Not going to be easy, especially for “zombie” companies.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
An unusually fierce spat broke out this week between two of Europe’s biggest utilities companies, Spain’s Iberdrola and Italy’s Enel, both of which are locked in a bidding war for the Brazilian electricity company Eletropaulo. The Spanish firm accused its Italian rival, almost a quarter of which is owned by the Italian State, of unfair competition due to its access to cheaper debt.
“With the obvious support of the State, Enel clearly benefits from a privileged regulatory situation in Italy, which makes access to the capital markets both cheaper and easier,” complained Iberdrola’s CEO Ignacio Sánchez Galán in a scathing letter to the European Commission. He called for a debate on the privileges certain state-owned companies continue to enjoy despite EU competition laws on illegal state aid.
Sánchez Galán raises an important point: in the EU, partly or majority state-owned companies like Enel and Électricité de France (EdF) clearly enjoy funding benefits over their rivals, especially with the Eurozone’s sovereign bond market still being propped up by the ECB.
But he also omits an inconvenient fact: his own company, Iberdrola, is one of the biggest beneficiaries of the ECB’s corporate bond buying program. As a result, it has been able to pay next to no interest on new debt for the last two years.
State-owned companies like Enel and EDF have benefited two-fold from the ECB’s largesse, first from its corporate bond buying, and secondly from its sovereign bond buying. At one point the central bank was buying €80 billion of sovereign and corporate debt per month, which helped push yields into the negative for many securities. This helped push down the funding costs of Member States’ national debts while giving a select group of European companies and subsidiaries a massive funding advantage over smaller rivals.
On a number of occasions, the corporate bonds were not even bought on the open market; instead, the ECB bought them directly from the companies through “private placements.” These arrangements enabled the companies involved, including Iberdrola, to raise cash more quickly without having to jump through the regulatory hoops.
In 2017, the German constitutional court raised doubts about the legality of the ECB’s bond-buying program. But instead of ruling on the matter, it passed the buck on to its European superiors, the European Court of Justice (ECJ). As the German judges well knew, the chances of the ECJ ruling against the ECB on such an important matter are tiny. And in the highly unlikely event that it did, the ECB’s QE party would have already probably ended.
Over the last 18 months the ECB has reduced its bond purchases from roughly €80 billion a month to around €30 billion in January. But nearly all of the reductions over the first three months this year came from government bonds, while it largely maintained its purchases of corporate bonds.
At last count the ECB had a total balance sheet of €4.54 trillion, more than any other central bank on Planet Earth, of which €149 billion are corporate bonds that it has acquired since June 2016.
But there are signs that the ECB has quietly begun to taper its corporate-bond buying program. The rate of purchases under the Corporate Sector Purchase Programme dropped 50% in April to about €700 million per week, down from €1.4 billion during the first quarter, analysts at Deutsche Bank pointed out. That could mean the ECB is starting a “stealth taper” in order to wean the European bond market off the corporate debt purchases it began in June 2016, Deutsche Bank said.
But are the companies that benefited from the ECB’s largesse ready for life without Draghi? There’s no doubting the ECB’s bond buying has exacerbated distortions in the corporate bond market — distortions that were first engendered by the central bank’s low interest rate policy. Yields came crashing down and spreads narrowed.
At the peak of ECB’s bond buying binge, the average yield of the Iboxx non-financials index fell as low as 0.69%. For German blue-chip companies such as BASF, Continental, Linde, SAP and Siemens, yields fell to less than 0.5%. France’s pharmaceutical company Sanofi and German consumer goods manufacturer Henkel even managed to issue bonds at slightly negative yields, effectively helping pay off their debts.
But that was then. Now, the average yield of the Iboxx non-financials index is back above 1.10%. As Reuters reports, some of Europe’s biggest money managers are reducing their exposure to corporate bonds. Some are even shorting them, betting that stress is building in a market that was buoyed by years of rock-bottom borrowing costs. Some new bond issues have even struggled to find buyers, when not so long ago they were flying off shelves.
Bank of America guesstimated last year that as many as 50 of the euro zone’s 600 biggest companies deserve to be classified as “zombies,” as they pay far too much interest in relation to their profits. For these companies the ECB’s bond-buying program was a godsend, allowing them to continue refinancing their debt and stave off default. But interest rates are beginning to rise again.
