Perhaps Germany should rescue Deutsche Bank and its eurozone peers, not by direct aid but via a fiscal expansion that might revive growth and free the European central bank to hike interest rates.
Shares in Deutsche Bank, which faces as much as US$14bn in fines from the US Justice Department, traded at all-time lows on Monday after a report that German Premier Angela Merkel had ruled out state aid.
Deutsche Bank denies seeking or needing state support.
Few expect Deutsche to end up paying a sum close to US$14bn to settle its US ledger over sales of mortgage-backed securities. But it is important to note that the broad eurozone banking sector has been under increased market pressure for much of the year.
This is in no small part because both the European Central Bank’s negative interest rate policy and the economic reality used to justify it are both toxic to the banking model.
Negative interest rates reduce the essential margin between what it costs a bank to gather money and what it can charge to lend it. The yield curve that governs that isn’t simply shallow at the short end due to ECB policy, it is depressed further out because the prospects of growth and inflation in the eurozone are rightly depressed.
While acknowledging the costs that negative interest rates impose on financial intermediation, the ECB’s defense of the impact of its policy on banking has had two main components.
Firstly, it points out that eurozone banks suffer due to overcapacity. Secondly, the policy is a call for action from elected leaders in the form of structural reform and expansionary spending from those, like Germany, that have the fiscal space.
“If no other policy is in place, the length of time for the effectiveness of our monetary policy will be longer,” ECB chief Mario Draghi said on Monday in an appearance before the European Parliament.
Speaking in Rome, ECB board member Benoit Coeure took a similar position, chiding governments for failing to play their part while warning that monetary policy could be trapped.
“Moving from interest rates being ‘low for long’ to being ‘low forever’ would severely limit the room for manoeuvre for conventional monetary policy tools. But even more worryingly, it would threaten the contract between generations, as well as risk tearing up our social fabric,” Coeure said.
Bailing out Main St, the banks or both?
Unlike negative interest rates, bond buying or even Bank of Japan-style yield curve manipulation, all of which simply kick the banking issue further down the road, fiscal stimulus has a chance to address underlying causes. Were Germany, and others, to open the fiscal taps, we might possibly see a virtuous cycle of rising growth and rising interest rates.
That, of course, would help bank profits and make the kind of mergers eurozone banking needs more attractive. As it stands, hopes for consolidation in banking are thwarted by the poor prospects of the system and the fact that the currency with which mergers could be done, banking shares, are depressed. A bit of growth in the eurozone would do wonders.
Growth, if it comes, would also bring with it inflationary pressures and a steepening yield curve, not just because the ECB might be able to take interest rates positive, but also because long-term yields would rise. This, too, would help banking shares.
As a matter of strategy, Merkel is highly unlikely ever to present any fiscal expansion as justified as helping banks. That would be only marginally less enraging to popular sentiment than a direct rescue. Yet a round of stimulative government spending by Germany and other eurozone countries with headroom to do so might bring lasting benefits, helping to address specific problems the banking system faces.
Let’s pause for a moment and consider the possibility that the argument that fiscal expansion would breed growth and with it allow ECB interest rate hikes and a steeper yield curve is wrong. If so, the most likely explanation is that depressed growth isn’t a bug that can be over-ridden by stimulus, but a feature of a secular stagnation caused by demographics.
If that is the case, it may well be that eurozone banks are in an impossible position, making state aid to one or another ailing bank a much higher possibility over coming years.
Fiscal expansion in Germany isn’t the right policy simply because it would help banks, but if it did, it would be because it proved justified in its own right.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
