What’s at stake at tonight’s Eurogroup meeting?

Explainer: What’s at stake at tonight’s Eurogroup meeting (starting at 5pm) to decide the EU/eurozone recovery package in response to the corona-economic crisis.

(Adapted from a Twitter thread @emmaclancy123)

The Eurogroup (eurozone finance ministers) met for 16 hours on Tuesday without reaching agreement. There are two main points of contention: the creation of a common debt instrument (coronabonds) and the use of the existing bailout fund, the European Stability Mechanism (ESM), which has €410 billion.

The ESM is a fund that makes loans, conditional on “structural reforms” and harsh austerity à la the Troika bailouts. Eurobonds have long been proposed as a solution to eurozone divergence but were shot down by Germany and others during the sovereign debt crisis.

The basic concept of the Eurobond is that an EU instrument would pool the issuing of government debt by the members of the common currency. All of the debt would be rated equally, and would not be on the member states’ books. This would lower borrowing costs for the so-called periphery but reduce the privilege of the core.

Despite the common currency, the bond market has treated the bonds (debt) issued by different eurozone states as very different. During a crisis, capital flees the risky states and flows to the “safe” bonds, namely German bunds.

If the sovereign bond market doubts the ability of high-debt states to repay their debts, the market will “price” the debt higher with a risk premium – applying much higher interest rates to these governments and even denying them access to the market.

This is what happened during the eurozone debt crisis, causing the bankruptcies & Troika bailouts. An important note here: states that have their own currency do not need to consider such a problem because their currency will be backed up by their own central bank, and they cannot go bankrupt.

On March 25, leaders of nine member states France, Italy, Spain, Portugal, Ireland, Greece, Luxembourg, Slovenia and Belgium wrote to Council president Charles Michel calling for a “common debt instrument issued by a European institution to raise funds on the market” – i.e, coronabonds.

This position is supported by the ECB, which (correctly) has stated that the monetary and fiscal response to the crisis need to be combined and coordinated. The ECB has said a fiscal intervention of  €1.5 trillion will be needed in the EU in 2020 (likely an underestimation).

The Netherlands has strongly come out against coronabonds, backed by Germany, Austria and Finland, the so-called “Frugal Four”. The obnoxious Dutch position is making headlines but as always, the German position is key.

The best-case scenario for a coronabond is one issued by the European Investment Bank, unlimited and unconditional, guaranteed by the ECB. The ECB is the only institution with the power to back the spending necessary to deal with this crisis.

While the ECB is prohibited by the Treaty (Articles 123 and 125) from directly financing governments, it is permitted to make purchases from the EIB, a public bank.

But the benefits of a coronabond depend entirely on its design. It could be designed to allow governments to borrow at low costs and keep this debt off their balance sheets. Or it could be designed with the usual EU austerity conditions attached (and/or to be “securitised”).

The French compromise going into Tuesday’s Eurogroup meeting was for a new fund to “issue bonds with the joint and several guarantee of EU Member States”, to be operated by the Commission and guaranteed by a new resource such as a “solidarity tax”.

Germany and France have reportedly now agreed not to include this in the text. So, if media reports are correct, coronabonds are off the table and the debate is now only on the conditions to be attached to the use of the ESM (though France may lead the nine willing states in setting up a common bond between themselves).

Leaving aside the repugnant nature of the ESM in general, even from the EU leaders’ own criteria it is entirely unsuited to this situation. It was designed to provide conditional credit lines to member states facing an asymmetric shock, who can’t borrow in the markets.

The Commission’s ‘non-paper’ leaked before the Eurogroup meeting proposed two new ESM instruments, a Pandemic Crisis Support Enhanced Conditions Credit Line (ECCL) of up to 2% of a member state’s GDP and a Rapid Financing Instrument (a smaller fund of €80 billion).

Both ESM instruments have conditions attached, that they are only to be used for health & economic emergency spending, & states must adhere to the fiscal rules. See the proposal here.

The substantial credit line (ECCL) proposed conditions are ensuring “respect of EU fiscal rules and European Semester… with this commitment to be laid out in a “Memorandum of Understanding, which would be based on common terms for all Members”.

It’s similar wording for access to the rapid financing instrument. The generous gift of the northern states is to include a reference to “any flexibility applied by the competent EU institutions” to the EU fiscal rules (the Stability and Growth Pact rules have been temporarily suspended).

Remember, the SGP rules apply to annual deficits (to be kept below 3% of GDP) AND to accumulated debt (to be kept below 60% of GDP). When the rules apply again post-crisis, high-debt states will be in a permanent debtors’ prison, forced to implement the inevitable austerity the Commission will demand.

Reportedly, the key remaining sticking point is that Italy wants the reference to a Memorandum of Understanding to be removed and the Netherlands refuses.

The Dutch government also opposes including a reference to “innovative financial instruments”, a vague reference to the future possibility of coronabonds agreed on by most states.

At this stage it appears that France, Italy, Spain and the other signatories to the letter calling for coronabonds are prepared to give up on all of their demands in exchange for the removal of the term “memorandum of understanding”.

To summarise: The Eurogroup is right now in a vicious fight over a LOAN from the bailout fund that will add to government debt, increase borrowing costs on the market, need to be repaid, and inevitably have austerity conditions attached.

Bond markets appear relatively calm, assured by the ECB’s recent actions, though yields are spreading somewhat (the market is increasingly pricing Italian and Spanish debt as riskier).

The immediate fallout from this farce will be political. The southern states asked for solidarity in the midst of a horrific pandemic and had the door slammed in their faces by Germany, the Netherlands, Austria and Finland.

The longer term implications will be both economic and political. It is no exaggeration to say this week is a defining one for the future of the common currency and for the EU. What’s the point of the euro and the EU?

It is crystal clear that direct monetary financing of government spending by the ECB is the answer. All of these limitations are ideological and self-imposed.

Governments should refuse to use the ESM, borrow what they need on the market in the expectation that the ECB will purchase their bonds, and demand that the suspension of the Stability and Growth Pact is permanent.

Image above shows Dutch Minister of Finance, Wopke Hoekstra (left) talking to German Federal Minister of Finance Olaf Scholz. Getty Images.

Austerity kills: Commission demanded cuts to public healthcare spending 63 times from 2011-2018

Protestors against government spending cuts to public services in the aftermath of the 2008 global financial crisis often carried placards and banners bearing the slogan “Austerity kills”.

The COVID-19 pandemic is demonstrating the brutal truth inherent in this statement. A decade of austerity imposed by the EU institutions and EU member state governments has caused significant deterioration in healthcare services across the EU.

Over the past week, doctors in northern Italy have described the horrific situation of their being forced to choose which patients are to be treated, and which are to be left to die.

The European Centre for Disease Control warned on March 12 that, “The speed with which COVID-19 can cause nationally incapacitating epidemics once transmission within the community is established, indicates that in a few weeks or even days, it is likely that similar situations to those seen in China and Italy may be seen in other EU/EEA countries or the UK…The risk of healthcare system capacity being exceeded in the EU/EEA and the UK in the coming weeks is considered high.”

The WHO has outlined the immediate actions we need to implement in each member state of the EU:

  • Find, isolate, test and treat every case and trace every contact;
  • Ready your hospitals; and
  • Protect and train your health workers.

This was the strategy used in China, South Korea and other countries in south-east Asia that effectively contained the epidemic. But the response from many EU member states does not include even the ambition to “find, isolate, test and treat every case and trace every contact”. The EU’s healthcare and public sector sectors are simply not equipped to respond in accordance with international best practice.

Healthcare gutted by spending cuts and privatisation 

A report I published last month found that the European Commission made 63 individual demands of member states to cut spending on healthcare provision and/or privatise or outsource healthcare services between 2011 and 2018, in order to meet the arbitrary debt and deficit targets enshrined in the Stability and Growth Pact.

These demands affected the “peripheral” economies hit by the sovereign debt crisis especially harshly: Greece, Spain, Italy, Ireland and Portugal.

Some of the key findings of the report, Discipline and Punish: End of the Road for the Stability and Growth Pact?, including its impact on public services in the EU, are briefly outlined below.

EU surveillance and control of member states’ budgets

The Stability and Growth Pact (SGP), first enacted in 1997, has proven to be one of the most contested and controversial features of the Economic and Monetary Union, and the broader EU. The SGP imposes two numerical ceilings on government expenditure: (1) the government debt-to-GDP ratio must be below 60 per cent; and (2) the annual deficit of member states must be limited to 3 per cent of GDP or less.

The power of the European Commission to surveil and control the national budgets of EU member states was significantly strengthened in 2011 by the adoption of the Six-Pack and in 2013 by the adoption of the Two-Pack, as well as the signing of the Fiscal Compact, an inter-governmental treaty.