Whether or not the ECB has already begun to taper its corporate bond buying on the quiet, the program will likely be phased out later this year. And yields have already been rising ever so gradually in anticipation. That means that the companies that have benefited from the central bank’s monetary support are going to soon find themselves facing a whole new, more challenging reality. For some it’s unlikely to be a pleasant one. By Don Quijones.
Too Little, Too Late? Read… EU Moves to Protect Financial System from Failing Banks
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Interest rates have been ticking forward since early last year here in the EMU, despite Mssr. Draghi’s best efforts to the contrary.
The reasons? Inflation is heating up (bought any vegetables lately?), there’s stiff competition from US dollar denominated bonds and, much more critically, there has been a spate of high profile bankruptcies (led by Air Berlin and Areva) which weren’t supposed to happen under the ECB’s watchful eye.
To paraphrase Mark Twain, reports of risks being dead and buried have been greatly exaggerated. Or like Mao Zedong and others throughout history have discovered, you can only suspend the laws of economics for a brief time. The longer and harder you suspend them, the worst the inevitable adjustments (see The Great Leap Forward, where lack of raw materials, infrastuctures and chiefly technical expertise were to be replaced by “revolutionary fervor”).
The European Central Bank has been playing an extremely dangerous game, especially in the last few years.
You see, financial failure and bad calls happen all the time. Even during economic booms companies go burst all the time: Honda bought their first Tokyo factory at the height of the early 50’s boom at a bankruptcy auction.
What the ECB has been trying to do is to if not eliminate, at very least seriously distort, the underlying dynamics making a company financially viable. Since directly buying junk bonds is too much even for them, at least for now, what they have been doing is wacking the whole credit system on the head with a massive mallet.
Using the double prong of starving investors for decent yield in the investment grade division and flooding even two-bit banks with liquidity they have tried to make the financially ridiculous feasible.
Without the ECB’s antics there would never be a company whose sole purpose is to design and sell little obscenely overpriced rubber mats to put underneath dogs’ food bowl (I am not joking!) and banks wouldn’t lend money to fly-by-night real estate speculators who don’t even know they should get a lawyer to help them with contracts (I admit this may be a bit obscure).
All these wacky companies and all these poor investments will have to be liquidated at some point in the future. It doesn’t need to be a massive financial crisis, it can be done in orderly fashion, but it would not go down well with the idea that GDP can only go up, preferably by a lot, and it would mean two of the cornerstones of the modern economy, automakers and mobile phone manufacturers, would have to hit a big unappetizing slice of humble pie.
Excellent comment.
We shouldn’t forget their political agenda, too: this stimulus and make-believe has, in addition to lining many pockets, helped keep the (deluded) radical Left and plain old (corrupted and arrogant) Socialists out of power in many places:
‘Look how prosperous we are! The Crisis is long gone, growth has returned, do you want to risk them getting into power and ruining it all (as indeed they might!) by taxing you more, borrowing, all that anti-Austerity stuff?’
The conservatives of whatever exact stamp are no wiser or better, but Brussels loves them, and not the ‘populists’.
This is very much the case in Spain: the conservatives are crowing over the wonderful ‘recovery’ – ‘Look at GDP!! – which they claim to have have overseen , but which has been handed to them on a plate by the ECB – a fairy tale environment.
Complete with ‘graduate’ serfs earning pitiful wages in the fields below the Magician King’s Magick castle. The ‘best prepared generation’ in Spain’s history (yes, I know…) is finding that their future truly sucks, even as GDP rises.
In fact, if one were to be lured by the Fairy of the Mists and taken to her Kingdom, it would I am sure be more real that the EU at present……
Awesome comment, made me think!
At last count the ECB had a total balance sheet of €4.54 billion, more than any other central bank on Planet Earth, of which €149 billion are corporate bonds that it has acquired since June 2016.
Typo?? 4.54 149??
Yes. Thanks. €4.54 trillion.
√
I’ve just spotted a typo in the text: “At last count the ECB had a total balance sheet of €4.54 billion” should read “trillion” :). Great article as always! Thank you
Yes, thanks.
I didn’t catch that typo because whenever I read about central bank balance sheets anymore, my brain automatically inserts trillion after any number.
Excellent comments above and I agree. However, I personally am not too afraid of a full-blown crisis or even a serious setback on the EU level. Of course, companies will feel the chill wind, results may go down, some may even go bankrupt and there will be no fantastic GDP growth. But in general “muddling through” will be the order of the day, as is standard EU practice really.
