Fixed Income Boutique

Mario Draghi: A great man with many achievements in a challenging era

Market Update

On October 31, Mario Draghi passes on the baton at the European Central Bank to Christine Lagarde. Mondher Bettaieb-Loriot, Head of Corporate Bonds shares his personal views on Mario Draghi’s tenure.

During his time as ECB president, Mario Draghi got the system back on its feet. His 'Whatever It Takes' speech in August 2012 marked the beginning of a series of well-orchestrated reforms to save the European banking system and the euro currency. Back then, we needed a strong statement from him because the Euro-wide system was facing dire consequences with major economies like Spain, for instance, unable to refinance themselves anymore.

Draghi: The “Eurospider” reconstructed the euro financial web

It is important to remember that a number of politicians invested huge political capital into the euro, going back to François Mitterrand and Helmut Kohl, who signed the Maastricht Treaty in 1992. I recall François Mitterrand saying that, by signing the Maastricht Treaty their intention was to avoid a Third World War in Europe. After that, they would introduce the euro to unify Europe. So, the euro’s political capital is nothing new. It dates back to the time of those two great statesmen.

Back in 2012, market conditions prevented Spain from refinancing at government level, so Spain could not issue bonds anymore. This was a key risk, which Mario Draghi spotted. He had to intervene to prevent the European area from imploding, and to ensure the survival of the euro. Spain was the weak link at the time. Tackling it sparked a series of major achievements that followed to save the euro as a currency and to save the European area.

There was a huge systemic risk at the time. To put it simply: if a government cannot refinance, its banks cannot refinance, and if the banks cannot refinance, they cannot lend in a country and that is basically the death of an economy – it’s as simple as that. So Mr. Draghi not only saved the European sovereign governments, but also all European banks, especially those banks that are linked like dominos through overnight inter-bank lending.

It needs more than a speech to get the system back on its feet

One of Mr. Draghi’s first actions was to create the Outright Monetary Transactions program (OMT), which allowed the ECB to make purchases of sovereign bonds under certain conditions to ensure that sovereign governments could refinance. The OMT was the vehicle to purchase bonds through the European Stability Fund, once countries had asked for assistance. Of course, these countries had to do something at the economic level to be able to access this program.

This way Mr. Draghi ensured that Spain and other peripheral countries would be able to refinance in the market, so spreads on sovereign bonds started narrowing again, which was good news. Under both the auspices of the European Stability Fund and then the OMT, sovereign governments could get the money required to recapitalize their banks. The program provided a band-aid to the banking system, as banks were able to recapitalize at affordable rates, which allowed them to pass on affordable loans to economic agents in the country, ensuring the system’s survival.

This was followed by the long-term refinancing operation (LTRO) for the banks - one of Mr. Draghi’s greatest actions. The LTRO was instrumental in making sure that European banks would be able to continue refinancing themselves at affordable rates with the ultimate goal of preventing credit from drying up in the economy.

When you ensure that banks are able to fund themselves affordably, you also slowly but gradually ensure that they become profitable again. This is because they earn a certain spread, which enables them to rebuild their capital positions by retaining parts of the profits.

At the beginning of 2013, the ECB became the single supervisory authority of the largest European banks to address the aggravation of the European banks' credit quality and spiraling credit costs that prevented lending activity. Back then, the situation of European banks was serious because they had accumulated large volumes of non-performing loans. Under the auspices of the ECB, clear guidelines were put in place to spot and reduce these non-performing loans. It took many years to ensure that this became the norm in the European area. By pressing for this, Mr. Draghi increased the probability of improving the quality of the banking system in Europe (reducing the system’s non-performing loans) and that's a great success. People tend to forget about these achievements but, today, European banks are generally well capitalized and quite healthy.

As one can see, Mr. Draghi’s achievements are extraordinary. He was also a professor of Economic Theory and Application – let's not forget that he earned a PhD at MIT in the US. So, he not only has the theoretical knowledge, he also has the required pragmatism to do the job of an ECB President. I think his background is unique. Without him, we would have really been in trouble. It's Mr. Draghi who saved the system in the end and I have no doubt that he will one day become a regular feature of economic history books.

Draghi lays the foundation for ‘low forever’ in an increasingly challenging era

Today is Mario Draghi’s last ECB meeting and his legacy passes on a much healthier financial system with very affordable rates and balanced programs to keep on stimulating economic activity and consumer consumption. This will become more of a challenge going forward as we are going through the fourth stage of the Industrial Revolution, which is digitalization. I believe that the second step of this new era will be known for a new generation of wireless communication or 5G that will enable massive connectivity between machines and objects, which in turn will enable the next step in industrial automation and efficiency. Sadly, this next automation leap will greatly impact manual jobs and employment, and further risks weakening consumer consumption as workers are replaced with mobile robots, sensor processes and network functions.

This is where Ms. Lagarde should make a difference in my view, by encouraging fiscal spending that would create replacement jobs and easing this transition. So, her tenure should be a continuation of Draghi’s in trying to sustain the European-wide system and solidifying it further given also her political background and connections. She recently addressed the International Monetary Fund and stated for instance that a banking and capital markets union is also high on her agenda for the issues that remain to be addressed. She will also be accompanied by another competent person, her new Chief Economist Philip Lane. Mr. Lane is a man who knows a thing or two about the benefit of central bank accommodation, having rescued the Irish banking system as Head of the Irish Central Bank post the 2008 crisis.

Ms. Lagarde’s term should therefore be as exciting as Mr. Draghi’s and could well mark the beginning of the “Low Forever Era” to ensure that employment and consumption opportunities remain plentiful in years to come in the European area.

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