Europe borrows from Peter to lend to Peter

July 28, 2009

jamessaft1(James Saft is a Reuters columnist. The opinions expressed are his own)

Europe’s experiment in borrowing from Peter to pay Peter argues for a slow economic recovery with a low ceiling.

Data released by the European Central Bank on Monday showed that the supply in money is growing at best haltingly and that loan growth to euro zone households and businesses is at its lowest since records began.

Annual loan growth to the private sector slowed to 1.5 percent in June from 1.8 percent in May while the broader measure of money supply growth hit 3.5 percent.

Loans to non-financial corporations grew at a 2.8 percent annual rate, and actually fell from May. Household lending wasn’t that peppy either, with the growth rate falling to a paltry 0.7 percent annual rate.

Banks in Europe aren’t lending to consumers and businesses for a really sound set of fundamental reasons — borrowers know they ought not to be borrowing and the banks know that, of those who are asking for money, a disturbing minority can’t be trusted.

Demand is poor in other words and what demand their is has been skewed to the feckless end of the spectrum.

But there is one area of the market where both supply and demand seem to be growing healthily, or if you prefer, strongly: loans to governments.

There was an absolute surge in banks assets in June, with government bond purchases by banks up 53 billion euros, a 16 percent annual growth rate, and outright loans to governments up 19 billion euros, up 2.5 percent year on year. Financial institution holdings of government debt has risen by 271 billion euros in the year to June.

“This increase represents 3.0 percent of GDP and is thereby financing roughly half of the net general government borrowing requirement,” according to Julian Callow at Barclays Capital in London.

And this credit is from the same banks which borrowed 442 billion euros last month for a whole year at a fixed interest rate of 1.0 percent. At the same time overnight deposits at the European Central Bank rose yet again to 195 billion euros, further indicating that funds are not making it into the private economy.

Europe’s banks are borrowing from Peter to lend to Peter.


The circularity of it all is admirable. Banks in Europe borrow at very low rates from the European Central Bank. At least to judge by the data, much of the money is ending up in government bonds. This government debt is being issued, at least in part, to fund banking bailouts. Everybody is happy right?

Of course there are some substantial ancillary benefits: banks themselves will make handsome, low risk money by collecting the difference between the cheap financing they get from one arm of government and the slightly more expensive rate they collect from Europe’s governments for holding their bonds.

This rebuilds a capital base that has been sorely eroded by higher risk lending, but it is a slow process. It also does very little to encourage better banking practices for the next cycle. It does not take a genius to borrow from one arm of government and make a float lending to another, and as such we can’t really say that Europe’s banks are going to have their weakest members thinned out.

What it does do is make government borrowing cheaper than it would otherwise be, which on balance is no bad thing. Given the difficulties some of the weaker euro zone governments were facing earlier in the year, a captive, or at least pliant, class of government bond buyers is a useful counterbalance to the more flighty behavior of people who can’t borrow money directly from the ECB.

A lot of lending to banks, and lending and spending by governments can help ease a recession but its unclear if it can be the basis of a strong recovery.

Politicians, inside and outside of the euro zone, are fond of leaning on banks to lend to the real economy in greater amounts at easier rates.

British Treasury Minister Alistair Darling met with bank chiefs on Monday to urge them to lend more to small businesses, a type of photo opportunity we may be seeing more of as the recovery drags on and growth fails to ignite.

It is good theater but it does little to address the underlying issues of poor prospects for corporate investment and the economy-wide need to retire or destroy debt.

If things work out well it is just possible that in a year or so good business with good prospects will have real complaints about not being able to get adequate funding.

At that point we will see if the borrowing from Peter to lend to Peter arrangement has worked or if it will prove to be a too slow and too indiscriminate way of healing the banking system.

( At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)


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looks like the europeans are printing money to fill up the banks so their assets cover bad debts, that have still to make there way onto their bottom line. As they are not lending it to anyone or each other. If they print enough maybe soon we will have a splurge of bank takeovers and investments rather than loans to small business and joe the plumber to buy his home. Methinks! this will only strangle economies and restrict trade due to constrained cashflows. Here we go again another type of credit crisis.

Posted by peter mitchell | Report as abusive

How is this practice any different from the QE used by the Bank of England and the Federal Reserve. Surely the ECB is just stoking up inflation down the line by underwriting the unproductive public sector

Posted by Johnson Revnik | Report as abusive

It seem to be a dumbest idea. Either Governments are stupid or banks think they are smart and people and even more dumber. Where does it say that lending money to banks at cheap rate so they invest in the Government bonds and pay higher rate is like giving banks bonus for just paperwork. They would same money not to do anything or lend it directly or even through the so called post offices( Post offices are owned by the government and could literally be banks for saving account as well as lender and they are more trustworthy than banking sector which of lately has proven to be not trustworthy and all the profits will go to the government. Unfortunately only problem is that it will push the ideology to either Marxism or fascism which is not accepted under democratic principles. That is the “catch 22″ part as we well know that both of the above ideologies have proven to be failure and current system of greed accompanied by power is the last of the system of free market, or in other words choosing between donkey and ass which makes it a very difficult choice.

Posted by VJ | Report as abusive

Banks are really in a sweet spot! Credit has become the way of life for people as well as for governments. It is like an addiction. A small town in Virginia wants to build a bridge and has no money…. it borrows money and pays interest. The elected official looks good. Everyone is happy. Loans come due, … and they borrow some more to pay the current dues! And the banks make a handsome profit pushing paper. But when this game of musical chair was about to collapse, the governments show their love for Marx by printing money (thereby taxing the savers via inflation) to bail out the banks so that the musical chair can continue. Until the next time. In the US, GoldmanSachs gambled with AIG, and Treasury Secretary Paulson (ex-GoldmanSachs honcho) gave tax money to AIG to save his friends at GoldmanSachs. He claimed that if AIG failed then all the whole world would collapse. Apparently we are all so addicted to credit that killing the drug-dealer now will kill us! So we are now subsidizing the drug-dealers. And we are still capitalist! Marx must be laughing in his grave.

Posted by Sanoran Triamesh | Report as abusive

[…] No wonder Bill Gross, Nouriel Roubini, Laurence Kotlikoff, Steve Keen, Michel Chossudovsky, the Wall Street Journal and Bernie Madoff all say that the U.S. economy is a giant Ponzi scheme. (And European banks play the exact same game.) […]

Posted by Congressional Research Service Confirms Big Banks Borrowed Cash For Next To Nothing, Then Lent It Back to the Federal Government at Much Higher Rates | prison planet blog | Report as abusive