BUT, and it’s a big but, I do wonder what is going to happen to Italy now. During Draghi’s reign at the ECB they have been able to continue screwing up their economy like never before, all the while being shielded from nasty consequences. Their compatriot uncle Draghi was always there to make sure that the ECB loaded their junky bonds on its balance sheet, bought every scrap of paper in sight, backed their not-so-secure “securities”, pushed down interest rates to they could continue generating megatons of debt and turned a blind eye when failing and rotten banks were being “restructured” in plain conflict with EU banking regulations.
I suppose a lot will depend on who is going to be Draghi’s successor at the ECB. When that turns out to be a guy like Jens Weidmann the Italians will probably be living in interesting times, as the Chinese proverb says.
Even if it is Jens Weidmann, is it likely that he will do anything different to Draghi if it means the break up of the EU?
Whoever is the ECB chief, the trigger (on the EU project – which is what is likely if Italy is left to itself) will be pulled only when it becomes beyond the ECB to keep the EU afloat. It will come to pass but only after ECB tries all it can and then some.
Great article and good comments. We will never know but how much of the 4.5 trillion euros has truly kept zombie companies going. Good call reference Spain and Italy.
The BoJ has been on a buy bonds and assets to keep the party going for the last 20 years. I have not heard an argument yet that says the CB’s cant keep doing this forever. For me, the ‘inflation’ argument against their efforts falls flat because they can say inflation is whatever they want it to be.
I have been watching this distortion for so long I feel I have wasted years and years of my life. Many of those who I think highly of have been foretelling of a crisis since 2009.
Colour me skeptical….
The value of a fiat currency is based on broadly held confidence that it isn’t going to be debased rapidly (emphasis on “rapidly”). Once that confidence wanes, central banks get into a situation like the central bank of Argentina, which has been overseeing the destruction of the currency. This results in a situation where no one will lend you in that currency over the median and long term, and the credit system in that currency collapses, in a credit-based economy!
Countries like Argentina then start basing their credits on another currency (for example, USD). Rents, mortgages, and other contracts are specified in USD, to be paid in local currency at the exchange rate at the time of payment. This means that payments increase in local currency nearly every month, but incomes in local currency might not increase at the same speed. This also poses big risks for the country overall and is economically very expensive.
What Japan is doing is fraught with risks. But they also have a lot of strengths — high-value-export oriented economy, etc. — that supports their currency and that few other countries have. So Japan is going to be able to drag this out for a while.
These things can work for a long time, until suddenly, they don’t.
Yeah and some people still remember the war, with Argentina that is
> but they also have a lot of strengths
Yes Japan can muddle along because for social cultural reasons they aren’t going to explode politically like the EU is going to.
Everybody keeps telling Japan to take in Immigrants (Which cause these Massive social problem’s).
For some silly reasons, the Japanese prefer to try to develop Machines to fill any labour voids in their shrinking population (which increases net population worth, as a side effect).
No Idea those silly Japanese. None what so ever.
You are correct. But don’t lose sight of the fact that monetary systems are essentially a game. Economists look at economies as games with each individual a game player.
Eventually the masters of the game will end the current monetary system. They will inflate the value of the monetary units until they are worthless and no longer serve a purpose. At that point they simply declare the game over and start up a new game with new monetary units. Everyone with hard assets can transfer them to the new game. Everyone who held monetary units from the old game will be screwed and left with nothing in the new game.
Wash rinse repeat.
The Japanese used to have a monetary unit called sen (1000 of them made 1 Yen) when the Yen was effectively a dollar.
Soon as 1 and 10 yen, can now buy nothing, some similar occurrence will be seen.
Do this. In a, Conformist, Stablle Mono-cultural, but basically free society, over 100/150 years and nobody rally notices. Do it at the speed of Mugabe, in an grossly mismanaged, ethnically and racially divided society, and everybody scream’s, and resists, from day 1
Much of the Eurozone has negative rates for public debt for 3 to 5 years out. Greece is slightly under positive 4% for 10 years out. Nobody who doesn’t have to will buy those bonds without someone to sell them to for a quick flip and an instant profit. https://www.investing.com/rates-bonds/european-government-bonds?maturity_from=10&maturity_to=310
The entire ECB bond program started to counteract normalized and rising rates a few years ago. The debt monetization was at the least a bonus of free money for governments to spend on various public projects and day to day expenses. More likely, it was for using printed money as an endless, cheap replacement for saved capital. The negative rates helped to combat Target2 imbalances in mostly north Europe. Low to negative rates also fulfilled a globalist agenda.
