Injecting Cash Europe's Banks Are Addicted to ECB's Cheap Money
The European Central Bank will give European banks another massive round of loans at bargain-basement rates on Tuesday, with financial institutions expected to borrow up to one trillion euros. The ECB is playing down the risks of providing so much cheap money, but critics say that banks have become too dependent on the flow of easy cash.
For Kleanthis Papadopoulos, chairman of Greece's TT Hellenic Postbank, the situation is not looking good. "I can't give any new credits," he admits soberly.
Many Greeks are withdrawing their euros from the country's banks. To make matters worse, insurance companies and other financial institutions have long since stopped giving any money to Greek banks. As a result, the country is simply running out of cash.
Even healthy companies are going out of business because they have lost important lines of credit. Greeks say that anyone intending to withdraw several thousand euros in cash from their bank would be well advised to warn them in advance. This dearth of money will prompt the European Central Bank (ECB) to once again open its seemingly bottomless coffers this week and grant generous loans.
Although this financial lifeline has become essential for bankers like Papadopoulos, many of his colleagues in the industry see it as a sheer luxury: "We don't need it," says Deutsche Bank CEO Josef Ackermann. "We will only take part if it makes economic sense for us." And the ECB's offer is hard to refuse. After all, where else is it possible to borrow money so cheaply?
The offer that the ECB will extend to banks on Tuesday involves loans at 1.0 percent interest and with a maturity of three years. And the amount that banks can borrow? Virtually unlimited.
For the first time, Ackermann is tempted to take up the offer -- as are a number of other bankers in the euro zone, regardless of whether they need the money or not. It's estimated that financial institutions could borrow up to 1 trillion ($1.34 trillion). Some 500 billion in loans were made during the last bargain-basement offer of this caliber, back in December. At the time, Commerzbank's ailing subsidiary Eurohypo borrowed 10 billion. According to sources in a large German bank, anyone who passes up such a bargain will have to be prepared to justify their decision.
When asked how long such a policy could be successfully pursued, ECB President Mario Draghi said that it was only "temporary." In his view, the financial system faces an emergency situation -- and therefore requires emergency aid.
But when does an emergency become business as usual? And how big is the danger that Europe's banks will simply forget how to stand on their own two feet if they are continuously being propped up?
Plugging the Hole
It's been years since the banks were last able to easily access money. "Before the Lehman Brothers collapse, liquidity was simply there," says Stefan Best, an analyst at the rating agency Standard & Poor's. At the time, banks readily lent each other billions at low interest rates -- overnight as well as for longer periods. It was an era of widespread trust.
There was such an abundance of money that banks became less and less reliant on customer deposits. But up until the 1990s, banks primarily recapitalized using funds that individuals and companies had squirreled away on their accounts. In 1997, the gap between deposits and loans granted within the euro zone was only 44 billion. During the 10 years that followed, this disparity increased to 1.3 trillion. The banks easily plugged the hole using funds that they acquired on the financial markets.
The fact that this situation changed dramatically is thanks to managers like Richard Fuld and Georg Funke, the former CEOs of the US investment bank Lehman Brothers and Germany's Hypo Real Estate (HRE) respectively. They invested money which they borrowed short-term at low interest rates in risky and protracted mortgage deals. As long as the profits continued to flow, nobody asked about the risks.
But after the collapse of Lehman Brothers and HRE in the fall of 2008, the financial industry's trust was shattered. The interbank lending market dried up, and the central bankers at the ECB became paramedics who eagerly rushed to the aid of ailing banks with each new crisis -- continuously increasing the dosage in the meantime. Today, euro-zone banks owe the ECB some 796 billion.
"The ECB's cash injections have significantly reduced the danger of refinancing bottlenecks and a credit crunch," says Stefan Best, the Standard & Poor's analyst. But how long can this policy of almost free money continue to work?
ECB President Draghi is hoping that the situation will resolve itself on its own. Since the beginning of the year, he says, the banks have again been increasingly borrowing via their normal financing channels. Even institutions that have recently been considered at risk from the crisis, such as Spain's Santander and Germany's Commerzbank, have managed to acquire money. Nevertheless, Commerzbank CEO Martin Blessing will have to pay 3.6 percent interest for the most recent billions in loans.
Like Free Heroin for Junkies
With the latest round of three-year loans granted by the ECB, the central bank is charging a rock-bottom interest rate of just 1.0 percent. Critics argue that this is like distributing free heroin to junkies. "If the ECB continues in this vein, we'll soon be able to shut down the normal money markets," says Hans-Werner Sinn, head of Germany's influential Ifo economic think tank.
