Mario Draghi Takes European Central Bank on Unexpected Easing Path

NEW YORK (TheStreet) -- Investors knocked down the value of the euro as the European Central Bank lowering of interest rates move today is more than they expected. Meanwhile, economists say a proposed ECB three-year program to buy asset-backed securities falls short.

The European Central Bank Thursday lowered all three of its main interest rates by 10 basis points. Its benchmark rate was reduced to 0.05% and the deposit rate was lowered to minus 0.2%.

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ECB President Mario Draghi stated that the governing council is reviewing a program to purchase up to 500 billion euros worth of asset-backed securities over three years. The purchasing plan, he said, had not been finalized and would be presented at the October meeting of the bank.

The market response was immediate as the euro dropped below $1.30 for the first time since July 2013. At 2:45 p.m. in New York, the value of the Euro was trading at $1.2942. Investors seemed to believe that Draghi and the ECB had moved to loosen up and this was seemingly more than they had expected.

However, in another circle, economists were disappointed that the program fell short of the board-based, extensive large-scale purchases of government bonds similar to the program of quantitative easing that the Federal Reserve has been conducting over the past five years.

Draghi has never seemed enamored with the idea of quantitative easing. He has resisted being pushed "over the brink" when it comes to such a massive program that is pre-programmed into the operating behavior of the central bank. He let it be known that there are a few members of the governing council that oppose buying ABSs.

This may be because Draghi faces a different problem from that faced by the Federal Reserve. A part of Ben Bernanke's justification for creating the Fed's quantitative easing program, although it did not get as much attention as the need to get the economy growing again, was the fear of a banking system collapse.

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Bernanke, a student of the Great Depression, is familiar with the fact that a large number of commercial banks failed in the 1929 to 1933 period and this helped to account for the fact that the M2 money stock at that time declined by one-third. Bernanke did not want a waterfall of bank failures during his tenure. The creation of quantitative easing helped him avoid such a result.

Since Dec. 31, 2007, there are 1,527 fewer U.S. commercial banks. In other words since that date, one out of five banks in existence at that time have closed! Banks continue to leave the system at a rate of more than 200 per year. I expect that this pace will be maintained over the next year or two.

But, these closures are not all due to failure. Almost all of the banks closing their doors today are being acquired by a bigger, healthier bank. And, these acquisitions are taking place under the supervision of the regulators and are being done in an orderly manner.

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In this respect quantitative easing was a very successful policy. The banking system may eventually lose 2,000 or more banks before this transition is completed, but, the adjustment is being done smoothly, with little disruption to the economic expansion.

Now, Draghi does not have this problem in the eurozone. The commercial banks are larger and there are a lot fewer of them than in the U.S. Single bank failures-- and there have been some -- can be handled on a case-by-case basis. Mass failures are not expected.

Furthermore, troubled banks don't lend much and people with excessive debt don't borrow much. This is why Draghi is concentrating on the ABS market and not the market for government securities. In buying ABS the ECB will be giving money back to people who have made loans, hoping they will put the money back into circulation.

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Buying the securities of governments does not accomplish the same thing. And, with the eurozone focusing on these governments reducing debts by cutting back on expenditures, buying the government debt does not seem likely to provide expenditures to spur on the economy.

Maybe we should applaud Draghi's discipline in this case and not jump all over him because he did not follow lock-step in Bernanke's footsteps.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


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