WATCH THE PRESSES ROLL AS EUROPE SCRAMBLES TO FIX ITS BANKS / THE FINANCIAL TIMES COMMENT & ANALYSIS

Watch the presses roll as Europe scrambles to fix its banks

Wolfgang Münchau

This is how the crisis may be resolved — not with a bailout or debt resolution but by printing money

 

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There is a story playing out in Italy that teaches us much about the practical and political limits of how you resolve a debt crisis. The European strategy of resolving bank crises through orderly legal resolution processes will ultimately have to be superseded by the crudest form of debt resolution in existence — old-fashioned money-printing by the central bank.

 

The story is about the suicide of an Italian pensioner last week after he realised that he had been “bailed-in” during a bank resolution procedure .

He had bought savings certificates from his bank, which, like so many financially inexperienced savers, he mistook for a deposit.

In Italy, in particular, many ordinary savers bought these certificates. Legally, however, these certificates constitute junior debt, one of the least secure asset classes of all. Under a new European law when a bank fails, first the shareholders pay, then the junior bondholders, and only then do national and European resolution funds pay up.

The pensioner’s bank was one of four small regional banks that recently went through resolution. Not only did the shareholders and junior bondholders lose out. The cost also swallowed about four years of future contributions into the Italian national bank resolution fund.

Since these are not the only imperilled Italian banks , this case raises some troubling issues about the whole process of dealing with ailing financial institutions. The EU now has the legislation to deal with bank rescues — the so-called bank recovery and resolution directive.

 

But the system is totally underfunded. In particular, it lacks a fiscal backstop.

 

This raises important questions about macroeconomic policy in the eurozone, and for the European Central Bank in particular. In an ideal world — the world of finance professors — you would end any private-sector debt crisis through a resolution process. This would include bankruptcy, bank resolution procedures, or the creation of bad banks where the government takes on the bad assets of floundering institutions.

We Europeans are notoriously bad at resolution — special interests usually stand in the way.

We are in the extend-and-pretend camp. We extend non-performing loans, and pretend they are still good. Italy’s statistics tell us that the volume of these loans is €200bn. Believe that if you will.
 
When pensioners start killing themselves, the political support for this process is hitting a limit.

This is now happening in Italy. The country has no fiscal capacity for big bank bailouts.

The government has exhausted the room for fiscal manoeuvre allowed under European rules.

So in terms of private sector debt resolution, Italy — and other highly indebted countries — have run out of all the legal options.

 

Resolving a public or private sector debt overhang through money printing is called debt monetisation — and it is strictly illegal under European law.

The central bank is allowed to buy debt instruments but only for the purpose of conducting its monetary policies — not to alleviate anyone of their burden. This opens a large grey area.

The official purpose of the ECB’s private and public sector asset purchase programmes — quantitative easing — is to achieve a higher level of inflation. If this goes on for a very long time — as I believe it will — it may end up as an ersatz debt resolution instrument.

The German policy establishment now openly accuses the ECB of debt monetisation. You will not get many members of the governing council to admit that debt monetisation is the reason for QE. But whatever the ulterior motive, the effect may be different from what they intended.

So, this is how the crisis may ultimately get resolved: not through debt resolution, not through a fiscal bailout, but through old-fashioned money-printing done under some legally sound disguise. The reason the eurozone will end up monetising debt is not because it is the intrinsically best way to do it, but because rules and political limits leave them with no choice.

Expect this process to take a very long time.