Opinion

Hugo Dixon

LTRO was a necessary evil

By Hugo Dixon
March 5, 2012

Bailout may not be a four-letter word. But many of the rescue operations mounted to save banks and governments in the past few years have been four-letter acronyms. Think of the TARP and TALF programmes that were used to bail out the U.S. banking system after Lehman Brothers went bust. Or the European Central Bank’s LTRO, the longer-term refinancing operation. This has involved lending European banks 1 trillion euros for three years at an extraordinarily low interest rate of 1 percent.

The markets and the banks have jumped for joy in response to all this liquidity being sprayed around. So have Italy and Spain, whose borrowing costs have dropped because their banks have been able to take cheap cash from the ECB and recycle it into their governments’ bonds — making a profit on the round trip. But as has been the case with other four-letter bailouts, the LTRO has come in for criticism — most of it a variation on the theme that the way to treat debt junkies isn’t to give them another heroin injection.

One problem is that European governments could now feel less pressure to reform their labour laws and do the other painful things that are needed to get their economies fit. Another is that banks may delay actions that are required to let them stand on their own two feet: such as rebuilding their capital buffers and raising their own longer-term funds on the markets.

As if this were not bad enough, undeserving banks will be able to make bumper profits on the back of the ECB’s cheap money and, potentially, route them into fat compensation packages — although two British banks, Barclays and HSBC, have said they won’t allow bonuses to be inflated in this way. Meanwhile, the ECB could incur losses if the commercial banks that have borrowed all this money can’t pay it back and the collateral they have pledged turns out to be insufficiently valuable. Oh, and don’t forget that this is just a three-year operation. There could be another crisis when the banks need to find 1 trillion euros to repay the ECB in 2015.

The charge sheet is a long one. But the LTRO was a necessary evil. Just think back to early December when panic was stalking the euro zone. Without some form of bailout, there would have been a severe credit crunch that would have dragged the economy into a deep recession rather than the mild one it now seems likely to suffer. Large countries such as Italy and Spain could also have easily been shut out of the markets, potentially leading to a break-up of the single currency.

The ECB faced a too-big-to-fail problem. If it didn’t bail out the system, it would be faced with catastrophe; if it did, it would reward foolish behaviour. One can argue with the details. Did the money, for example, really need to be so cheap? But the central bank made a rational choice. The priority now is to limit the bad side-effects.

Mario Draghi, the ECB president, has made a start by telling European Union leaders at their summit last week that the three-year cash injection would not be repeated, according to Reuters. He said it had merely bought the euro zone time and it was essential that structural reforms were pushed through.

Hopefully, such lectures will be sufficient to do the job. But countries rarely reform unless their backs are to the wall. Take Italy. Mario Monti has made a remarkable start pushing through pension changes and liberalising services since taking over from Silvio Berlusconi. But there is much left to do: freeing up the labour market, privatising assets, revamping public spending and fighting tax evasion. How easy will he find it to push all that through now that Italy’s 10-year borrowing costs are below 5 percent?

Similar points can be made about Spain, where Mariano Rajoy’s reform programme has only just begun. Meanwhile, France, which has so far largely escaped the crisis, will not be under pressure to address its deep-seated labour market and pension problems. Francois Hollande, the socialist who will probably be the country’s next president, certainly has no ideological desire to do so.

But won’t the new European fiscal treaty deal with the issue? Sadly not. The demand for fiscal austerity was, indeed, the quid pro quo for the ECB’s bailout. But it was the wrong sort of conditionality. Balancing budgets is not the same as structural reform. The only thing pushing Europe’s governments down the latter route is exhortation and the warning that there won’t be any more bailouts.

With the banks, more tools are available to mitigate the damage from the LTRO. After all, governments, the ECB and regulators can tell lenders what to do. The most important changes – requiring them to build stronger capital bases and rely less on short-term funding — are already under way. The key thing will be to resist lobbying to delay and dilute these rules.

But there is also a case for revisiting the industry’s lax tax regime, especially if compensation remains high. Politicians have given most of their attention to taxing financial transactions, the so-called Tobin tax. But a better alternative could be to introduce what is known as a financial activities tax or FAT tax. Most countries do not apply VAT to banking. FAT, which would tax profits and compensation, would do a similar job. A three-letter tax could be part of the answer to a four-letter bailout.

Comments
7 comments so far | RSS Comments RSS

Bailouts are NEVER a “necessary evil”, they are simply an “evil” that should never be tolerated in a free market economy, since it completely voids the risk/reward basis of free markets, and simply generates more unsound financial practices by a few at the expense of everyone else.

This is especially true, since it is being done as a QE program

In other words, “printing” electronic money without any value whatsoever that ends up as sovereign debt capitalized on the individual eurozone nations, especially that of Germany.

This will result in inflation, and destabilize the eurozone economy so that at some point soon it collapses.

If you want proof, look at how well the US economy is doing after being bailed out continuously since 2008. We are MASSIVELY in debt that we cannot ever hope to pay off and the economy is struggling to survive.

Bailouts are NEVER an acceptable solution. It is the investors who should take the haircut, since it is they who have profited.

Posted by PseudoTurtle | Report as abusive
 

The banks now understand who’s in charge. Mr. Draghi will learn soon enough whose gonads are being squeezed.

Posted by johnvos | Report as abusive
 

Round Tripping, they call it.

expect banks to make huge profits coming 3 years, on the back of the European tax payers.

the ECB MUST be in the bank’s pockets, 4sure.

banks—>nice profits !
plebs—> austerity!

Posted by Willvp | Report as abusive
 

Long term the prospects of structural reforms in EUrope are better than ever. Fiscal pact will make impossible to avoid reforms by borrowing money. Thus, countries will face either accelerating decline or reforms. Reforms are always painful and public hates them. But with time, people get used to change and go with the flow. One can think the best model for this type of change is reform in Eastern Europe after the fall of communism. People there moved from no-unemployment jobs-guaranteed-for-life to the being leaders in temporary jobs. It was painful but in the end it became accepted.

Posted by wirk | Report as abusive
 

Kool Aid!

Hugo . . if you aren’t part of the solution, you’re part of the problem . . .

Posted by Hinch | Report as abusive
 

Every so often in history, those who think they’re in charge, this time the central bankers, discover they’re not. Bernanke, Draghi, et al have been neutered. We’ve now flown into a cloud with no instruments.

Posted by johnvos | Report as abusive
 

It’s good for intermediate inflation and making the inevitable more catastrophic.

At what point did the West do away with capitalism and decide that price discovery was a bad thing?

Posted by agonzal0 | Report as abusive
 

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