The European Semester is the annual programme of coordinated economic policy across the EU, introduced by the Commission in 2011. It essentially aims to make the national budgets of member states subject to the scrutiny, alteration and approval of the Commission and the Council before the final budget plan is finally put to a vote in the national parliament.

The European Semester incorporates the requirements of the SGP and the Macroeconomic Imbalance Procedure, as well as broader structural reforms under the Europe 2020 strategy. In response to the draft budgetary plans submitted by member states, the Commission produces “country-specific recommendations’” to individual states.

Singling out healthcare for budget cuts

The report examines the SGP’s role in intensifying the transfer of wealth from labour to capital in the EU, in particular since the global financial crisis. It examines the precise ways in which the SGP achieves this transfer by examining the content of the country-specific recommendations made by the European Commission to EU member states on the basis of the SGP and the Macroeconomic Imbalance Procedure. It also examines the deeply corrosive impact of the SGP and its enabling framework, on democracy in the EU, and the implications of this.

The report analyses the content of all country-specific recommendations made under the SGP and the Macroeconomic Imbalance Procedure from 2011 to 2018. It finds that in addition to consistent demands for reductions in public spending, the Commission has specifically singled out pensions, healthcare provision, wage growth, job security and unemployment benefits.

The content of Country-Specific Recommendations from the Commission under the Stability and Growth Pact and the Macroeconomic Imbalance Procedure 2011-2018

NUMBER OF EU28 MEMBER STATES RECEIVING INSTRUCTION FROM COMMISSION

YEAR Increasing pension age/
cuts to pension funding
Spending cuts on healthcare/
privatisation of healthcare
Suppression of wage growth Reducing job security/
workers’ bargaining rights
Reducing support
for unemployed, vulnerable or people with disabilities
2011 14 2 7 5 8
2012 13 3 6 7 10
2013 15 10 6 9 6
2014 17 16 13 10 9
2015 13 9 8 3 3
2016 10 8 4 2 3
2017 10 5 4 2 3
2018 13 10 2 0 3
TOTAL: 105 63 50 38 45

Source: Author’s calculation based on Commission CSR data 2011-2018

From the introduction of the European Semester in 2011 to 2018, the Commission made 105 separate demands of individual member states to raise the statutory retirement age and/or reduce public spending on pensions and aged care.

It made 63 demands that governments cut spending on healthcare and/or outsource or privatise health services.

Demands aimed at suppressing wage growth were put to member states on 50 occasions.

Instructions aimed at reducing job security, employment protections against dismissal, and the collective bargaining rights of workers and trade unions were made 38 times.

In addition to routine demands to cut government expenditure on social services generally, the Commission also made 45 specific demands aimed at reducing or removing benefits for the unemployed, vulnerable people and people with disabilities, including by enacting punitive measures to force these individuals into the labour market – or, at least into becoming jobseekers.

Under the cover of limiting debt and deficits, the European Commission is enforcing austerity in policy areas it has no legal authority over.

The current political focus must of course be on responding to the immediate and enormous challenges posed by the pandemic. But as we face into a likely far sharper recession than that of the global financial crisis, we also need an honest assessment of the failed public policies that have left EU healthcare systems in such a weak position, with such devastating results.

Discipline and Punish: End of the road for the EU’s Stability and Growth Pact?

pension protest

Below is an excerpt from the new study, Discipline and Punish: End of the road for the EU’s Stability and Growth Pact?, commissioned by Martin Schirdewan MEP, co-president of the European United Left group in the European Parliament. Read the full study here.

Against a backdrop of prolonged stagnation and low growth, ultra-low interest rates, rising income and wealth inequality, and a desperate need for massive public investment in the climate transition, placing arbitrary restrictions on the borrowing and spending abilities of European governments cannot be economically or socially justified.

It is almost universally acknowledged that the Stability and Growth Pact (SGP) has failed to ensure either economic stability or growth in the European Union (EU) since its introduction in 1997. It has in fact demonstrably acted to stifle growth, and it has deepened and prolonged the double-dip recession in the EU. The strict fiscal rules have acted as a direct barrier to the recovery of economic growth to pre-crisis levels, and they contribute to the ongoing sluggish growth in the EU.

While the SGP was loosened due to political opposition to the rules from powerful member states in 2005, the post-crisis reforms of 2011 (the Six-Pack) and 2013 (the Two-Pack and the Fiscal Compact inter-governmental treaty) dramatically increased the power of the European Commission over the budgetary decisions of member states. These changes strengthened the fiscal rules but weakened the democratic decision-making process.

The content of the SGP, and the Maastricht Treaty (1992) convergence criteria it was based on, reflect the dominant economic ideology of the 1990s, as well as reflecting the general economic conditions that prevailed at the time. The numerical ceilings of the SGP – that EU member states must keep their budget deficits below 3 per cent of GDP, and public debt to GDP ratios below 60 per cent – may have been based on the prevailing standards of 1997 in the EU, but neither threshold has any sound economic basis.

Transferring wealth from labour to capital

Fiscal policy is one of the most important ways a state has to redistribute wealth and contain or reduce income and wealth inequality. The constraints imposed by the SGP have directly limited states’ ability to redistribute wealth. While moves have been made to exempt certain forms of investment from the rules (i.e, national contributions to European Fund for Strategic Investment projects) on the grounds that such investments will generate GDP growth, direct transfers of resources through expenditure on welfare programmes and public services are threatened by the SGP.

The SGP actively promotes the transfer of wealth from labour to capital, a process that has intensified through the Macroeconomic Imbalance Procedure introduced as part of the Six-Pack. The specific policy measures demanded by the Commission focus on limiting wage growth; increasing the threshold age for receiving a pension; privatising state-owned enterprises and healthcare; promoting longer working hours; demanding a reduction in job security; and cutting funds to social services.

An analysis of the country-specific recommendations under the SGP and the Macroeconomic Imbalance Procedure since 2011 finds that in addition to consistent demands for reductions in public spending, the Commission has specifically singled out pensions, healthcare provision, wage growth, job security and unemployment benefits for attack.

The content of Country-Specific Recommendations from the Commission under the Stability and Growth Pact and the Macroeconomic Imbalance Procedure 2011-2018

NUMBER OF EU28 MEMBER STATES RECEIVING INSTRUCTION FROM COMMISSION

 

YEAR Increasing pension age/
cuts to pension funding
Spending cuts on healthcare/
privatisation of healthcare
Suppression of wage growth Reducing job security/
workers’ bargaining rights
Reducing support
for unemployed, vulnerable or people with disabilities
2011 14 2 7 5 8
2012 13 3 6 7 10
2013 15 10 6 9 6
2014 17 16 13 10 9
2015 13 9 8 3 3
2016 10 8 4 2 3
2017 10 5 4 2 3
2018 13 10 2 0 3
TOTAL: 105 63 50 38 45

Source: Author’s calculation based on Commission CSR data 2011-2018

Under the cover of limiting debt and deficits, the European Commission is enforcing austerity in policy areas it has no legal authority over.

From the introduction of the European Semester in 2011 to 2018, the Commission made 105 separate demands of individual member states to raise the statutory retirement age and/or reduce public spending on pensions and aged care.

It made 63 demands that governments cut spending on healthcare and/or outsource or privatise health services.

Demands aimed at suppressing wage growth were put to member states on 50 occasions, while instructions aimed at reducing job security, employment protections against dismissal, and the collective bargaining rights of workers and trade unions were made 38 times.

In addition to routine demands to cut government expenditure on social services generally, the Commission also made 45 specific demands aimed at reducing or removing benefits for the unemployed, vulnerable people and people with disabilities, including by enacting punitive measures to force these individuals into the labour market – or, at least into becoming jobseekers.

The SGP’s flawed ideology and methodology

The architects of the euro were aware of the many “spillover” effects that imbalances in one economy can have on others in a currency union. However, the EU institutions have focused single-mindedly on pursuing internal devaluation and reducing “wage rigidities”. The deflationary impact of a state or states running a large current account surplus has been largely ignored.

The economic justification for the EU’s pre- and post-crisis austerity policies is based on the fringe theory of “expansionary austerity” that has been decisively disproved.

The calculation of the structural deficit (the discretionary spending by a government minus cyclical factors) that is used to determine whether a state is breaching the 3 per cent deficit target since the introduction of the Six-Pack is highly contested. The fact that the structural deficit is “unobservable” has led to bizarre situations such as the Excessive Deficit Procedure the Commission opened against Italy in 2018 in fear that the stagnant Italian economy was at risk of overheating.

The question of public debt

The average public debt to GDP ratio in the EU has expanded from an average of around 65-70 per cent in 1997 to 80.4 per cent in 2018. Eurozone debt was lower than the EU average in 1997, but this trend has now been reversed. Eurozone public debt peaked at 93.0 per cent in 2014 and declined to 86.1 per cent in 2018.

