articolo collegato di Martin Sandbu

Arigged market price
Almost everything about Italy’s agreement with Brussels over the country’s so-called “bad bank” policy to rid Italian banks of its problem loans should set off alarm bells. It illustrates how halfhearted is Europe’s commitment to reform the way it does banking.

The agreement, as the Financial Times reports today, involves a scheme by which the Italian state will issue financial guarantees for packages of non-performing loans that are burdening the banks’ finances. The guarantees are supposed to help the banks sell off the loans to other types of investors such as hedge funds.

To be clear, getting bad loans off Italian banks’ backs is a good idea. At about €350bn or 17 per cent of the banking system’s total loan book (three times the European average, according to the European Banking Authority’s last transparency exercise), they constitute a large patch of rot on the banking system’s balance sheet. The uncertainty over the eventual size of the losses is bound to restrain both the banks’ willingness to issue loans and their ability to raise capital as and when that becomes necessary. That fact that Italian bank lending is growing again, which is very welcome news, is nevertheless no reason not to shift this uncertainty to investors willing to bear it and whose risk exposure does not damage the wider Italian economy.

It’s such a good idea, in fact, that it’s useful to ask why banks haven’t sold off these loans to foreign hedge funds already. The Italian government’s plan has been to issue guarantees on the bad loans to facilitate their sale. The sticking point with the European Commission has been how to price the guarantees so they don’t constitute a subsidy. The agreement supposedly ensures that the insurance against losses will be sold at the market price for similar loss insurance on equally risky products.

But if it’s the market price, why does the government need to be involved at all? There are plenty of investment banks in the world that will issue loss insurance at a price. And there is little reason to think that the Italian government’s risk assessment is more reliable than a third-party investor’s: on the contrary. The very notion that the government must provide the insurance because the market doesn’t should make us suspicious of the risk it attributes (or rather not) to the loans in question.

If banks are not already selling off loans to private investors, it’s because the price at which they are willing to sell is higher than the price buyers are willing to pay. The reason for that is most probably not that the banks know the loans are better than they look. Instead, it is that a price at which buyers would be interested would expose losses that the banks would rather be without — or pretend to be without.

The only way a state guarantee can get around this problem is by making the bad loans look more attractive to investors, and thereby raise the price they would consider paying to a level that flatters the selling banks. But don’t let Rome and Brussels fool the rest of us into thinking that this is a market price: if the government needs to make it happen, it’s a price at which there is no market.

The alternative policy is, of course, to write down the value of the trouble loans to their real market value, which could be done, for example, by forcing banks to auction them off to the highest bidder with no state-sponsored insurance (banks could buy the insurance privately if they thought it would sufficiently raise the market price). That this has not happened simply illustrates that Rome remains unwilling to apply the spirit of the EU’s new bail-in rules, which requires bank shareholders and creditors to share in any losses. Yet again, a proper restructuring is too much to stomach for a national government.

As Free Lunch has complained during a previous public bout of Italian bank rescues, this unreconstructed attitude illustrates that European governments are still not comfortable with the banking reforms they signed up to in 2012. That is dispiriting but not surprising. That Brussels is willing to play along, however, is both.

Other readables
- An idea developed to address the job displacement due to trade and globalisation may well have a new lease of life in an era of job loss through automation: Lori Kletzler argues for wage insurance, which would compensate displaced workers for the lower salary in whatever job they managed to find.
- New research documents the long-term effect of migrating from a poor to a rich country by comparing winners and losers of New Zealand’s immigration lottery for citizens of Tonga.
- Harvard economist Gita Gopinath chills the optimism about India that many — including Free Lunch — had allowed themselves to feel. about India’s economy. Investment is falling, not just because reform promises have not been kept, but because of growing rot in the banking system. Seventeen per cent of Indian bank loans are in bad shape, and the cost of borrowing has soared.

articolo collegato di Martin Sandbu

The referendum on UK membership of the EU is still some time off but the rhetorical attacks have begun, calling out those who wanted Britain to join the euro, most of whom have retracted their support or tried to forget it. Eurosceptics do not intend to let them get away with it. If you were so misguided as to have supported the euro then, they argue, surely we cannot take seriously your argument for continued EU membership today.
So, even if euro membership for the UK is not on the agenda, it is important to revisit the case. And the sceptics’ argument is unfounded: there is a good case to make that Britain would have fared better in the crisis inside the single currency than it did outside.
The eurozone’s terrible economic performance weighed heavily on Britain, dashing hopes of a recovery led by investment and exports. It happened because European leaders failed to pursue the best policies — in particular, their failure to end the credit crunch and loosen monetary conditions sooner, and their choice to push austerity even in economies with ample fiscal space.
The important question, therefore, is how the UK would have changed the eurozone’s policies from the inside. The answer is: in ways that would have brought growth back faster.
Take monetary policy first. The Bank of England would be a heavyweight inside the euro, and not just on account of its economy’s size. The BoE’s intellectual pole position on monetary matters and its feel for financial markets, honed by centuries in the middle of the City of London, would have made it a leader within the European Central Bank.
How would that influence have been used? The BoE understood the need for extraordinarily aggressive policy much better than its counterpart in Frankfurt. In October 2008, the ECB raised rates while the BoE embarked on a loosening that cut rates by four percentage points in less than six months. It has kept them at 0.5 per cent since March 2009, the month in which it launched an asset purchase programme that has accumulated government bonds worth a fifth of annual national income.
In contrast, the ECB raised rates twice in 2011, which helped throw the eurozone back into recession with knock-on effects on UK growth. And it took Frankfurt six years to follow Threadneedle Street’s lead on asset purchases.
Britain’s central bankers would have fought for similarly aggressive policies on the ECB’s executive board. Indeed the country’s huge, wobbly banking sector would have left them — and the rest of the ECB ­— with no other choice. (Even outside the euro, UK banks have trillions of liabilities denominated in euros, which the BoE could not have printed in the case of a run. Within the euro, that would have been the ECB’s problem.) One of the euro’s largest economies could not have been bullied the way smaller countries at risk were treated.
We cannot know how successful they would have been, but it is clear eurozone monetary policy would have tilted in a more pro-growth direction, and one that more confidently stabilised financial markets. Had the ECB started a broad bond-buying programme in early 2009, before the sovereign debt crisis was on the horizon, yields might never have spun out of control as they did.
What about fiscal policy? George Osborne, chancellor of the exchequer, can seem more fiscally conservative than Germany. But his original economic plan relied on eurozone demand for UK exports picking up the slack left by brutal deficit consolidation. From his perspective, the optimal policy would have been rapid cuts for high-deficit countries but compensatory stimulus in those with room to do so. That implies resisting Germany’s push for deficit cuts by all. This could have spared the eurozone a second downturn and shortened the UK’s patch of stagnation.
So in the fiscal sphere, too, British euro membership would have tilted policy in the direction of growth. And the influence could have been substantial. Recall Prime Minister David Cameron’s “veto” of the contractionary fiscal compact. In the event it was no veto: Germany pressed ahead, via an intergovernmental treaty committing 26 states to balanced budgets. But its intent was always to change fiscal policy for the currency union as a whole. One eurozone member could have stopped it.
To deny that British euro membership would have made the crisis better for all is to ignore the difference the UK would have made. Perhaps this is credible if one thinks Britain is as mismanaged at home and ineffectual abroad as Italy. But that is a strange view to take for those who believe Britain is so much more capable than its neighbours that it is better off outside their team.