In last week’s column (Connecting the Dots, JLN FX, March 6, 2012), I pointed out that the ECB’s second-round, EUR 530 billion long-term refinancing operation (LTRO) is really Europe’s version of the U.S. Federal Reserve’s TALF and TARP programs from 2008-09. From the column:
“Since the U.S recession predated Europe’s woes by a few years, it is further along the timeline. At this point in the U.S. the market is saying that stimulus is not really a “one-off event” – it must continue, lest the tenuous recovery falter. The current ECB is really the same story, only a couple rounds behind in terms of stimulus. But, as we see in the U.S. case, the economy has a steady pulse, but only while receiving periodic shock treatments.”
Case in point: Europe’s banking institutions are this week taking another page out of the U.S. playbook. Concurrent with the taking of tremendous amounts of emergency funding, the banks make public statements downplaying the need for such funding. Most notably, Deutsche Bank, who had earlier looked down its nose at its weaker brethren that utilized the first-round funding facility, tapped the ECB for up to EUR 10 billion in round two of LTRO. This came after earlier statements saying that Deutsche had never accepted government money, which demonstrated just how strong DB and how it is a source of their competitive advantage..
Credit ECB president Mario Draghi, though, for calling it as he sees it, criticizing such puffery as “statements of virility.”
Such statements are reminiscent of those made by U.S. financial titans subsequent to the last crisis, whom I often referred to as “bailout deniers.” “We didn’t need the TARP money,” said Jamie Dimon, the CEO of JPMorgan Chase. “We took it because they asked us to.” Once the crisis abated, the denials escalated. “The Fed actually made money on TARP”, so the story goes. And so on.
As if they would still be in business without taxpayer-funded fiscal intervention. As if the fiscal stimulus pumped into the U.S. economy – $5 trillion in deficits in the past four years, the money thrown at the job market, the auto market, and especially the housing market, just to keep them from imploding, does not count toward the bailout tally card.
But I digress. Today’s column is about Europe, and it is here, with fiscal policy, that the U.S. parallel ends. At this point, monetary shell games such as LTRO are the last trick the ECB has up its sleeve. Not only is there no easy fiscal backstop, the powers that be (that would be Germany) is going the other way, with forced austerity. It will be an interesting experiment to watch. Which will play out better as an accompaniment to easy monetary policy – the U.S. with massive fiscal deficits or Europe with stringent austerity?
Where does it end? I don’t know, but I have seen a glimpse of the next round as it is playing out in the U.S. The Federal Reserve is set to release the results of its latest “stress test” of U.S. banks, and it appears that the largest institutions will pass with flying colors. In fact, things are so Jim-dandy that dividend issues by banks such as JPMorgan Chase, BofA and Citigroup are set to soar.
But, do not worry. In order to gain approval to distribute cash to shareholders, these banks must show proof that they can withstand certain shocks to the system, including global recession and spikes in the unemployment rate, and that they will be ready for upcoming capital reserve requirements such as Basel III.
Time out. Did we not fall for this one a few years ago? Have we not learned that internal models break down when faced with real-world scenarios? Didn’t the Fed acknowledge that things are so tenuous that they dare not move the Fed funds rate off the zero-bound for another two years?
I say that if the Fed wants to conduct a stress test, do a real one rather than a theoretical one. Move the Fed funds rate up a quarter-point and see what happens. My guess is the result would be much worse than the models predict. Borrowing free money from the government and buying treasurys was bad enough, but borrowing for free to pay dividends to shareholders seems unconscionable.
Such is the relationship between central banks and member institutions, both in the U.S. and Europe: We will take the money, but we don’t really need it. And please, do not tell us what we can and cannot do with it.