As Europe’s government debt crisis deepened, the European Central Bank helped out by buying the bonds of troubled countries and accepting them from banks as collateral for loans even as they were downgraded to junk status.
Now exposed to hundreds of billions of dollars of securities issued by Greece, Ireland and Portugal, the ECB is fighting hard to ensure that those countries don’t default on what they owe. Although central bank officials say a default might put the broader European economy at risk, a growing body of analysts is questioning whether the ECB’s concerns are overstated. They contend that an organized default may be the only way to get Europe’s weakest economies back on track.
They also say that as one of the chief opponents of a default or restructuring, the ECB may be part of the problem.
“The ECB, in a sense, does not want to be a permanent ‘bad bank,’ ” the place where low-quality assets are stashed to keep the financial system functioning, said Jan Randolph, head of sovereign risk at IHS Global Insight, a consulting firm. In debating the future of Greece and other economies, “they are playing the risk and burden-sharing game. . . . Is it the taxpayers who carry the burden or the ECB? The ECB would rather have the taxpayers carry the risk” through loans from European governments and the International Monetary Fund, Randolph said.
The ECB has been central to Europe's crisis response, but it has not been a willing player. As Greece’s problems unfolded last spring, the ECB at first opposed the idea that it use unconventional methods to ensure economic stability among the 17 nations that share the euro.
The bank eventually capitulated — only to be drawn into an increasingly complex situation that has required it to steadily relax its standards. It has also been caught between German demands that private bondholders share in any future bailout of Greece, the exposure of its own balance sheet to Greece’s problems, and the growing sense that Greece’s debt is too high to be fixed without years of reform and some sort of debt relief.
The bank had maintained strict rules on the type of collateral it would accept when making the short-term loans needed to keep private banks adequately funded — and able to lend to customers. But as ratings agencies progressively downgraded the credit rankings of Greece, Ireland and Portugal, the ECB watered down its collateral rules so banks could continue getting loans on the basis of their sizeable government bond holdings.
The most recent such step came Thursday, when the ECB agreed to continue accepting Portugal’s bonds as collateral, despite their recent downgrade to a junk rating by Moody’s Investors Service.
To have done otherwise would have been a likely death sentence for banks in Greece, Ireland and Portugal that have become heavily reliant on ECB loans, but it has left the ECB with $350 billion outstanding to banks in those countries.
The ECB has bought $105 billion more in government bonds, intervening at different times to try to keep borrowing costs down for Europe’s weakest countries.
A default by one or more of those countries would imperil the ECB’s direct investments and the repayment of the loans it has made to banks. It could also possibly require the ECB to be rescued by Germany and other euro-zone countries. More broadly, the ECB worries that a default in one country might cause a general banking system collapse in Europe — a concern new IMF Managing Director Christine Lagarde has said she shares.
ECB President Jean-Claude Trichet, in a news conference Thursday, insisted that the bank has drawn a hard line on the issue and would not accept as collateral bonds of any country that have been declared in default.
“What is our message? . . . No default,” Trichet said, adding that it was up to European governments to solve the region’s problems without risking what he sees as financial turmoil on the scale that followed the collapse of Lehman Brothers. “We are not the actors,” Trichet said. “The governments and the authorities are the actors.”
Yet economists argue that a restructuring of government debt — at least in Greece’s case — may be the only realistic fix. As part of the currency union, the country lacks some standard crisis-fighting tools — such as currency devaluation — which means that much of the brunt of its economic adjustment must come through lower wages, fewer government services and lowered living standards.
A debt restructuring would ease that burden, and analysts say that if it is well-designed, it could be done with minimal disruption. Although bond-rating companies might consider it a default — and have said as much in regard to ongoing talks about possible concessions by Greece’s private bondholders — there is a broad perception among analysts that, in the end, the ECB will back down again.