There is a long list of possible risks and side effects. Draghi's cheap money is also keeping financial institutions afloat that simply don't earn enough to cover their financing costs. The ECB's money is even paving the way for deals that in reality are too risky. However, the price for such risks is blurred when a central bank continuously maintains artificially low interest rates. Draghi's prescription for the crisis is also "a recipe for a new speculative bubble," says Uwe Burkert, head of credit analysis at Landesbank Baden-Württemberg, a state-owned regional German bank.
In Germany, for instance, rates on real-estate financing loans are about as low as they have ever been. In its most recent monthly report, the German central bank, the Bundesbank, noted a "marked price reaction on the housing markets." Thanks to the flood of cash from the ECB in Frankfurt, large amounts of money are once again also being invested in stock markets -- despite the uncertainty created by the sovereign debt crisis.
Interest rate expert Uwe Burkert points to an additional risk that concerns the general public: Interest payments on life insurance policies are already declining from year to year. "The ongoing low interest rates are insidiously eating away at people's pensions," he argues. Since money is no longer circulating normally, the entire economic system is going off the rails.
'This Is a Bank Run'
Ifo head Hans-Werner Sinn is extremely concerned about the ECB's new policy -- particularly after he discovered an item on the central bank's balance sheets that is barely comprehensible to most laypeople, but which, in his opinion, is extremely dangerous: the so-called TARGET2 balances. Simply put, this measures where the money in Europe is flowing.
When, say, a Greek auto dealer pays for a German car, the money flows from his home country to Germany. When a Greek bank receives a loan from a foreign investor, the money flows back.
However, since banks in ailing countries like Greece are no longer receiving money from private investors and the ECB is helping out instead, the TARGET2 deficit of these countries has soared in an alarming manner. Italy, for instance, now owes the euro system 180 billion -- compared to just one year ago, when it had a deficit of only 20 billion. "This is a bank run," says Ansgar Belke from the German Institute for Economic Research (DIW). "Investors have basically withdrawn their money from Italian financial institutions from one day to the next."
Germany, on the other hand, is currently owed around 500 billion within the TARGET2 system. In an interview with the center-right Frankfurter Allgemeine Zeitung newspaper last week, ECB head Draghi played down the significance of those imbalances. "There are no risks in a cohesive monetary union," he said.
But what happens if one or more countries actually default on their loans and leave the euro zone? Ifo head Sinn has no doubt: "Then the deficits would have to be balanced out." Germany would have to shoulder enormous costs as a result.
In response to such grim prophecies, the ECB stoically points to the collateral that financial institutions have to deposit at the central bank in exchange for loans. Nonetheless, their quality standards have been drastically reduced since the start of the euro crisis.
Dubious loans for wind parks and housing development projects still under construction have been accepted as collateral. The governments of crisis-stricken euro-zone countries furnished bonds issued by their banks with guarantees -- and obtained fresh money from the ECB in exchange. Financial institutions can even use loans from the ECB to buy sovereign bonds from their own governments, and immediately turn around and park those bonds with the ECB in order to receive additional loans. Even Greek sovereign bonds still qualify as collateral at the central bank, despite the fact that the rating agencies awarded them junk status long ago.
ECB President Draghi can get unusually emotional when someone points out the risk that he's taking. That risk is being "very well managed," he recently said, with an edge to his voice. Nonetheless, his team is making hefty writedowns on loan collateral. When it comes to sovereign bonds, for instance, as much as 13.5 percent is deducted from what are often already very low market values.
But is that enough? One can only speculate about what exactly Draghi's books look like. What is known is that, since the start of the crisis, the ECB has purchased a total volume of 220 billion in sovereign bonds. Aside from the central bankers, however, hardly anyone knows how much was bought from which countries. It's also unclear what exactly the banks have palmed off to the ECB as collateral.
'We Have Done Enough'
In any case, Draghi is convinced that it's all been worth it. He's also convinced that it's now time to stop. "We have done enough," he told the FAZ, adding that, in future, the focus would be on "tightening the requirements again." But there are many bankers who suspect that he won't find it that easy to slip out of the role of Europe's bankroller. Indeed, it will be difficult to wean the banks off cheap and generous loans from the ECB.
In fact, a number of banks would again find themselves in trouble if that happened, because investors are even more loath to lend them money after years of dependency on the ECB. In many regions, the economy would simply run out of money -- as is the case in Greece.
For TT Hellenic Postbank chairman Kleanthis Papadopoulos, the situation in his country is clear. "Greek banks are dependent on the ECB for their funding," he says.
Translated from the German by Paul Cohen