Public debt is not inherently “good” or “bad”. The literature claiming that once a certain threshold of public debt has been reached (90-100 per cent of GDP), the GDP growth rate will decline, is inconclusive and disputed. The level of debt is not as important so long as the state is able to continue rolling over and servicing its debt. In the current context of prolonged ultra-low interest rates, there is little to no cost to borrowing.

The precise scenario the SGP was supposed to prevent – a contagious sovereign debt crisis within the economic and monetary union – unfolded following the global financial crisis.

The key factors behind the surge in the public debt levels in the “peripheral” member states after 2008 were: (1) the policies of the EU institutions and member states in organising a coordinated rescue of the financial sector, socialising massive levels of private debt; (2) the ECB’s actions in failing to intervene to provide credit to the crisis-affected states for an extended period of time, causing the market borrowing costs for these states to surge; and (3) the contractionary austerity programmes imposed by the Troika.

At the same time as limiting public investment and expenditure, the EU facilitates massive levels of tax avoidance by multinational corporations that further deny governments’ access to vitally needed revenue. The system whereby individual member states of the EU, several of which are recognised internationally as tax havens, are allowed to veto proposals for effective action to combat tax avoidance enables this situation.

Politicised enforcement of the fiscal rules

Almost all EU member states have breached the rules at some point – during the Great Recession only Luxembourg did not go over the 3 per cent deficit benchmark. Only Estonia and Sweden have escaped the Excessive Deficit Procedure under the SGP.

The examples of the high-profile clashes between member states and the Commission regarding the application of the Excessive Deficit Procedure under the SGP demonstrate the arbitrary, biased and highly political enforcement of the rules in practice. The powerful and compliant are rewarded, while the weaker member states and dissenters are punished. The cases of Germany, France, Spain, Portugal and Italy are used here to demonstrate the disparity in the application of the rules.

The inconsistent, biased and secretive decision-making process under the SGP is perhaps the most glaring symbol of the EU’s democratic deficit, significantly undermining public confidence in the EU.

A Left perspective on fiscal strategy

The SGP is currently facing unprecedented criticism from member states, EU institutions such as the European Central Bank, European Court of auditors and European Fiscal Board, and international institutions including the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD). The forthcoming review of the SGP by the Commission that will take place throughout 2020 is an important opportunity to put forward political demands regarding the fiscal rules.

Proposals for reform such as excluding green investment or public investment in general, and simplifying the rules, are welcome, but insufficient. The necessary climate transition is impossible under the SGP. Decisions on borrowing and spending must be decentralised to accountable national parliaments.

The EU needs a major, coordinated public investment effort in order to radically transform our economies and societies to meet the challenges of climate change, digitalisation and growing inequality.

Brussels’ plan for bad loans is a second bailout for the banks

Clancy-1

Barely a word has been said in the Irish media to date about an extremely important new proposal from the European Union (EU) Commission – to develop a so-called ‘secondary market’ for non-performing loans. If implemented, this package of policies will directly cause an increase in evictions and homelessness, enable the harassment of mortgage-holders by debt collectors, and generate massive new risks to financial stability.

This proposed EU Directive on credit servicers, credit purchasers and the recovery of collateral will jettison even the (extremely) limited progress the Irish state has made on regulating vulture funds.

“Credit purchasers” refers to vulture funds and securitisation institutions, “credit servicers” means debt collection agencies, and the proposal for the “recovery of collateral” is for accelerated out-of-court enforcement of loans secured by collateral – meaning banks will be able to seize their customers’ property without going through the courts.

In short, it will let the EU’s banks carry out a mass sell-off of bad loans to US vulture funds; shift almost a trillion euros of bad debt off the banks’ balance sheets into the opaque and unregulated shadow banking sector through the same instruments that caused the 2008 crisis; implement rules that mean the vultures cannot be regulated in any way within the EU and can operate across borders without any restrictions; and add nothing whatsoever to the existing level of consumer protection to borrowers and homeowners in the EU.

A toxic debt mountain

Non-performing loans (NPLs) are bank loans that are subject to late repayment or are unlikely to be repaid by the borrower. EU standards now generally require banks to classify loans as non-performing if they are more than 90 days in arrears. The ability of borrowers to pay back their loans deteriorated significantly during the financial crisis and the subsequent double-dip recession. As a result, many banks saw a build-up of NPLs on their books, particularly in the countries worst affected by the crisis.

Euro-area banks held just over €1 trillion in NPLs in 2016, the equivalent of around nine per cent of the Eurozone’s GDP, and amounting to around 6.4 per cent of total loans in the Eurozone. The level of NPLs differs dramatically across the euro area, with almost half bank loans in Greece and Cyprus classified as NPLs, and Italy, Ireland, Portugal and Slovenia all holding NPLs at rates of 10-20 per cent. While the average ratio of NPLs in the EU has decreased by more than one-third since 2014, the total volume of NPLs remains high, at around €820 billion as of December 2018.

The proposed EU Directive is touted by the Commission as having one main aim: to free up banks to lend to consumers and small businesses again by reducing the high levels of bad loans on their balance sheets.

But even a cursory glance at the lending statistics across the Eurozone and the EU demonstrate clearly that the lower level of lending by banks is not caused by a lack of willingness by banks to provide credit, but rather by a lack of demand for credit from SMEs, companies and households.

In reality the proposal has three key aims:

  • To encourage EU banks to reduce their stocks of sour loans by any means necessary so they can return to pre-crisis profitability levels and compete once more with US banks;
  • To take away the right of EU member states to place regulations and restrictions on vulture funds and debt collectors that may impede their ability to enter the EU and operate freely across borders; and
  • To give the banks and vulture funds new powers to seize their customers property if they fall behind in repayments of debt – without having to bother with the irritating process of actually claiming this collateral through a court in which the judge is legally obliged to consider the rights of the consumer.

Replicating the Irish model across the EU

The European Commission has looked at the post-crisis process in the Irish state where banks have reduced their stocks of non-performing loans significantly, decided it is a glorious success story, and resolved to replicate this process across the entire EU.

The key components of this ‘success’ story in Ireland were the creation of the National Asset Management Agency (NAMA), which used public funds to take bad loans off the balance sheets of the bailed-out Irish banks; the grovelling invitation to US vulture funds to enter the Irish market by former Finance Minister Michael Noonan; and the eagerness of the Irish banks to engage in the mass sell-off of their customers’ mortgages and loans to these debt vultures at a fraction of their value.

Following this logic of trying to replicate the Irish model across the EU, the Commission made a legislative proposal in March 2018 based on four key aspects:

  • Provisioning by banks – a Regulation to require banks to put aside their own capital to cover the loss of a bad loan;
  • A Directive on developing a secondary market for NPLs – promoting the sale of bad loans to vulture funds, and promoting securitisation;
  • The same Directive to cover debt recovery – giving banks more power to enforce the collection of collateral through out of court recovery; and
  • Non-binding guidance for Member States on how to establish a national Asset Management Company – a NAMA-style bad bank, including possibly using public funds.

In fact, the Commission has proposed that all credit agreements – i.e., even performing loan agreements in which the customer has fulfilled every obligation required of them – should be within the scope of this Directive and therefore able to be sold on to a third party.

ECB Guidance on reducing non-performing loans (2017)

The Commission proposal of March 2018 was preceded by rules issued by the ECB, which published its Guidance to banks on NPLs in March 2017, setting out the manner in which it expected banks to reduce their existing stocks of NPLs. This Guidance is non-binding but subject to a comply-or-explain type system in which supervised banks must explain deviations upon supervisory request, and in which non-compliance may trigger supervisory measures.

The Guidance only applies to the largest banks in the EU, which are supervised by the ECB’s Single Supervisory Mechanism. It states that each bank with elevated levels of NPLs is expected to develop portfolio-level reduction targets with a view to reducing the level of non-performing exposures on its balance sheet in a timely manner. The Addendum to the Guidelines calls for these banks to enact a reduction plan if their level of NPLs passes a threshold of five per cent of their overall balance sheet.

This Guidance has been used by banks in several member states – and particularly by Irish banks – to prompt and justify their mass sell-offs of mortgages to vulture funds. Irish banks constantly point the finger at the ECB when selling mortgages to vulture funds, claiming the ECB forced them to. But this is simply not true.

The ECB “has not expressed a preference for certain NPL reduction tools over others” in its non-binding Guidance, and has clearly stated that the combination of tools or strategy reduction drivers for a given bank is the responsibility of, and chosen at the discretion of, its management, which could include debt restructuring, debt forgiveness and many other measures that don’t involve vulture sales.

No doubt the ECB has applied pressure to banks to reduce their bad debt levels, but it has no legal mechanism to force banks to sell loans to vultures and it explicitly denies doing so.

