by Adam S. Posen, Peterson Institute for International Economics
Op-ed in the Financial Times
June 4, 2014
© Financial Times
The European Central Bank (ECB) clearly will announce some package of expansionary measures on Thursday—as well it should, given sustained below target inflation in the euro area and forecasts of further falls. The most important and promising policy it will announce is the one with the longest lead time: fostering a market in securitized lending in Europe, primarily for loans to small and medium-sized enterprises (SMEs), through direct purchases of such asset-backed securities (ABS). This is absolutely the right initiative for the ECB to take because it is not only going to be effective (unlike limited interest rate cuts or very long-term refinancing of bank loans, also likely to be announced), but will address the right problems and do so with lasting structural benefits.
Active policy intervention is needed to restore Europe's risk-taking capacity and investment. The ECB leadership is right to take responsibility for this issue. As ECB president Mario Draghi and others have repeatedly observed, the interest-rate spreads between similar corporate borrowers in different countries of the euro area, and the obvious rationing of credit to SMEs in southern Europe, are a direct impediment to monetary policy transmission. These persistent conditions also erode monetary union. Given any mandate for financial stability as well as price stability, a central bank should respond to obstructions in the credit markets it oversees and not wait for overt crisis. So doing would be a far more fitting and accountable role for a central bank than conditioning monetary policy on sovereign nations' fiscal discipline, let alone their labor market reforms.
Yet, when in a September 2011 speech, I was the first sitting central bank policymaker to propose actively purchasing and promoting a market in securitized SME loans, my plan engendered a lot of opposition. Too often, the practical difficulties of implementing this ABS purchase policy are vastly exaggerated—it would be far less difficult than what central banks in emerging markets regularly undertake to create more liquid trading in various bonds (to cheers from markets and the official sector alike). As Mr. Draghi remarked at the ECB Forum in Sintra last week, getting global bank regulations to put different weights on simple versus complex derivatives would be another feasible and logical step to facilitate this process. And unlike quantitative easing in already existing government bond markets, let alone further long-term refinancing operations on individual banks' specific illiquid assets, this policy measure would yield lasting structural benefits by deepening European credit markets.
The key is to get euro area banks to bundle and securitize new loans made to SMEs. Essentially, Europe needs a functional equivalent of Fannie Mae and Freddie Mac to create a more liquid and deep market for illiquid securities that can then be sold and taken off bank balance sheets. This is all the more needed given the balance sheet contraction under way in still bank-finance dependent Europe in response to the coming asset quality review. It is worth remembering that for decades the mortgage "agencies" in the United States provided a vital service and did not undermine financial stability. It was only from the late 1990s—when they were allowed to keep mortgages on their own books in pursuit of excessive short-term payouts to their management, and were not supervised strictly enough, given their perceived government guarantees—that they did harm (admittedly then quite serious). If the ECB was to encourage development of ABS in Europe, it would have no such distorted incentives and would look to have others hold the securities.
Critically, the ECB can address the fragmentation of credit markets in the euro area by creating a deep market for vanilla, relatively transparent SME securitization. A specific size limit on businesses whose loans would be bundled could be set, and interest rates on loans could be specified as a mark-up from a given market rate. Of course, the ECB has no particular abilities in evaluating or monitoring small business loans, but we should not kid ourselves about how the bulk of business lending is done nowadays in the private financial sector: through the application of large-scale largely automated scoring software and clear company-wide rules that rely on the law of large numbers, not careful local monitoring or evaluation, to prevent excessive losses. The bundling of commercial loans is already happening de facto within European lending institutions; what the ECB can contribute is to make this a tradable and liquid market.
The ECB governing council is right to recognize that there is no one interest rate that determines credit conditions throughout the euro area, especially under today's stressed conditions, and that therefore it has to go beyond the tools that act only on government bond markets or on large companies that already have access to global markets. At present, when there is too much risk aversion in the private sector, the European public can ill-afford unjustified risk aversion on the part of its monetary policymakers as well. The task will now be to accelerate the implementation of this SME securitization scheme beyond its announced intent—there is no practical reason to hold it back, and I fear the other measures being taken tomorrow will be of little lasting impact.