Throughout his waning months in office, European Central Bank President Jean-Claude Trichet boasted that he had avoided the excesses of his counterparts at the U.S. Federal Reserve and kept the ECB’s response to his continent’s financial crisis relatively modest.
It has taken his successor, Italian central banker Mario Draghi, less than three months to upend that approach, triggering a debate about whether the ECB has quietly solved the euro-zone debt crisis or simply postponed a reckoning by shuffling hundreds of billions of dollars among banks, governments and the central bank’s own coffers.
As it did in December, the ECB this week again offered inexpensive three-year loans to euro-region banks, and demand was strong. Some 800 banks borrowed around $700 billion -- more banks and more money than were involved in the first rounds of loans.
Much of the money went to retire short-term loans that banks already had outstanding with the ECB. But the operation will still put more than $300 billion of extra cash into the euro zone system. The fact that the loans won’t come due for three years means the banks will be more willing to put the money to use, on the assumption that the region’s economic problems will be sorted out in the meantime.
The long-term loans “further reduce the threat of a credit crunch in parts of the euro region,” Capitol Economics analyst Martin van Vliet wrote of the ECB loan results.
The policy has stabilized European finances in recent weeks, contributing in a roundabout way to a decline in the exorbitant interest rates that some heavily indebted governments had to pay. After the first round of ECB loans, banks spent some of the money on government bonds, and Italy and Spain as a result saw a drop in the cost they had to pay to attract bond investors.
The banks also began to retire their own bonds, reducing the competition for money on private markets. And bank lending to households and businesses ticked up.
These were all reassuring developments after an autumn consumed by fears that the region’s debt crisis would lead to a breakup of the euro zone.
“There are tentative signs of stabilization,” Draghi said at a recent news conference on ECB policy.
But some analysts and bankers are warning that the policies under Draghi could leave the European financial industry addicted to cheap ECB loans that will be difficult to replace if the region’s economy remains stagnant.
For a variety of reasons, the euro zone remains in trouble. The region is heading into recession, and governments are scrambling to restructure economies ill-suited to compete globally or support the costs of aging populations.
Greece, the region’s hardest-hit country, is in the midst of a bond restructuring that will shape its future. If all goes smoothly, the exchange of new, less-expensive bonds for older ones will greatly reduce the country’s outstanding debts and pave the way for a large package of new international loans. But the debt restructuring has left the country in technical default on its bonds, possibly triggering insurance payments to bond holders — a development that some analysts worry could stigmatize the euro region for years.
If nothing else, the ECB loans have bought time and helped the currency union through a bulge of borrowing required by governments and financial companies in the first months of the year.
The ECB lending program was launched at a critical moment, when borrowing costs for Spain and Italy were at such a high level that those countries might have needed a bailout that the rest of Europe and the International Monetary Fund could ill afford. As those rates have dropped, Spain has accelerated its borrowing for the year to take advantage.
The loans have reduced one of the chief risks cited by U.S. and other officials: that a large or important bank might collapse and trigger a Lehman-like run of corporate bankruptcies.
The ECB has cast the purpose of its new policies narrowly, describing them as an effort to loosen up tight lending markets that were making it difficult for European banks to raise the money they needed to operate. The central bank has not framed the lending initiative as an attempt either to boost the European economy or to help overly indebted countries.
But ECB lending has been a back door through which the central bank helped markets that were veering toward serious trouble last fall, said Jacob Funk Kirkegaard, a European analyst at the Peterson Institute for International Economics. And even as Draghi was opening the spigot to banks, he was pressuring governments in Italy and elsewhere to get more serious about economic reform.
The ECB loans aren’t so much a solution, he said, as they are a “bridge” to an era of greater fiscal discipline, including more balanced budgets and perhaps a more robust European economy. The lending “only makes sense if the other wheels of reform keep going,” Kirkegaard said. “Otherwise, it is just heroin” for the banks.
Draghi’s approach has limits.
The ECB has stopped short of lending directly to governments — something that many analysts have called on it to do, noting that in the United States, Japan and Britain, the central bank ultimately stands behind the government.
The ECB also appears to have halted — or at least slowed — its program of buying government bonds as a way to hold down interest rates for Italy and Spain. The total amount of government bonds held by the ECB has remained roughly constant in recent weeks at about $280 billion.
Perhaps more significantly, the central bank has insisted that it be repaid in full for the Greek bonds it purchased at the start of the country’s crisis, while private bondholders face a 50 percent loss on the value of the bonds they hold. The ECB’s demand that it be treated as superior to private investors may prove destabilizing in unforeseen ways, the Standard & Poor’s credit rating agency warned last week.