In a few months European Parliament will take a vote on the European Commission’s proposal known as the European Capital Markets Union. This proposal aims to create a single European market for capital and eliminate all remaining barriers to cross border investments in the EU. As with the single markets for goods, services, energy and labor, this is, in principle, a good idea. A single market allows for a more efficient use of our limited resources and benefits investors as well as those looking for funding. Moreover, Eurogroup chairman Dijsselbloem has said (e.g. http://www.consilium.europa.eu/nl/press/press-releases/2015/11/04-jd-speech-tatra-summit/) such a Single European Capital Market can help stabilize the Eurozone. It allows surplus countries to invest their excess savings in deficit countries, thus diversifying risk and synchronizing the European business cycle. The Capital Market Union thus aims to mobilize more investment and allocate it better across the EU to help stabilize the Monetary Union.
It is a good thing the European Commission has set these goals. Europe is facing quite serious investment challenges. The crisis has starved our businesses of much needed capital and investment across the Union has grinded to a halt. This could not have come at a worse time as the urgent transition to a more sustainable energy system requires massive innovation and an updating of a lot of private and public infrastructure and outdated technology. Moreover, in the crisis the financial sector across Europe retreated back to national markets, causing cracks and fault lines in the Eurozone that still have not been healed. In short, our capital markets failed when we needed them the most. It is time to act.
But the currently proposed Capital Market Union does not address any of these major challenges, nor prevent such crises from happening again. Instead it proposes to introduce, this time at a European scale, a regulatory framework for securitization. Securitization is the bundling of existing, non-tradable loans into a package that can be traded. Typically one takes a big number of existing loans, puts these on the balance sheet of a new company and then sells equity and debt in that new company to investors. The idea is that such securitization will allow European banks to give more credit to business and thus channel more savings to productive, innovative investment. Unfortunately this is not likely to be the effect and in fact this will give us less, not more of the type of finance we now need.
Moreover, securitization will increase the leverage in our financial system and reduces role of bank (and other intermediaries) equity. When we require less ‘skin in the game’ we indeed will stimulate the creation of more credit, but also more systemic risk. This is risk of the ‘heads I win, tails you lose’-variety that we promised European tax payers we would eliminate. We all agreed the originate-to-sell model was to be eliminated because of its perverse incentives. The CMU now does the exact opposite. Investing in innovative, experimental SMEs and startups, especially in other countries, is risky. And European savers and investors are more than willing to take on such risk for the right return. But they will not do so if our financial sector offers them safe bets with higher returns at the risk of whoever ends up with the worthless assets, not rarely the taxpayer.
Finally, no benefits are to be expected in terms of stabilizing the Eurozone either. With more securitization, European banks can channel their depositors’ savings into (deficit) countries, but given the preference for mortgage loans, most of these funds will flow into those countries’ real estate markets. A smart deficit country will then use the freed up national savings to finance innovative SMEs with equity, but chances are the deficit country banks and investors will also want a piece of the securitization-pie. If European banks fund European businesses with long term equity, the CMU could stabilize the Monetary Union. If they inflate housing and real estate bubbles instead, the tradability of the securitized debt instruments adds to the instability. A country in boom will attract cheap savings from all over Europe, fueling the boom and most probably a real estate bubble. When the tables turn and crisis hits, the same tradability implies a quick withdrawal as we saw so many times before in developing countries, starving the already struggling economies of liquidity and deepening the bust. It is unlikely the Eurozone can sustain another round of the core fueling real estate bubbles in the periphery, but the irony of the CMU is that now also periphery savers can join in, depositing their savings in the core only to see them reinvested in periphery mortgage backed securities.If we summarize the above:
- CMU will not channel more finance to productive and innovative SMEs
- CMU will not make banking more stable
- CMU will not stimulate diversity in EU financial markets
- CMU will cause more of our investment to be diverted into unproductive, speculative real estate and asset bubbles.
- CMU will destabilize the Eurozone forcing surplus countries to bail out either their TBTF banks or the deficit countries they lent to.
CMU should stimulate real, productive, long term equity cross border investments. Instead it now promotes on financial, speculative, short term debt investment. Securitization under the CMU creates an accident waiting to happen at an unprecedented scale. Banks have lobbied hard for this result. One can only wonder why…