Having said this, the role of the ECB has been one of consistently undermining the rights of homeowners and borrowers, to the benefit of the banks and vulture funds. Every attempt to regulate the debt vultures that we have seen in the Irish state in recent years – every draft piece of domestic legislation – has been referred to the ECB for its ‘opinion’. The ECB’s opinion always seems to be that the banks should be allowed to get rid of their bad loans by any means necessary.

The Commission’s proposed Regulation on banks covering NPL losses is similar to the ECB Guidance except it applies only to future NPLs and not the existing stock; it provides a slightly more lenient time frame for banks to set aside their own funds to cover future NPL losses; it is legally binding; and it applies to all banks and not only the largest ones that are under the direct supervision of the ECB.

In theory, the proposal for a Regulation to require banks to put aside their own capital to cover the loss of future NPLs is sensible from a financial stability point of view in that it will encourage banks to engage in more responsible lending behaviour, and reduce the likelihood of the need for public bailouts of banks in future.

The Commission’s proposal could have encouraged banks to work through future non-performing loans with their customers on a case-by-base basis; and provide concessions to their customers including extensions of repayment periods, lower interest rates, debt forgiveness or many other options.

But taken in combination with the Directive on developing a ‘secondary market’ for bad debt, in reality it instead encourages the banks to take no responsibility for their predatory lending practices and dump their toxic debt into the shadow banking sector, or worse, taxpayer-funded ‘bad banks’.

We cannot apply a one-size-fits-all reduction target that will incentivise banks to offload their loans onto the secondary market. Banks should be required to keep their NPLs on their book and to work through them with their customers by writing down, restructuring or forgiving the debt, particularly in cases of residential loans.

Wtf is securitisation?

As well as giving free rein to debt vultures, this Directive also aims to promote the use of securitisation vehicles to ‘refinance’ bad loans, or to move this bad debt off the banks’ balance sheets and into opaque and unregulated hedge funds.

Mortgage-backed securitisation vehicles are created when individual mortgages are sliced up and bundled together into packages that can be traded on – gambled on – by investors. The idea is that betting on the return of the bundled, securitised vehicle is supposedly less risky than betting on a single mortgage.

The main investment vehicles that held mortgage-backed securities in the 2000s were collateralised debt obligations (CDOs). CDOs were instruments that included slices of different bank loans, each with a different level of risk and a different interest rate. The rationale behind CDOs was that by pooling together risky loans with less risky assets, the overall risk profile would be lowered – the CDO would be able to gain a higher credit rating – and they would be more profitable for investors. But if one slice defaulted, it increased the risk of a default by the next slice in the bundle. The bad loans infected the rest of the sector until major investment banks could no longer put a price on certain securitisation vehicles.

The moment that marked the onset of the global financial crisis was not actually the collapse of Lehman Brothers in September 2008, but rather the moment in July 2007 when Bear Stearns found that it couldn’t put a value on a number of hedge funds that were contaminated with CDOs that included subprime mortgages in them. One of these hedge funds lost 90 per cent of its value overnight; another lost its entire value.

It is almost beyond comprehension that, just a decade on from the global financial crisis, mortgage-backed securities – and non-performing ones at that – are being posed by the Commission as a solution to a toxic debt crisis that is the legacy of the 2007-08 crisis, which these instruments literally caused.

Moving almost a trillion euros out of the regulated and relatively transparent banking sector into the opaque and almost totally unregulated shadow banking sector (by the existing ECB Guidance alone) is incredibly misguided and will pose massive new risks to financial stability in the EU and internationally. Expanding this process under the Directive for all future bad debt is incomphrehensible. How exactly does moving billions of euros of bad debt into the wild west of finance improve financial stability?

‘Buy when there’s blood in the streets’: enter the vultures

The Commission wants to move the toxic debt off the balance sheets of the EU’s banks so they appear healthy and well-functioning, and can compete internationally, particularly with US banks.

An 18th century banker is credited with coining the phrase that best defines the “contrarian” investor’s guide to make a killing in a financial crisis: “The time to buy is when there’s blood in the streets.” This principle underpins the strategy of the private equity funds referred to as vulture funds. You buy when the price is at rock-bottom and make a profit in the shortest possible time frame by any means necessary.

In the Ireland of today this means buying non-performing loans from banks at a fraction of their worth, and securing the underlying asset (usually people’s homes) as quickly as possible through making some sort of dodgy deal with the person who owes the debt, or simply throwing them out on the street.

The red-carpet treatment the Fine Gael-led government has provided to the vulture funds over the past five years – through open-door lobbying access, a virtually tax-free environment for most of the past five years, and consistent government opposition to attempts to rein them in through regulation – has made Dublin a favoured spot for US vulture funds to set up shop in.

Under the proposed EU Directive virtually all restrictions on “credit purchasers” (vulture funds) registered within the EU to operate across borders will be removed, and the fund will be bound only by the regulations of the EU member state in which it is registered. So the light-touch regulation of the Central Bank of Ireland may soon be the only line of defence against vulture funds preying on millions of indebted and impoverished borrowers across the EU.

Third-country credit purchasers – say a US vulture fund that has not set up a subsidiary in an EU member state at all – will simply have to designate a “credit servicer” (a debt collector) to enforce the credit agreement and not even bother with registering in the EU. Only the credit servicer and not the vulture fund itself will be regulated in any way under EU law.

This is precisely the political debate that has played out in the Irish state over the past three or four years. The owners of the credit agreement – the vulture funds – are the ones who make the key decisions regarding the distressed loan, including the setting of interest rates, whether to restructure a loan, and the enforcement of the loan. So it is crucial that the credit purchaser – and not only the credit servicer that acts as an intermediary – is authorised and regulated in the EU, and subject to supervision, investigation and sanctions by the national competent authorities in the member state in which it operates,.

Jettisoning the minor progress made in Ireland

In an Irish context, we have made only limited progress to date in terms of regulating vulture funds and protecting consumers and mortgage-holders. Yet even this modest progress made in the Dáil – usually in spite of Fine Gael opposition – will now be under threat by this EU Directive.

For years Irish campaigners for the rights of mortgage-holders have demanded that the vulture funds themselves, and not only the middlemen must be directly regulated by the Central Bank. Ireland’s Consumer Protection (Regulation of Credit Servicing Firms) Act 2018, which came into effect in January, is a positive step forward in that it allows the Central Bank for the first time to regulate, investigate and sanction the owners of the credit agreements and not just their designated debt collectors.

This modest but significant step forward in our framework for regulating vulture funds is now under threat by the EU Directive, as described above. The Irish government must defend our right to maintain this important piece of legislation in the European Council when negotiating this Directive, and all Irish MEPs in the European Parliament must also defend this position.

The second substantial potential piece of Irish legislation that must be defended from the EU is TD Pearse Doherty’s ‘no consent, no sale’ bill requiring banks to gain the written consent of their customers before selling their mortgage to a vulture fund; if this bill becomes law based on the will of our elected representatives in Dáil, it will be simply overruled by the EU through this Directive.

Campaigning for the Directive to be withdrawn

Leftists in the European Parliament have tabled amendments to the Parliament’s report on the Directive demanding the direct regulation of the vulture funds and not only their intermediaries; the need for banks to obtain the written consent of their customer before selling their loans on to a third party; a debt buy-back scheme for customers to have the right to purchase their own debt at the same reduced price that their bank would sell the loan to a vulture for; and for a range of additional consumer protection improvements to the Directive.

But these amendments are not enough. This Directive is a second bailout for the banks that gives free rein to the vultures and allows the banks to throw their customers under the bus. Minor improvements here and there won’t cut it. It needs to be scrapped in its entirety – and consumer rights groups, housing campaigners, human rights organisations and a range of political forces from across the EU will be organising a campaign in the coming weeks and months demanding this Directive be withdrawn .

Originally posted on Irish Broad Left

 

 

 

Sounding the alarm on the EU’s proposed Directive on non-performing loans

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Below is a letter to trade unions, farmers organisations, housing campaigners and others from Matt Carthy MEP raising alarm over the EU’s new proposed Directive on non-performing loans

10 January 2019

I am writing to inform you of a serious threat to the rights of borrowers and consumers arising from a proposed new EU Directive, which aims to develop a secondary market for non-performing loans. (Proposal for an EU Directive on credit servicers, credit purchasers and the recovery of collateral).

This proposed EU Directive is designed to promote the use of vulture funds and securitisation vehicles in order to move this bad debt off the banks’ balance sheets and into the opaque and unregulated shadow banking sector.

This proposal will also empower banks to seize their customers’ collateral through an out-of-court recovery mechanism, and will result in borrowers, including mortgage-holders, being pursued more aggressively by vulture funds and debt collectors.

1. Background

Non-performing loans (NPLs) are bank loans that are subject to late repayment or are unlikely to be repaid by the borrower. EU standards now generally require banks to classify loans as non-performing if they are more than 90 days in arrears. The ability of borrowers to pay back their loans deteriorated significantly during the financial crisis and the subsequent double-dip recession.

