Draghi takes slow road to QE with packaged-debt push

April 11, 2014

(Reuters) – The European Central Bank is mulling creative measures to stave off deflation but one of them, revamping a market that was at the heart of the financial crisis, will take time with no guarantee it will take off.

It is scrambling to boost Europe’s market for securitized assets – those backed by loans.

With inflation running at 0.5 percent – far below the ECB target of just under 2 percent – the bank’s policymakers last week agreed to using “unconventional instruments” to prevent price pressures staying weak for too long.

There is growing pressure, both from within and outside the euro zone, that these measures should include quantitative easing, or asset buying.

But buying sovereign debt – and the Federal Reserve and Bank of England have – raises hackles among hawkish ECB policymakers, led by Bundesbank chief Jens Weidmann, who see it as thinly veiled state aid

“The European authorities’ response is they are prepared to engage in such asset purchases if necessary, but in the euro area context buying private assets – bundles of bank loans – is more feasible and more effective than purchasing sovereign debt,” said Huw Pill, Goldman Sachs’s chief European economist.

“As a result, the market for securitized bank loans needs to be re-activated, widened and deepened,” Pill added.

This would require rule changes at EU level and in the regulatory treatment of such assets under international bank capital rules.

A more active market for asset-backed securities (ABS) would help banks lighten the load on their balance sheets and enable them to lend more. But getting there will take time.

Sassan Ghahramani, CEO of New York-based SGH Macro Advisors, which advises hedge funds, said the ECB’s plans “make a lot of sense in theory, and would be the most targeted mechanism for providing credit where needed”.

“But it is all effective only on the margins from a macro perspective, and certainly nothing markets would get overly excited about if and when it were to slowly materialize.”


Securitized loans have widely been blamed for causing the financial crisis that brought the world’s banking system to the brink of collapse. Tougher rules were the answer but these have made the assets less attractive for banks to create and hold.

In Europe, however, the market is seen as being key to unlocking lending to smaller and mid-sized firms, which form the backbone of the euro zone economy.

Last year, 180.8 billion euros of securitized product was issued in Europe, down from 251 billion in 2012, the Association for Financial Markets in Europe said. This is a far cry from levels seen before the crisis, around 450 billion euros in 2007 and even 711 billion the following year.

Small- and medium-sized business securitization makes up a fraction of the current total.

The ECB is pushing to revive the market, arguing that European ABS are different from their more complex U.S. cousins that also have a higher default rate, and should therefore be assigned more lenient capital treatments.

Its new requirements for detailed loan data information on ABS it accepts as collateral in its credit operations should also raise transparency and restore confidence in the market.

At the G20 meeting this weekend, ECB President Mario Draghi and his entourage want to convince the world’s financial elite that the European market deserves a different treatment.

Together with the Bank of England, the ECB will present a joint paper on the issue in Washington to back up its push.

A person familiar with the matter said the ECB had also joined forces with the European Commission and the European Insurance and Occupational Pensions Authority.

The European Investment Bank could also play a role.


It might still be some time before the ECB decides large-scale purchases will be needed, if at all, but even if rules changed in the near term, it is unclear how markets would react.

Several policymakers have said there is no immediate need for action and that the ECB is likely to wait for a clearer picture on price developments before it pulls the trigger.

“We won’t see large-scale asset purchases from the ECB unless we see the macro economic situation deteriorate and deflation risks intensify relative to the ECB’s base case published in March,” said Pill.

ECB staff projection updates in June and September will give the bank a better idea of whether the surprise drop in March inflation to 0.5 percent derailed its medium-term outlook for price stability.

“If we do get there, it will be towards end-year or early next year rather than the next couple of months,” Pill said.

In the meantime, the ECB could take steps to pave the way.

Francesco Papadia, a former director general for market operations at the ECB, said one option would be to introduce a program similar to the initiatives the ECB launched from 2009 to 2012 to revive the covered bond market.

As such, the ECB could for example propose spending 100 billion euros over the next 12 to 18 months on ABS, agreeing only to buy the tranches with the highest quality, 30 to 50 percent and leave the rest to the market.

While still falling far short of full-blown QE, such a step would underline the ECB’s readiness to buy such assets.

Commerzbank said that even a double-digit billion euro sum spent on senior tranches of ABS backed by loans to small and mid-sized companies could have an impact.

Overall, however, the ECB would not get around buying government debt if it had to intervene on a large-scale, mainly because the pool of sovereign debt would be the deepest.

“We expect that government bonds will play a dominant role in possible asset purchases by the ECB,” said Commerzbank economist Michael Schubert. “Which of course does not mean the ECB would abstain from securities in other market segments.”

Back to list