Let me preface this note by pointing out that I think that although the EZ banking system needs massive help (again 9% of EZ GDP in bad loans within the banking system, heaven forfend), it is hopeless without a change in the structure of the Euro and a relaxation of the fiscal straight-jacket inflicted with bogus German logic across the zone.
However if you are trying to help fix banks we can look back into the heart of the financial crisis when one of the final acts of the Bush administration was to enact the Troubled Asset Relief Program (TARP) to buy toxic assets off banks to help them maintain solvency and keep lending.
Now let’s start by acknowledging this was a program of mixed efficacy, with some banks not wanting to be tarred by the program, while others behaved with few moral scruples, and overall it didn’t kick start a new lending boom to offset the economic collapse, because, well, the economy was busy plummeting, which is not normally a condition that encourages either lenders or borrowers.
Nonetheless the principle makes a degree of sense in that it can free bank balance sheets and at least allow them to work effectively within an economy to support struggling borrowers through the tough times and have capital free to lend into, and support, an economic recovery.
Effectively the ECB TARP would become the Bad Bank, which would take on the dodgy loans within the EZ banking system (which amounts to €809bn at the end of 2013 according to the recent stress tests), which funnily enough is less than the amount the ECB could add to its balance sheet to build it back up to end 2012 levels, which is the latest ECB notion.
By going in directly like this the ECB would avoid the problems of having to create a whole new ABS market overnight, as well as avoiding some of the sticky rules already imposed on this program, which really direct it towards buying good credits only (which therefore don’t need a borrower of last resort as there should be a ready market of investors for them).
Doing it this way the ECB could expand its balance sheet, help the EZ economy immeasurably and perhaps kick start sufficient confidence that even the constraints of the FrankenEuro can be overcome, at least for a while. In those circumstances it might even reflect some of the US experience in reinvigorating those damaged loans and get much of the money back as. Who knows.
Will it happen, almost certainly not…but..but, if Super Mario could get German support for this mega-moral hazard move, maybe he’ll stay in his role and the Euro holds together. It is the only thing I can think of that might do that, but then I do daydream a lot!