Should Draghi be more like Bernanke?June 14, 2012: 12:41 PM ET
Spanish 10-year bond yields have officially pulled a Kenny Loggins and ridden into the 7% danger zone. Italian bond yields are north of 6% again and climbing. And oh yeah, Greek elections on Sunday may lead to the end of a Hellenic presence in the euro and a return to the drachma. The crisis is far from over.
So what's the European Central Bank doing to try and stop it from getting even worse? Not much. The ECB left interest rates alone last week even though they technically do have room to cut them further. Rates in Europe are at 1% compared to the near-zero level in the U.S. and 0.5% in England.
ECB president Mario Draghi hinted last week that there could be a rate cut at the bank's next meeting in July. But he also noted that central bankers can't do much more to stabilize the region and that it's the job of the leaders of individual European nations to take more action.
Draghi is right to assert that. In that regard, he's taking a page from the playbook of Federal Reserve chairman Ben Bernanke, who has been urging Congress to get its act together and not hurl the nation over a "fiscal cliff" later this year or in early 2013.
But Draghi may need to be even more like Bernanke. And I don't mean that Super Mario should grow a beard ... although it would probably look good on him. Draghi needs to show Europe that the ECB, despite having only a mandate to keep prices stable, will do what's necessary to prevent the crisis from spinning out of control.
Bernanke and other dovish central bankers in the U.S. have continued to stress that they are leaving all options on the table. That could mean the Fed will extend Operation Twist, its program to swap short-term bonds for longer-term Treasuries, or even announce a third round of asset purchases. The market seems to be betting that such quantitative easing, or QE3, is now increasingly likely given that the U.S. economy (especially the job market) is losing momentum.
But for all the problems facing the United States, America's economy is not nearly in as dire a shape as Europe's. (At least not yet. Let's check back in later this year and see what happens to bond yields if our nation's least and dimmest on Capitol Hill don't heed Bernanke's advice and decide to take an Acapulco-esque leap into the ocean of higher tax rates and automatic budget cuts.)
The Fed can arguably afford to take the prudent approach and preach patience. Long-term bond yields are low. The housing market seems to have finally stabilized. The unemployment rate has come down even though the long-term jobless continue to struggle to find work.
But the situation is grave in Europe. As the chart below shows, yields for all the PIIGS nations are troublesome. The unemployment rate in the eurozone is in the double digits and youth unemployment is alarmingly higher. Spain's housing problems are far from over, which is why Spanish banks are in need of a bailout.
How can the ECB try and stem the tide? At a bare minimum, it may have to bite the bullet and launch a third long-term refinancing operation. The first two programs, which provided cheap loans to banks, did help bring down interest rates temporarily as European banks used some of the cash to buy sovereign debt. That admittedly may be a short-term Band-Aid solution, but any action may be better than none at this point.
"There is no reason why more easing should produce a long-term fix and the market boosts are getting shorter-lived. But the ECB has to break the negative feedback loop," said Frances Hudson, global thematic strategist with Standard Life Investments in Edinburgh, Scotland.
Still, the ECB could go further than just lending to banks and actually deviate from its mandate in this time of crisis. It could unveil a more concrete commitment to buy the bonds of Spain, Italy and others. The ECB has done this in dribs and drabs but has not unveiled anything remotely like the Fed's QE programs.
"Unlike Bernanke, Draghi seems reluctant to purchase more sovereign debt. That is the ECB's biggest problem," said Jeffrey Bergstrand, a professor of finance with the Mendoza College of Business at the University of Notre Dame. "The ECB can change the rules but they have been unwilling to do that. The ECB is more or less waiting things out."
There is no more time for waiting. Draghi and other ECB members probably need to lower rates next month and also do more to convince Germany that it needs to take one for the European team and accept the notion of a banking union that could provide deposit insurance like the FDIC in the U.S. German chancellor Angela Merkel may also have to accept that the idea of eurobonds, a common form of debt that could ease funding pressures for the PIIGS, needs to be given serious consideration.
However, Merkel is unlikely to budge unless Draghi or other bankers can convince her that things may soon get much worse. For one, she has her own political future to think about. Germans have proven to be very much in favor of more austerity and fewer bailouts for their weaker euro neighbors.
And Hudson notes that even though it seems like Europe is on the verge of a meltdown, the fact that the euro currency is still above the debt crisis lows from the summer of 2010 gives Germany breathing room. Unless (or until?) the euro completely unravels, Germany doesn't face any urgent need to acquiesce.
"The perverse thing is the euro is still not suffering that much. It's at a comfortable level for Germany, and Merkel's motivations might not be the same as the rest of Europe's," Hudson said.
With that in mind, one investing expert said that Draghi shouldn't do anything differently. In fact, overreacting to the current crisis could make things worse in the long run.
"If I were Mario Draghi, I'd be on some Caribbean island hiding right now. The dilemma he faces is that the ECB is close to being tapped out unless they turn on the printing presses," said Jeff Sica, president and chief investment officer of SICA Wealth Management in Morristown, N.J.
"There is no magic solution. The mindset of the U.S. is to just invent money out of thin air. The ECB can't do that," Sica added. "If Draghi wants to be irresponsible, the worst scenario would be adding inflation to a sluggish economy with civil unrest. That would be far worse than bank runs and bank failures."
That may be true. But even if you don't always agree with Bernanke's actions, he deserves credit for usually being proactive and not assuming that the free market will eventually take care of things. (Well, after Lehman's bankruptcy at least.) Waiting to see how bad things will get in Greece, Spain and Italy is not really a luxury that Draghi has right now.