Why does anyone think they will pay normalized rates ever again by choice since they refused to earlier and invented ECB QE and tons on BS reasons as an alternative? The corporate QE program is a one-off and is probably limited by the number of bonds available to buy.
The common belief that late this year it will all stop will be interesting to watch. Even Kreswell would get this one right … He would predict a continuation for ‘excellent reasons’. ‘Kick the Can’ should be on the EU flag.
Since the start of QE, Europe has invited and accepted hundreds of thousands, perhaps millions, of mid eastern visitors to live with them and to pay their living expenses for them. I suspect the hope was the globalist dream of importing cheap abundant labor who would happily assimilate. The true reality is different and adds more need to public funds.
I think history will use the EU as the premiere example for bad government. The eventual snap back towards normalization will be interesting to live through.
Life after Draghi will be interesting, because his successor is supposed to be German, something that might be hard to digest for Italy, Spain & co. After all, the state religion of the Germans is sound money. Maybe a compromise candidate from one of the smaller € countries close to Germany might turn up. The Netherlands is out of the question because of ex ECB chief Duisenberg, but maybe Finland or Austria. Such a candidate would probably be easier to accept for the club med countries.
At popular level perhaps a sound (less insane is perhaps a better definition) monetary policy still has appeal in Germany, but it never had that much at top level.
In 1978 Helmut Schmidt openly threatened a very recalcitrant Bundesbank to ratify the EMS (European Monetary System) or face the consequences: a constitutional amendment to openly end the Bundesbank’s independence once and for all.
Schmidt resurfaced in 1987, together with another failed politician, Valery Giscard d’Estaign (whom my maternal grandfather considered in the days “one of the most dangerous politicians alive”) to lead the “Association for the Monetary Union of Europe” whose three chief “financial sponsors” were all from the then Western Germany: Volkswagen, Daimler-Benz and Commerzbank.
Before the Maastricht Treaty was signed in 1991, Karl Pöhl, Bundesbank president, recommended Helmut Kohl to “avoid putting the cart ahead of the ox”: in short a monetary union could only happen at the end of a long process of political integration, with many checkpoints and stops to avoid taking shortcuts.
However Kohl, who has since ascended to lay sainthood despite being, well, a politician, brushed Pöhl aside and took his marching orders from the usual suspects: Siemens, Deutsche Bank, Robert Bosch, Bayer etc.
As the saying goes, with friends like these who needs enemies?
Ah but if they are zombies they are not alive to start with, right? So they won’t live without Draghi after all.
Wordplay aside, zombies die without brins and zombie companies die without cheap debt.
What is to prevent the ECB from increasing their portfolio to 5t ,6t ,7t or more?
NOTHING except for a collapse of the Euro
Germany + Austria + the Netherlands + Finland, but foremost Germany. I suppose that Estonia is to be counted into this group, too.
People are gullible when it comes to money and economics. If an important person pulls fantasy from a dark bodily place and states printed money, very low to negative rates, monetized debt, and the need for inflation are all needed, necessary, good, and should continue forever – the gullible will believe and the media will not argue about it.
If, as a result, the people of said place are, metaphorically, consuming themselves to keep it going (low growth, increasing poverty, consuming real capital for living expenses) then it will keep going until it can’t. They’re basically eating the seed corn. Politicians won’t help the people because it was their idea to put them in this situation in the first place. The media is compliant and won’t peep a negative word. Some might see the roots of dystopia forming.
It will continue until the people can’t consume themselves any longer. The euro will collapse someday, but not soon. The fun will be watching the imaginative Kick the Can excuses and how sheeplike the people and media remain.
“They’re basically eating the seed corn.”
All central bank QE, everywhere, encapsulated and summarized in one short sentence. It’s not a free lunch. It’s consumption and destruction of capital assets for the purpose of today’s agenda. Once it’s gone, anyone from somewhere else with capital has the advantage and will likely exploit it.
QE only works if everyone does it and all are eating their own seed corn to support the QE agenda. Then, when the capital has been expended, printed money becomes a fine substitute for saved capital. A few who can exploit asset bubbles and politicians live at the top. The rest live at subsistence levels.