As a result, many banks saw a build-up of NPLs on their books, particularly in the countries worst affected by the crisis. While the average ratio of NPLs in the EU has decreased by more than one-third since 2014, the total volume of NPLs remains high, at around 900 billion euros.

Unfortunately the role of the EU institutions has been one of undermining the rights of homeowners and borrowers, to the benefit of the banks and vulture funds. Every attempt to regulate the debt vultures that we’ve seen in the Irish state in recent years – every draft piece of domestic legislation – has been referred to the European Central Bank for its ‘opinion’. The ECB’s opinion always seems to be that the banks should be allowed to get rid of their bad loans by any means necessary.

2. ECB Guidance to banks on NPLs (March 2017)

The ECB published its Guidance to banks on NPLs in March 2017, setting out the manner in which it expects banks to manage their NPLs. This Guidance is non-binding but subject to a comply-or-explain system in which supervised banks must explain deviations upon supervisory request, and in which non-compliance may trigger supervisory measures.

The Guidance only applies to the largest banks in the EU, which are supervised by the ECB’s Single Supervisory Mechanism. The Guidance states that each bank with elevated levels of NPLs is expected to develop portfolio-level reduction targets with a view to reducing the level of non-performing exposures on its balance sheet in a timely manner. The Addendum to the Guidance calls for these banks to enact a reduction plan if their level of NPLs passes a threshold of 5% of their overall balance sheet.

The ECB Guidance has been used by banks in the Irish state to prompt and justify their mass sell-offs of mortgages to vulture funds. However, the ECB has repeatedly stated that it “has not expressed a preference for certain NPL reduction tools over others”, and that the combination of tools or strategy reduction drivers for a given bank is the responsibility of, and chosen at the discretion of, its management.

3. Commission proposal on NPL package (March 2018)

In March 2018, the Commission made a specific legislative proposal based on four key aspects:

  • Provisioning by banks (banks putting aside their own capital to cover the loss of a bad loan);
  • Developing a secondary market for NPLs (promoting the sale of bad loans to vulture funds, and promoting securitisation);
  • Debt recovery (giving banks more power to enforce the collection of collateral through out-of-court recovery); and
  • Non-binding guidance for Member States on how to establish a national Asset Management Company (a bad bank, including possibly using public funds).

Unlike the ECB Guidelines, the Commission proposal applies only to future NPLs, not the existing stock. It is mandatory instead of non-binding and applies to all credit institutions, not only the biggest banks under ECB supervision.

The package consists of three different proposals from the Commission: a Regulation (on provisioning), a Directive (on developing the secondary market) and a non-legislative blueprint (on setting up national Asset Management Companies).

4. Analysis of the proposed package

On the proposed Regulation, I am generally in favour of the idea that banks should be required to put aside their own capital to cover the losses they incur when the loans on their balance sheets turn non- performing. This would incentivise banks to adopt more prudent lending standards. It would increase financial stability and lessen the likelihood of future public bailouts being necessary.

However, we cannot apply a one-size-fits-all reduction target that will incentivise banks to offload their loans onto the secondary market. My view is that banks should be required to keep their NPLs on their book and to work through them with their customers by writing down, restructuring or forgiving the debt, particularly in cases of residential loans.

i) Promoting securitisation

I am extremely concerned by the proposed Directive on credit purchasers, credit servicers and recovery of collateral. “Credit purchasers” refers to vulture funds and securitisation institutions, “credit servicers” means debt collection agencies, and the proposal for “debt recovery” is for accelerated out-of-court enforcement of loans secured by collateral (though consumer loans are excluded from this aspect of the proposal), meaning banks will be able to seize their customers’ property without going through the courts.

The Directive aims to promote the use of vulture funds and securitisation vehicles in order to move this bad debt off the banks’ balance sheets and into the opaque and unregulated shadow banking sector.

Moving hundreds of billions of euros of bad debt into the shadow banking sector through the securitisation of non-performing loans is incredibly misguided, and will cause major new risks to financial stability. Mortgage-backed securities in particular played the key role in the 2007-2008 crisis.

ii) Giving free rein to debt vultures

It seems to me that the Commission is trying to replicate the Irish model in reducing non-performing loans and impose this model across the EU. That’s why it is so important for Irish campaigners to highlight the massive problems that we have experienced – from the NAMA debacle to the mass sell- off of distressed loans to unregulated vulture funds. It is not a model to follow but a lesson in what to avoid.

The debt vultures will be encouraged to spread their wings and move from just operating in Ireland and Spain to operating across the EU, while securitisation will be promoted as a so-called solution to the non-performing loan problem.

A private equity fund will be able to register in one member state and get a “passport” to operate in any EU state, while only being bound by the regulations in place in the state where it is registered.

iii) A second bailout for the banks

This EU proposal is nothing less than a second bailout for the banks. The non-performing loan problem is a legacy of the 2008 financial crisis. This problem was not caused by ordinary people and they should not be forced to bear the brunt of resolving it.

The Commission says the new Directive is necessary in order to allow banks to lend to small businesses once again. But all of the evidence shows that the ongoing economic problems in the EU are not caused by a lack of lending, but a lack of demand in the economy. The only way to boost demand is to increase public investment and foster real wage growth.

The real goal of this proposal is not to ensure banks lend again but to ensure they return to making massive profits again.

iv) Directive will tie our hands on future regulation of vulture funds

Suggesting that the Irish model is a success story that should be replicated across the EU is bad news for borrowers in the rest of Europe.

But the worst part of this proposal is that it will put major restrictions on all future attempts to regulate vulture funds at the Irish level. Our hands will be tied behind our banks.

Say, for example, that public pressure forces the government to finally act to put in place measures to regulate the vultures in a meaningful way.

Unless these laws comply with the EU Directive – which, let’s not forget, is designed to promote the sale of debt to vulture funds – the legislation will be struck down because it will amount to an infringement of the “right of establishment” or “right to provide services” of these private equity funds.

5. Campaigning for the Directive to be withdrawn

I have been heavily involved in trying to shape this package of proposals in the European Parliament and will be very much focused on this in the coming months. The Commission has clearly not taken consumer protection issues or fundamental rights into consideration when conducting its impact assessment for this proposed Directive.

The Directive should be withdrawn, and I am investigating possibilities for legal action in this regard. The European Parliament must block this proposal from becoming law.

Sinn Fein will be organising an EU-wide campaign against this Directive in the coming months, together with other progressive forces and consumer protection organisations.

If the Directive is not withdrawn, we will attempt to insert the strongest possible protection of borrowers’ rights into this package, to ensure this proposal does not give free rein to vulture funds across the EU. Ensuring that strong protection for borrowers is included in this legislation is absolutely crucial.

Specific policy proposals we will campaign for if the Directive is not withdrawn include:

  • Banks must include a mandatory clause in their residential loan contracts that provide the customer with the option of denying the bank the ability to sell on their loan to a third party (no consent, no sale).
  • Banks must provide their customers with the option of purchasing their own debt at a reduced rate – rather than the bank selling this debt to a vulture fund at this same reduced rate.
  • Vulture funds and debt collectors operating in the EU cannot be given a “passport” to operate in one state but be bound only by the regulatory framework of the state in which they are registered.

I hope that all those campaigning here in Ireland for better protections for homeowners and farmers against evictions and the sale of their loans to vulture funds will also get involved in this campaign at the EU level. We need your voices to be heard by the European Parliament and Commission, and in particular, we need to force our own government to oppose this proposal at the Council level.

The Green Jersey: Is Ireland helping Apple pay less than 1% tax in the EU?

Below is an outline and summary of a new report I co-authored with Danish researcher Martin Brehm Christensen (University of Copenhagen), which examines Apple’s post 2014 Irish restructure, the effective tax rate it pays today as a result, and the role of the Irish government in facilitating industrial-scale tax avoidance by Apple and other multinationals.The report was commissioned by GUE/NGL and was launched on 21 June 2018 in the European Parliament in Brussels.

Apple’s Golden Delicious tax deals: Is Ireland helping Apple pay less than 1% tax?


Download the full report here: Apple tax structure and rate post-2014-3

This report was commissioned by GUE/NGL members of the European Parliament’s TAX3 special committee on tax evasion, tax avoidance and money laundering. It examines the corporate tax rate paid by Apple globally and in the European Union (EU) over the period 2015-2017, after it made significant changes to its corporate structure in 2015.

These changes were made in response to the United States (US) Senate Subcommittee on Investigations examination of Apple’s tax affairs in 2013, the European Commission’s 2014 investigation into state aid provided by Ireland to Apple, and the changes to Irish tax residence law ending the ability of companies to be “stateless” for tax purposes.

