by Mitch Feierstein about 1 year 2 months ago
A friend of mine recently bought an old property – an eighteenth century cottage with a towering inglenook fireplace. At some stage in the past, somebody had taken it into their head to block up the chimney. They clearly didn’t have any stone slabs large enough to fill the void, so they simply wedged what stone they had up there, slapped some mortar around, banged a couple of iron spikes into the wall for support and hoped for the best. A bodge job.
The bodge, inevitably, didn’t work. My friend tells me that you could see, from the different types of mortar used, that successive owners of the house had tried to keep the collapsing mass in place by slapping on more mortar, more stone, more low-quality fixes. When my friend acquired the house, the chimney was blocked with stone so loose that he could literally reach up and remove chunks of it by hand … except that he didn’t, because anyone standing under that chimey was at risk of having the whole lot come down on his head.
I’ll come back to the chimney a little later, but meantime let’s consider rotten building of a different sort. Let’s say, for the sake of argument, that you are Mario Draghi, currently head of the European Central Bank (and congratulations on that, by the way.) You haven’t been in the position long, but you are already aware of a number of points claiming your attention.
One, a number of governments in your jurisdiction are either bust (Greece) or heading that way fast (Portugal and, just possibly, Ireland).
Two, there are a number of governments in your jurisdiction with weak finances, lousy growth prospects, mountainous deficits and excessive debts. The pair that cause you the deepest anxiety are Spain and Italy. You are uncomfortably aware that if either of those countries got themselves into Greek, Portugese or Irish levels of trouble, you would have on your hands a financial crisis to dwarf anything that we saw in 2008-09.
And number three – because your in-tray isn’t yet scary enough – you have to consider the banking system. Josef Ackermann, the CEO of Deutsche Bank, said last year that he considered most European banks to be insolvent. He’s probably more right than he knows, because since the solvent banks have mostly lent a load of money to the insolvent banks, then they’re insolvent too. And since somewhat-solvent governments, like the government of France, would need to pick up the pieces if their major banks went belly up, those somewhat-solvent governments are best regarded as bankrupt too. Yikes!
These concerns are significant enough, that you might think it was time to start addressing them directly. Dodgy governments should be required to bring their taxes and spending into line, and to reform their sputtering economies. If that means wrenching change and fiscal austerity – well, that’s just tough.
Same thing with the banks. If a bank is bust, it should be required to raise capital or close its doors. Quite apart from anything else, trading while insolvent is a criminal offence.
But the ECB has taken the exact opposite approach. The Bank recently extended €529 billion worth of loans to European banks, making a cumulative total of more than €1 trillion. The Bank has not demanded top quality collateral in exchange. On the contrary, they’re accepting 40,000 different financial securities and there just aren’t that many good quality European securities in existence. They’re treating all European sovereign debt as risk-free when – duh! – the reason there’s a crisis is precisely because that debt is massively risky. If you volunteered your neighbour’s cat by way of collateral, you’d probably be asked whether you wanted €1 million or two.
And that’s the Big Fix we’re meant to applaud. The problem arises from weak governments and dodgy banks. So the solution – according to the ECB – is to accept weak collateral from insolvent banks so that those banks can buy damaged bonds from insolvent or financially impaired governments.
And just how can that story possibly end well? My friend, the one with the eighteenth century inglenook, got a builder to remove all the suspended masonry blocking the chimney. An iron plate was then fitted and properly secured. Instead of a potentially lethal bodge job, he’s fixed the problem well enough to see out another two or three hundred years.
The ECB is not like that. It’s looked at the tottering stack of bad debt in Europe (€5 trillion? €8 trillion?) and decided the stack wasn’t big enough. So it’s tossed another trillion onto the pile. When that trillion is soaked up, as it soon will be, another half trillion will be added. And then half a trillion more. But that’s not a game which can last for ever. At some point the weight of hanging masonry becomes too great.
The fall is going to be tremendous. And I don’t want to be standing close by when it happens.