic and Monetary Affairs Committee of the European Parliament.
“Proper due diligence is as much qualitative as quantitative and SME loans are so heterogeneous that this is a big ask of the asset managers who may not have the skills, or it will cost so much the returns will be much reduced so the funds may not be that attractive,” Bowles said in an e-mail. A light-touch approach to such due diligence “is likely to lead to sub-prime SME loans, and we then know the story.”
Draghi yesterday held out the possibility that the ECB could purchase such securities outright. As the euro area recovers, credit demand may rise faster than supply because banks are still repairing their balance sheets and capital markets are only slowly developing.
“We have to be mindful of mismatches between these various trends,” he said in his opening speech. “Term-funding of loans, be it on-balance sheet -– that is, through refinancing operations -– or off-balance sheet -– that is, through purchases of asset-backed securities -– could help reduce any drag on the recovery coming from temporary credit supply constraints.”
Making packages of loans to companies into an attractive and tradeable investment may not be feasible without some kind of government backing that could distort the market, according to Tucker, who is now a senior fellow at Harvard Business School.
“When you say that maybe the ECB should buy this paper, how can you convince the world that it isn’t going to be at subsidized prices?” he said. “Does a viable euro-area ABS market in fact depend upon a hidden transfer union, or can it survive without a subsidy from a federal state?”
Former BOE policy maker Adam Posen, now president of the Peterson Institute for International Economics in Washington, said government backing should be considered.
“We do need to put in some form of government guarantee for some tranche or part of these bundles,” he said. “It’s a beneficial intervention. It means that we are not just disrupting markets but we are helping to build a new market, so to me this is the way forward.”
An ABS-purchase plan could lead the ECB into a conflict of interest by associating it too closely with one type of financial instrument, said Martin Hellwig, director of the Max Planck Institute for Research on Collective Goods in Bonn, Germany.
“The ABS question is an example of the problem that I raised about financial stability concerns and monetary policy concerns becoming too closely intertwined,” he said. “If the monetary-policy institution gets involved in that question of design as a way to improve the performance of the system right now, to what extent is it then liable if things go wrong with these new developments in the future.”
The ECB Forum in Penha Longa, a resort that traces its origins back to a 14th century monastery, is the central bank’s answer to the U.S. Federal Reserve’s annual monetary conference in Jackson Hole, Wyoming.
Draghi’s opening speech yesterday signaled that officials will ease monetary policy next month should they see low inflation becoming entrenched. That reflects comments on May 8 when he said the Governing Council is “comfortable” with acting at their June 5 meeting.
Governing Council member Ewald Nowotny said in Vienna today that “inflation rates are so low that there is a risk that economic growth will slow” and an easier monetary policy is being discussed. Euro-area inflation has been below 1 percent, or less than half the ECB’s goal, since October.