In addition to estimating the effective corporate tax rate Apple has paid from 2015-2017, this report also examines the nature of Apple’s 2015 corporate restructure, and the methods it uses to continue to avoid paying tax today. Lastly, it examines the features of Irish tax law and policy that facilitate Apple’s ongoing tax avoidance.

Tax rate in the European Union and globally 2015-2017

1) Apple may have paid as little as 0.7% tax in the European Union (EU) from 2015-2017.

2) Using data from Apple Inc’s 10-K filings to the US Securities and Exchange Commission, we estimate that as a result of the new Irish structure, and Apple’s broader global tax structure, Apple’s tax rate for the period 2015-2017 for its non-US earnings is between 3.7% and 6.2%.

3) Two alternative calculations of the average rate paid on non-US earnings reach similar results, of between 4.5% and 6.7%, and between 4.7% and 6.9%.

4) Using data from Apple Inc’s 10-K filings to the US Securities and Exchange Commission we estimate that Apple is paid corporate tax at a rate of between 1.7% and 8.8% in the European Union during the period 2015-2017. This estimate assumes that Apple’s provisions for foreign tax equals money actually transferred to foreign governments.

5) If we assume the highly likely scenario that Apple’s provisions for foreign tax is substantially smaller than the amount actually transferred to foreign governments, we estimate that Apple may have paid as little as 0.7% tax in the EU from 2015-2017.

6) Applying the range of estimated tax rates paid in the EU from 2015-2017, we estimate that Apple has avoided paying between €4 billion and €21 billion in tax to EU tax collection agencies from 2015-2017.

Apple’s Irish restructure in 2015

7) Apple’s new European tax structure remains shrouded in secrecy, partially due to a lack of financial transparency in Ireland and Jersey. Most of its financial information remains secret globally.

8) Apple continues to use Ireland as the centrepiece of its tax avoidance strategy. Following the US Senate inquiry (2012-2013) and the initiation of the European Commission’s state aid investigation into Ireland (2014), Apple organised a new structure in 2015 that included:

  • The relocation of its non-US sales from ‘nowhere’ to Ireland;
  • The relocation of much of its intellectual property from ‘nowhere’ to Ireland;
  • The relocation of its overseas cash to Jersey.

9) As well as relying on the information revealed in the Paradise Papers and Apple’s statement responding to these revelations, this restructure can be observed in the macro-economic data of Ireland from 2014-2018, particularly in the first quarter of 2015. Major changes occurred in  Ireland’s GNP, GDP, exports, imports, investment, external debt and more. Despite the relocation of sales income and intellectual property to Ireland, there was no observable corresponding increase in corporation tax received from Apple by Irish Revenue.

10) With the assistance of the Irish government, Apple has successfully created a structure that has allowed it to gain a tax write-off against almost all of its non-US sales profits.

Apple is achieving this by:

  • Using a capital allowance for depreciation of intangible assets at a rate of 100% (this rate will be capped at 80% from 2017, but the cap will not apply to the intangible assets brought onshore from 2015-2016, which can still benefit from the 100% rate);
  • A massive outflow of capital from its Ireland-based subsidiaries to its Jersey-based subsidiaries  in the form of expenditure on IP and debt;
  • Using interest deductions of 100% on this intra-group debt;

11) The Irish government introduced the 100% rate on capital allowances for intellectual property (IP) following a recommendation made by the American Chamber of Commerce in Ireland in 2014.

12) The law governing the use of capital allowances for IP is not subject to Ireland’s transfer pricing legislation, but it includes a prohibition from being used for tax avoidance purposes. Apple is potentially breaking Irish law by its restructure and it exploitation of the capital allowance regime for tax purposes. If the same legal reasoning used in the European Commission’s state aid ruling on Apple and Ireland is applied, Apple is in breach of Irish tax law, and owes Irish Revenue at least 2.5 billion additional euros in unpaid tax annually from the period 2015-2017.

13) The use of this structure has contributed to a significant increase in the amount of cash Apple is sitting on in offshore tax havens.

Features of Irish tax law that enable Apple’s tax avoidance

14) Apple is unlikely to be the only multinational corporation using this structure, which is advertised as a typical structure used by large corporations involved in trading in intellectual property by corporate law firms. We have called it the “Green Jersey” in reference to the use of the Jersey-based subsidiary by Apple, though it is not strictly necessary to use an offshore tax haven as Apple has.

15) The essential features of the Green Jersey scheme are:

  • It can be used by large multinational corporations engaged in trading IP;
  • It has specifically been designed by the Irish government to facilitate near-total tax avoidance by the same companies who were using the Double Irish tax avoidance scheme;
  • While the Double Irish was characterised by the flow of outbound royalty payments from Ireland to Irish-registered but offshore tax-resident subsidiaries, this scheme is characterised by the onshoring of IP and sales profits to Ireland;
  • Sales profits are booked in Ireland, but the expenditure the company incurs in the once-off purchase of the IP license(s) can be written off against the sales profits for years by using the capital allowance programme for intangible assets;
  • It is beneficial for the company to complement the tax write-off by continuing to use an offshore subsidiary, but not for outbound royalty payments to flow to. The role of the offshore subsidiary is to store cash and provide loans to the Irish subsidiary to fund the purchase of the IP. The expenditure on the IP is written off, but so too are the associated interest payments made to the offshore subsidiary, which thus accumulates more cash that goes untaxed.

16) Many of the features of Irish tax law that were identified as factors facilitating tax avoidance in the Commission’s state aid ruling remain partially or fully in place in Ireland. Despite the announced phase-out of the Double Irish scheme, we have found that the “management and control” provision allowing the creation of Double Irish structures remains in place through several of Ireland’s tax treaties, including treaties with states considered to be tax havens.

17) Several other key features of Ireland’s tax regime that were criticised in the context of the Apple state aid ruling, and which remain fully or partially in place, include:

  • Ireland’s intellectual property tax regime including R&D credits that are open to abuse, and the lack of withholding taxes on outbound patent royalty payments;
  • The use of private “unlimited liability company” (ULC) status, which exempts companies from filing financial reports publicly. The fact that Apple, Google and many others continue to keep their Irish financial information secret is due to a failure by the Irish government to implement the 2013 EU Accounting Directive, which would require full public financial statements, until 2017, and even then retaining an exemption from financial reporting for certain holding companies until 2022;
  • Ireland’s one-way transfer pricing laws that examine only the Irish-resident party involved in a transaction;
  • Continued use of Advanced Pricing Agreements and Revenue “opinions”, which may not be subject to the same requirements on mandatory automatic exchange of information between EU member states under the third EU Directive on Administrative Cooperation.

Download the full report here: Apple tax structure and rate post-2014-3

The monetary policies of the ECB – Europe’s unelected government

MONETARY POLICY is a key tool for governments to use to benefit citizens, societies and economies. Central banks are empowered to determine interest rates, and to influence the exchange rate of their currency (and others’) by buying and selling reserves of foreign currencies. If a central bank sets a higher interest rate, this makes the return on this currency higher, leading to a higher demand for the currency and a resulting higher exchange rate. By lowering interest rates central banks can stimulate growth by expanding credit. With the creation of the ECB in 1998, members of the common currency transferred their power to set interest rates and other monetary policy powers to the ECB, which would set a centralised monetary policy across the Eurozone. The ECB and national central banks form the European System of Central Banks (ESCB), and the ECB can “exceptionally” provide emergency liquidity assistance (ELA) as a last resort for struggling Eurozone banks. The ECB differs from most of the other major central banks around the world in that it has a more limited mandate, and in its governance structure.

A narrow mandate

The neoliberal ideas, and the German economic ideology of ‘Ordoliberalismus’, that shaped the construction of the Eurozone can also be seen starkly in the nature of the ECB. This ideology has been dominant in Germany since the Second World War and combines a belief in a welfare safety net with the view that one of the government’s key roles is to promote market competition, stressing the importance of constitutional rules, as opposed to the use of discretionary policy. This ideology shaped the nature of the Bundesbank, which was dedicated to tightly controlling the money supply to maintain price stability. The ECB was constructed on this model, with a mandate to focus on price stability – controlling inflation. Despite the total discrediting of this ideology in the wake of the financial crisis, Berlin’s belief that if the government ensures inflation is kept low and stable, then markets will ensure growth and employment of their own accord, persists.

The ECB’s mandate is in contrast to many other major central banks, like the Federal Reserve in the US, which are tasked with the broader role of maintaining full employment and promoting growth, in addition to maintaining price stability. As a result of its narrow mandate the ECB only focuses on controlling inflation, regardless of how high the unemployment rate is. If there is low and stable inflation in the Eurozone as a whole – and in Germany in particular – then the ECB will ignore the growth needs of states experiencing high employment. In the midst of the recession and the sovereign debt crisis in 2011, the ECB actually raised interest rates twice, in April and July, contributing to the cause of the Eurozone’s double-dip recession. This caused major hardship in the crisis countries, particularly for mortgage-holders who were pushed further into arrears.

