The whole situation is reminiscent of the 2008 crisis in the United States, when there was a basic tension within the government on who would undertake expensive but unpopular bailouts of financial firms. The Federal Reserve had the ability to take rapid, decisive action, given its unlimited ability to print money and flexible legal mandate. But the Fed undertook the bailouts of Bear Stearns and American International Group with considerable reluctance — and with the blessing of the Bush administration — because it viewed it as not the proper role of unelected officials at a central bank.
Bush’s Treasury Department, by contrast, lacked the legal authority or financial resources to move on bailouts until conditions got so bad that Treasury Secretary Hank Paulson was able to persuade Congress to enact the $800 billion Troubled Asset Relief Program. The legislation gave Paulson the requisite authority to rescue financial firms through more democratic — if still wildly unpopular — means.
In many ways, though, Europe faces an even more complex situation now than the United States did three years ago. After all, whatever the complexities of the U.S. Congress, it is one legislature, not 17. And Congress was not being asked to make sacrifices on the same scale that Europe is.
Italy is a prime example. Investors began selling off the nation’s bonds this summer, causing the interest rates it must pay to borrow money to skyrocket. The ECB feared that the sell-off could cause the continent-wide crisis to spiral out of control, so began it buying Italian bonds to keep keep rates from rising too high. But, as a condition, Trichet and Draghi sent Italian Prime Minister Silvio Berlusconi a detailed letter explaining the actions needed to make the Italian economy more competitive over the long run and reduce its indebtedness.
Berlusconi initially agreed to the proposed actions, and Italy enjoyed the benefits of lower rates thanks to ECB buying. But the Italian government soon backtracked, refusing to pass some of the provisions earlier discussed. The ECB, in turn, backed away from its purchases, prompting a rise in interest rates, which in turn got the Italian government back on track.
“The ECB is worried that if it does too much, the Italians will backtrack on structural reforms,” said Joe Gagnon, a senior fellow at the Peterson Institute for International Economics. “It’s a game between the ECB and the Italians, ‘we’ll help you, but help yourself first’; ‘you go first,’ ‘no, you go first.’ ”
But the dynamic isn’t limited to Italy and other nations, like Spain and Portugal, that have faced difficulty funding themselves. Just as those nations have looked to the ECB to support their debt with as few strings attached as possible, nations with more sound finances, notably Germany and neighbors like the Netherlands and Austria, have looked to the central bank to bear the cost of bailouts, rather than their taxpayers directly.
The split is one reason why Chancellor Angela Merkel did not turn to any representatives of the German central bank, the Bundesbank, when a slot opened up on the ECB board last month. She opted instead for a German finance ministry official. Bundesbank officials were opposed to the bond purchases.
In theory, the ECB’s bond buying program is only temporary, to be supplanted by an expanded program created by the governments of Europe, known as the European Financial Stability Facility. But even once all 17 nations approve the expansion of that fund to 440 billion euros, it might not be enough to provide the backstop that will ultimately be needed to assure global investors that Europe stands together.
Some say the contributions by individual governments to the facility should be viewed as an initial investment, with more money then being borrowed to ensure that the fund has the trillions of euros available needed to guard against any new wave of crisis.
One way to do that would be for the stability fund to issue debt, which the ECB could buy. But the central bank is resisting those calls, reluctant to find itself in the position of permanently backstopping what the continent owes.