Amid a sea of red in European stock markets, Sweden's central bank, the Riksbank, cut its already negative interest rate deeper into negative territory this morning, by 15 basis points to -0.5%. In theory, negative interest rates should push commercial banks towards granting riskier loans to businesses, and this in turn should help the economy grow.
In practice, however, this does not happen. And until it does, there is no hope that the world economy will go back on a path of sustainable growth.
It's very possible that stock markets are tanking because investors realize that central banks are close to the limit of what they can do to stimulate the economy. One thing is sure: confidence is in short supply. The Fed's moves are keenly watched, as usual, but like Real Money contributor James "Rev Shark" De Porre said yesterday: "Janet Yellen Really Has No Ammunition."
No single event precipitated the sharp fall in European stock markets this morning, but banks seem to be once more the ones bearing the brunt. Jim Cramer wrote that U.S. banks' book values were solid, but warned that as long as there are still doubts about European banks, jitters will continue.
And doubts abound again. France's Societe Generale (SCGLY) seems to have encompassed the difficulties ahead for the financial sector as it warned that it may miss its profit target because of hard market conditions and tighter regulation.
The latter could be the key to what's happening with banks right now. Since the financial crisis, banks have been under pressure from various regulators, especially in Europe, to strengthen up in order to ensure that taxpayers will not have to foot the bill to save them again if another crisis strikes.
This has meant they have been forced to amass much higher capital buffers than before, hire thousands of staff to ensure compliance with various rules and regulations, make higher provisions for bad loans and only lend money to the safest bets.
They were also forced to issue hybrid instruments to fill in their new capital buffers, and these instruments were gobbled up by investors, even some unsophisticated ones, when the market was sloshing with liquidity due to the Federal Reserve's rounds of quantitative easing.
(You can read more about these instruments, known as CoCos, in a story I wrote earlier this week. Carleton English also wrote a very good take on the CoCos issued by Deutsche Bank (DB), which was forced to come out and say it was "absolutely rock solid" -- a statement that Ed Ponsi said has made him fear it even more.)
Despite all these attempts to make banks safer while providing them with a lot of liquidity, and despite the imposition of punishing, negative interest rates by central banks, commercial banks aren't exactly ramping up their lending to businesses to any degree that would help a strong recovery. Why?
Well, as Julien Noizet, a banking sector analyst, notes on his blog "Spontaneous Finance", the decision on what sector of the economy a bank will allocate capital to is shaped more by regulation than by how much money the bank has available to lend.
Basel rules classify mortgage lending as less risky than business lending, especially to small and medium size enterprises. There should be no wonder, therefore, that house prices are bubbling up again in many parts of Europe while small businesses -- the main creators of jobs and growth -- are starved of cash.
Sweden is one of the best examples of this anomaly: house prices, especially in Stockholm, are at record highs as cheap mortgages encourage more and more buyers to take out loans and pile into the bubble. Pushing interest rates lower will only serve to accelerate this trend.
Perhaps the plunging stock markets are trying to tell policymakers that it's time to give up relying on central banks to sort out the economy and instead to start looking at ways to stimulate real economic growth. Redressing the regulatory imbalance between lending for asset price speculation and lending to businesses for real investment would be a good start.