Failing that, those with the largest capital accumulation will persevere over those who use their’s up first. The Fed is on the right track, finally, and will hopefully continue as the US rebuilds its capital over what was lost over the past decade. The others are on a different track and will follow a different path. China might have finally ‘got it’. Japan is in another universe. The eurozone is comic relief.
“China might have finally ‘got it’. Japan is in another universe”
Bias will destroy you Every time.
Japan is Most defiantly Another planet. You learn this quiet quickly when you arrive there, if your mind is open and you have any degree of cultural sensitivity.
The only thing china has, is a so many times before. Both feet on an irreversible slope, to the doom, caused by excessive high speed money printing.
ccp china is a VERY BIG bubble, that has been blowing since Nixon. Its simply a when, and a, who else it destroys when it pops.
The only reason the Eu is obvious, is that it is nowhere near as Opaque as ccp china.
Is it presumptuous to assume that a contraction in global credit will lead to less global commerce? Enough has been said about the possible dislocations; excess capacity in China, and labor shortages in the US, but what about global banking? The premise of preventing a financial crisis, is the diminution of risk by spreading it around, US banks buy DBs derivatives, will Yellen and Draghi, and Kuroda give way to bankers with more parochial interests? What’s that say about global risk?
The happy status quo exists because – thanks to the central banks – all major fiat currencies were devalued in synch over the last 10 years. Despite an orgy of fiat printing, the relative movements of the currencies were small.
Now this happy equilibrium is ending. The Fed has started to raise interest rates and even begun quantitative tightening. This will eventually force other CBs to tighten as well. Hard to say what caused that change of direction. Possibly the out of control house price inflation or the explosion of fiscal stimulus (deficit) or wages showing some growth.
The question is will the CBs be able to “engineer” a soft landing? I can’t recall they ever managed that before.
Yes, if you like to look at charts, you’ve noticed that soft landings are a rarity (I can’t think of any). Typically, stock market charts show spiky rises, spiky falls, and periods of consolidation – flatlining, more or less,- between them. The Fed has tried to solve the spiky fall with super-low interest rates etc., but the unintended? consequence has been the harrowing of savers. We are now at a market, according to AdvisorPerspectives analyses, overvalued by about 100 %. Middle-class savers with any retirement accounts have to look at the likelihood of once again watching their stock portfolios crater.
If you don’t have periods of contraction, consolidation, you miss out on the benefits of such times- achieving sobriety, and the like.
Very few want to see the economy crash, and we can expect the Fed to muster the lifeboats….how many are there, anyway ? Enough ? Let the savers swim; they should have spent more of their life energies on “wealth management”.
Here’s a couple of positives (and I’m serious here; I’ve been reading some Dickens and Gaskell lately): 1) we no longer have debtor’s prison; and 2) we do have the FDIC (banks used to go under, and you had NO recourse, savings all gone). And oh, yes, here’s another: there will be Wolf Street for all the dark humor of it, a place where it’s safe to laugh.
Thx once again, Wolf, DQ, and Commenters.
“Spain’s Iberdrola and Italy’s Enel… are locked in a bidding war for the Brazilian electricity company Eletropaulo.”
Does the ECB or EU have rules preventing low interest debt being used to acquire non-EU companies? If not, how much has ECB QE facilitated similar european take-overs? For that matter, how much has BOJ QE facilitated Japanese acquisitions abroad (companies, equities, real estate…..)?
In such a game, the central bank with the most aggressive QE gets the most properties on the Monopoly board!
“In such a game, the central bank with the most aggressive QE gets the most properties on the Monopoly ”
You are in the ballpark but the swiftest and most spectacular gains have been made by a State, not a CB.
Much of that States global holdings are so well obscured they could fairly be described as Deliberatly Covert. They can do this as among other things they are not, and do not even claim to be, a Democracy. They make the activity’s of the BOJ and others look quiet pathetic in this field.
Before being ECB President, Draghi was President of the Italian Central Bank. You only have to look at the state that Italian banks are in to see the kind of legacy which Draghi leaves. ECB policy to try to defy the natural laws of capitalism, harsh as those laws can be, was always bound to end in tears and recriminations.
Very Well said, but you forgot !!! to mention that ECB vice-president, the ex-Portuguese of the Portuguese Central Bank which also left the Portuguese banking system very very bad, as you can see here in Wolf’s Blog.
So we have the 2 most important bankers of ECB who only made sh..t in their previous jobs.
So they were rewarded with these new jobs!
Strange capitalism who indulges incompetence