Draghi’s ECB: Quantitative Easing or Cash for Trash?

By Pam Martens and Russ Martens: March 25, 2015

Bloomberg News is carrying an article today that raises the question as to whether cash for trash may be the comeback kid at the European Central Bank. That, in turn, leads to speculation as to how long it will be before the comeback kid leaps across the pond and nestles into the  arms of the U.S. Federal Reserve.

According to the article, the European Central Bank is buying up billions of Euros in asset-backed securities made up of things like Spanish auto loans, Portuguese home loans, and legacy deals that have been stuck on the balance sheets of European banks since the financial crisis of 2008 and 2009. The article notes that the ABS market is down from a peak of 524 billion Euros in annual issuance in 2006 to a paltry 77 billion Euros in annual average issuance over the past five years.

Now let’s face it, European Central Bank President Mario Draghi is not buying 60 billion Euros a month of European sovereign debt and asset-backed securities because things are going swimmingly in Europe’s economy. Europe hopes to skirt another financial crisis and the headwinds of deflation.

There’s a ring of familiarity to all of this. Back on September 21, 2008, one week after the failure of Lehman Brothers and the shotgun marriage of Merrill Lynch to Bank of America, Paul Krugman wrote in his New York Times column that “Some skeptics are calling Henry Paulson’s $700 billion rescue plan for the U.S. financial system ‘cash for trash.’ ”

At the time, Paulson was U.S. Treasury Secretary in the administration of President George W. Bush. Krugman noted that the Paulson plan called “for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities” while Paulson demanded “dictatorial authority, plus immunity from review ‘by any court of law or any administrative agency…’ ”

By March 22, 2009, Krugman was worrying aloud in his column that newly elected President Obama, through his Treasury Secretary, Tim Geithner, was going to resurrect Paulson’s “cash for trash” plan. Krugman wrote insightfully:

“Right now, our economy is being dragged down by our dysfunctional financial system, which has been crippled by huge losses on mortgage-backed securities and other assets.

“As economic historians can tell you, this is an old story, not that different from dozens of similar crises over the centuries. And there’s a time-honored procedure for dealing with the aftermath of widespread financial failure. It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books.

“That’s what Sweden did in the early 1990s. It’s also what we ourselves did after the savings and loan debacle of the Reagan years. And there’s no reason we can’t do the same thing now.

“But the Obama administration, like the Bush administration, apparently wants an easier way out. The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks’ books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn’t be in trouble.”

As Krugman and much of the press fretted over the potential for the $700 billion Troubled Asset Relief Program to become a cash for trash program, an alphabet soup of lending programs operating primarily through the Federal Reserve was secretly bailing out the banks. In a study by James Felkerson released by the Levy Economics Institute of Bard College in December 2011, the gargantuan price tag of both the lending and asset purchase program was  $29 trillion. One of the largest programs was the Primary Dealer Credit Facility. Felkerson writes:

“The Fed officially announced the Primary Dealer Credit Facility (PDCF) on March 16, 2008…Initial collateral accepted in transactions under the PDCF were investment grade securities. Following the events in September of that year, eligible collateral was extended to include all forms of securities normally used in private sector repo transactions.”

Felkerson’s study comes to the same conclusion as that recently raised by Senator Elizabeth Warren in a Senate hearing: of the $9 trillion doled out under the Primary Dealer Credit Facility, $6 trillion of that went to just three institutions: Merrill Lynch, Citigroup, and Morgan Stanley, effectively bailing out their shareholders.

The Fed stridently refused to turn over the details of its massive lending programs, prompting Congress, with leadership from Bernie Sanders, to order the Fed to provide data. Bloomberg News was also forced to wage a multi-year court battle under the Freedom of Information Act for further details.

This month marks the seventh anniversary of the collapse of Bear Stearns. Should the global financial system still be this weak or are the global banks just too big and too leveraged to allow a financial recovery?

Borrowing from the Fed Under the Primary Dealer Credit Facility (In Percentages): Levy Economics Institute of Bard College

Borrowing from the Fed Under the Primary Dealer Credit Facility (In Percentages): Levy Economics Institute of Bard College

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