The other key difference between the ECB and other major central banks is its level of democratic accountability: for example, while the Fed is often described as “independent”, it is ultimately accountable to Congress. The ECB is unaccountable to any elected government or parliament. This feature reflects the drive by elites to “depoliticise” economic policy by outsourcing it to supposedly independent technocrats in order to weaken resistance to highly political decisions that have profound redistributive consequences for society. Bill Mitchell and Thomas Fazi write: “[T]he creation of self-imposed ‘external constraints’ allowed national politicians to reduce the political costs of the neoliberal transition – which clearly involved unpopular policies – by ‘scapegoating’ institutionalised rules and ‘independent’ or international institutions, which in turn were presented as an inevitable outcome of the new, harsh realities of globalisation, thus insulating macroeconomic policies from popular contestation”.

The decisions that the ECB has taken in response to the crisis have been extremely political, such as its decision to raise interest rates in 2008 and 2011, when the real danger to the majority of Eurozone members was deflation. The two most strikingly political acts during the crisis were the ECB’s threat to cut off emergency liquidity assistance to the Irish state unless it agreed to request a bailout, and its decision to cut off emergency liquidity to Greek banks in the middle of 2015 in a threat to Syriza that Greece would be forced out of the Eurozone if it did not submit to the conditions of the Troika that were resoundingly rejected by Greek voters in a referendum. The ability to withhold credit to elected governments gives the unaccountable ECB an enormous degree of power to impose its own policy on countries in need of assistance.

The ECB’s financing operations

In 2011 the ECB began the first of several financing operations in order to assist the economic recovery in the Eurozone. In December 2011 it announced its long-term refinancing operation (LTRO), which provided one trillion euro in credit in secured funding to troubled banks at a rate of one per cent interest. The banks often invested it into government bonds at higher rates, which helped the banks’ balance sheets but cost government budgets in debt servicing payments, and tied the banks and sovereigns even closer together.

As the Eurozone teetered on the brink of fragmenting in July 2012, ECB President Mario Draghi made his famed speech that is widely believed to have “saved” the common currency, which included the statement that, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. The speech preceded a new financing operation called Outright Monetary Transactions (OMT) in which the ECB offered to purchase sovereign bonds of the most indebted states. In 2014 Paul Krugman described the OMT programme as a “bluff” because “nobody knows what would happen if OMT were actually required”. The OMT programme has not in fact ever been used, because no member state has met all of the requirements needed to activate it. Martin Wolf and others have observed that the bluff was so successful not only due to its announcement, but also due to the tacit acceptance of the announcement by all member states including Germany, as this was perceived by markets as a signal that the risk of the Eurozone disintegrating was eliminated. But he adds that while the spreads between government bonds in crisis and core countries fell sharply in response to the OMT announcement, they remain significant. “For countries caught in a deflationary trap, these spreads might yet prove unmanageable.”

In a telling side note, it was revealed in October 2017 that the Eurosystem had made super-profits of €6.2 billion between 2012 and 2016 from Greek bonds the ECB had purchased at knock-down prices in 2012. While the Greek government and its creditors in 2012 had agreed to “haircut” Greek bonds, those purchased by the Eurosystem were conveniently excluded.

Neither the LTRO nor the OMT programmes did much to actually improve the supply of credit to the productive economy. The next financing operation was announced in 2014 – targeted longer-term refinancing operations (TLTRO) – and it was aimed at providing banks with funds on the condition that they would be used to supply credit to small and medium enterprises as opposed to being directed towards speculation. But the lack of demand in the economy has meant that the TLTRO offer was not widely taken up by firms. Despite the ultra-low and at times negative interest rates, and the billions of euros handed over to banks through its financing operations, the ECB was not able to generate recovery in the real economy and restore growth, and it has persistently missed its target of 2 per cent inflation.

In March 2015, the ECB announced a quantitative easing (QE) programme in which it would create €60 billion each month and use it to purchase corporate sector assets and government bonds. It was originally intended to last for one year but has been extended and remains in place, though economists expect the announcement of “tapering” in the near future, the phased winding-down of the programme. The Corporate Securities Purchasing Programme (CSPP), introduced in March 2016 and now valued at around €125 billion, has been widely criticised by NGOs and MEPs for the lack of transparency on how the bonds are selected, and the fact that the funds are being directed towards multinational corporations and the fossil fuel industry. Corporate Europe Observatory has examined the limited publicly available data on the bonds favoured by the CSPP and found a marked preference for climate-damaging corporations. Another report by Corporate Europe Observatory published in October 2017 found that 98 per cent of all advisors in the ECB’s advisory groups have been assigned to representatives of the finance industry. Just three financial institutions, Deutsche Bank, BNP Paribas and Citigroup, occupied 208 out of 517 total advisory seats.

The QE for People and Positive Money campaigns have developed a detailed critique of the limited impact on real economic recovery of the ECB’s “trickle-down” QE programme and have developed excellent policy alternatives. This campaign is supported by dozens of leading economists. Two examples of alternative monetary policies they propose are for the ECB to transfer newly created money to Eurozone governments directly, who can use it to increase public spending on green infrastructure and services; or for the ECB to create money that can be directly distributed to citizens of the Eurozone, which would increase their purchasing power and directly enter the real economy. The current QE programme is not only unfair and ineffective – it is also increasing financial volatility and encouraging the inflation of new speculative bubbles.

A new banking crisis?

Despite the fact that the European banking sector has received more than €1.6 trillion through taxpayer-funded bailouts since 2008 – and despite the fact that the ECB has pumped in €60-€80 billion each month through its financing operations since March 2015 amounting to an additional €2 trillion in support – another crisis is unfolding in the European banking sector.

Banks in the EU, and particularly in the Eurozone, have been experiencing a chronically low level of profitability since the global financial crisis. While profitability of US and British banks has improved somewhat post-crisis, many Eurozone banks are struggling to keep their heads above water.

ECB Vice President Vítor Constâncio noted in a speech in Brussels in February that the key measure of profitability – return on equity – for euro-area banks “has hovered at around 5 per cent”, a rate which, he pointed out, “does not cover the estimated cost of equity”. By contrast, the return on equity in the US has recovered to above 9 per cent (around the current cost of equity in the euro area banks), and the industry generally considers 10 per cent to be a good rate of return. European banks’ income from interest, which was on average 19 per cent of their equity in June 2016, is less than their operating expenses of 20.9 per cent, according to the European Banking Authority (EBA).

The crisis has been demonstrated in the failure (or near-failure) of several banks across the Eurozone this year – including Italy’s Monte dei Paschi di Siena (MPS), Veneto Banca and Banca Popolare di Vicenza, and Spain’s Banco Popular – as well as the serious ill-health of German giant Deutsche Bank. Other banks that have caused concern, largely due to the results of the 2016 banking stress tests carried out on 51 major EU banks under the authority of the EBA, include RBS, which was bailed out by the British government in 2008 in the world’s largest ever bailout, and has since posted nine straight years of losses. Irish banks Allied Irish Bank and Bank of Ireland, British bank Barclays, Switzerland’s Credit Suisse and Austrian bank Raiffeisen are all also subject to concerns about their health and viability.

In an illustration of the seriousness of the systemic risk posed by the profitability crisis, EBA chairperson Andrea Enria said last October: “The problem is European in scale: we have more than €1 trillion of gross non-performing loans in the system; even considering provisions [money set aside to cover losses], the stock of uncovered non-performing loans is at almost €600 billion — more than all the capital banks raised since 2011, more than six times the annual profits of the EU banking sector, more than twice the flow of new loans.

“For supervisors, this casts serious doubts on the long term viability of significant segments of the banking system [my emphasis]. The same concern is shared by investors and is reflected in the low valuations registered in stock markets.”

Most experts and financial commentators point to four key contributing factors to this lack of profitability – the high volume of non-performing loans on the banks’ books (loans that are in default after 90 days of non-repayment); the very low interest rate environment arising from the ECB’s recent monetary policy; the fines for misconduct banks have been required to pay since the crisis; and over-capacity in the sector, including increasing competition from FinTech.

Between 2010 and 2014, EU banks paid out around €50 billion in settlements and fines imposed by regulators for misconduct, largely due to mis-selling the risky financial products that contributed to the global crash. The EU’s largest banks, those classified as global systemically important banks (G-SIBs), were the worst culprits and paid the vast majority of the €50 billion figure. A report by the European Systemic Risk Board in 2015 found that past and looming fines would wipe out erase basically all of the new capital that had been raised by European G-SIBs over the past five years.

While misconduct fines and over-capacity dampen profits, the two most important of the four factors listed above are the NPL problem and the interest rate environment. But a key pressure on profitability that the ECB, EBA and the other EU institutions routinely fail to acknowledge is on the demand side – ie, the general economic stagnation in the Eurozone that has caused the demand for credit to fall and remain low. This stagnation has also contributed to and worsened the NPL problem. Euro-area banks held just over €1 trillion in NPLs last year, the equivalent of around 9 per cent of the Eurozone’s GDP, and amounting to around 6.4 per cent of total loans in the Eurozone. The level of NPLs differs dramatically across the euro area, with almost half bank loans in Greece and Cyprus now classified as NPLs, and Italy, Ireland, Portugal and Slovenia all holding NPLs at rates of 10-20 per cent.

There is a clear overlap between the high level of NPLs and the impact of the financial crisis on the so-called peripheral economies in the Eurozone, and a clear interaction between the austerity measures prescribed for these economies by the Troika and their inability to significantly reduce their NPL ratios. The collapse of the industrial sector in Greece and Italy in particular has been a major contributing factor to the rise of distressed loans as businesses of all sizes failed and their owners were unable to repay loans. The austerity policies enforced by the Troika in the crisis countries in return for bailout funds inevitably exacerbated the NPL problem.

Publicly funded bank bailouts are back with a vengeance

“EU forges bank bailout deal to protect taxpayers” – that was the Associated Press headline in June 2013, describing the agreement reached in Brussels on the EU Banking Union. The Banking Union is an initiative to further integrate the banking and financial sectors in the Eurozone countries, which was promoted as a response to the global financial crisis and subsequent sovereign debt crisis. It is envisioned as having three pillars based on a “single rulebook” – a system of harmonised supervision under the Single Supervisory Mechanism; a single resolution mechanism and associated fund implemented by the Bank Recovery and Resolution Directive (BRRD) at the beginning of 2016; and an as-yet to be developed third pillar of a European Deposit Insurance Scheme.

The Banking Union, European lawmakers assured the public, would call time on the “too-big-to-fail” problem and ensure taxpayer-funded bailouts – which had cost EU governments more than €1.5 trillion since 2008, including €64 billion in the Irish state – were a thing of the past. The BRRD was supposed to make sure that in case of a bank failure, the institution would be wound down in an orderly way by an early intervention by regulators, and that senior bondholders and depositors with more than €100,000 in the bank would be “bailed in”. Creditors would have to incur losses of at least 8 per cent of their liabilities before a bank would be able to receive government aid. Speaking to reporters at the summit where the deal was reached between EU Finance Ministers that day in 2013, then-Irish Finance Minister Michael Noonan said: “Bail-in is now the rule… This is a revolutionary change in the way banks are treated.” But there was an exception clause, as there usually is in EU legislation, and its name was “precautionary recapitalisation”.

Resolution Directive fails miserably in its first test

The Italian banking crisis that deepened throughout 2016 culminated in the December announcement by the Italian government of a €20 billion taxpayer-funded rescue package for the ailing MPS and other Italian banks, indicating its intention to activate the precautionary recapitalisation clause of the BRRD. The clause allows for the bail-in of creditors to be sidestepped if certain conditions are met – namely that the bank is still solvent, and its resolution would threaten financial stability. This exceptional clause is complemented by a similar “safeguard” clause in the EU’s state aid legislation on burden-sharing.

After months of negotiations between the European Central Bank (ECB) and the Commission, about both the extent of the capital shortfall and the terms of the deal, Competition Commissioner Margrethe Vestager reached an agreement in principle with the Italian Finance Minister on June 1, 2017. The Commission, and the ECB in its supervisory role, gave the green light to the precautionary recapitalisation. “State aid in this context can only be granted as a precaution (to prepare for possible capital needs of a bank that would materialise if economic conditions were to worsen) and does not trigger resolution of the bank,” Vestager said in a statement.

Conditions of a precautionary recapitalisation include that broader financial stability must be threatened by the bank’s failure; the state support cannot be used to cover previous or near-term expected losses; and the need for state support must be only temporary. But MPS already received two state-funded bailouts in 2009 and 2012, casting significant doubt on whether it meets these two latter criteria.

Back in December when the Italian government made its rescue package announcement, the ECB suddenly began to say that MPS’s capital shortfall was not €5 billion as previously estimated but actually €8.8 billion. The ECB didn’t bother to explain publicly how it arrived at this figure, but its retroactive and opaque revision of the figures raised serious concerns and questions about the health of MPS. Was the bank actually solvent when it applied for a precautionary recapitalisation? If not, it would not qualify for public assistance. The details of the Commission’s agreement in principle have not yet been made public.

There are many criticisms that can be made of the resolution aspects of the Banking Union legislation. The bail-in of creditors of only 8 per cent is, in many cases, going to raise a totally insufficient proportion of the costs of a resolution. In ordinary insolvency procedures investors would usually lose far more than 8 per cent. Bail-in also poses additional risks to ordinary taxpayers in a number of ways including through increased premiums in pensions and health insurance, and through the mis-selling of risky and inappropriate financial products that are eligible for bail-in to small retail investors.

The precautionary recapitalisation clause, however, is the glaring loophole that makes a joke out of the Banking Union’s promise to end taxpayer-funded bailouts of banks and to resolve the ‘too-big-to-fail’ problem. Under the Bank Recovery and Resolution Directive, a review of the precautionary recapitalisation clause was supposed to have taken place by now. The Commission was required to review whether “there is a continuing need for allowing the support measures” in the clause by December 2015 and report on this to the European Parliament and Council, which it has failed to do.

Now, the European Banking Authority (EBA), supported by many within the European Central Bank (ECB), is making a concerted push for the precautionary recapitalisation loophole to be invoked in order to use public funds to bail out the big bank across the EU more generally, by calling for state funds to be used to reduce the high level of non-performing loans in European banks and to restore them to profitability.

A crisis of abundance

Writing in response to the Great Depression, Keynes said, “This is not a crisis of poverty, but a crisis of abundance,” a description that is perfectly fitting for the current economic crisis. The ongoing tendency towards stagnation in the Eurozone and in the broader economy is not primarily the result of trade imbalances, which in any case, have been reduced as a result of the fall in aggregate demand. There is an unprecedented mass of money not being used in the economy, which has built up over decades of a declining labour share of income and record-high corporate profits. There is at least US$5 trillion in “idle money”, much of it resting in tax havens. Varoufakis writes: “Try to imagine the mountain of cash on which corporations in the United States and Europe are sitting, too terrorized by the prospect of insufficient consumer demand to invest in the production of things that society needs.” He notes that every crisis generates two mountains: “one of debts and losses, another of idle, fearful savings” – the only difference being the scale of this crisis.

Investment continues to stall across the Eurozone, and the Juncker Investment Plan, and its key instrument, the European Fund for Strategic Investment (EFSI), has been a dismal failure. It was announced in late 2014 as an initiative from the Commission in partnership with the European Investment Bank (EIB) in order to address the ‘investment gap’ that the Commission estimates to be 200-300 billion euros per year in the EU. The stated goal of the Juncker Plan was to “mobilise” more than €300 billion in private capital investments – by creating an initial fund of just €21 billion to secure loans for infrastructure projects. The European Trade Union Confederation immediately responded to the Juncker Plan by saying the Commission was “relying on a financial miracle like the loaves and fishes”.

There was no new money forming the EFSI – the seed capital was cut from other existing EU budgetary programmes, including the research plan Horizon 2020 and the Connecting Europe transport infrastructure programme. This €21 billion in initial capital was to be used to guarantee €60 billion of EIB borrowing to fund riskier projects than the EIB usually funds. The entire rationale of the Juncker Plan was to ensure that private investment that would otherwise not have happened took place. The investment plan stipulates that the funds must be disbursed across all EU economies according to the size of their GDP levels, meaning most of the projects that have been approved have benefited Germany and Britain instead of the smaller peripheral economies who are in greater need due to the fact that investment has largely ground to a halt. It has largely focused on public-private partnerships, which are being used across the EU to promote privatisation of public goods and services.

The Bruegel think-tank undertook a study of the first 55 EFSI-funded projects that were approved in the first year, and found that 42 would in all likelihood have proceeded anyway in the absence of the Juncker Plan. The only difference is that public money is now being used as a guarantee for private ventures.

The European Parliament admits the results of the Juncker Plan have been disappointing and that it has failed to unleash any discernible surge in investment. The most critical group, the European United Left (GUE/NGL) points out that most of the investments made under the plan would have proceeded regardless, without the EU guarantee, but now private investors can shift the risk of their investments to taxpayers. The group argues, “The EFSI induces rent seeking and asset stripping by private investors at the expense of the Union budget, via public private partnerships, the privatization of profits and the socialization of losses, while only sparely contributing to additional investment”.

This is an excerpt from the economic discussion document launched by MEP Matt Carthy on October 27, entitled The Future of the Eurozone. Download the full document for a referenced version of Chapter Six, above.