ECB faces showdown over government debt
By Howard Schneider,
FRANKFURT, Germany — The European Central Bank’s emergency efforts to address the continent’s debt crisis represent a highly unorthodox leap into politics and an exceptional foray into the financial markets.
But while these steps in recent weeks have helped keep the continent’s crisis at bay, in particular by keeping borrowing costs for several large countries under control, the central bank has not been able to put the European economy on a sounder footing, according to analysts and government officials.
The cost of doing that — in terms of both money and political compromise — could put even more stress on Europe’s struggling experiment with a common currency.
The central bank’s steps in recent weeks have, by historic measures, been extraordinary, including tens of billions of dollars invested in the bonds of Italy, Spain and other governments to hold down their interest rates.
And ECB President Jean-Claude Trichet entered uncharted political waters this month by raising his concerns about Italy in a letter to Italian Prime Minister Silvio Berlusconi. Afterward, the Italian leader eliminated an additional $64 billion in public spending and moved up the timetable for balancing the government’s budget.
These developments have prompted an escalating debate about the eroding political sovereignty of Western Europe. Three euro-area nations — Greece, Ireland and Portugal — have agreed to adopt strict economic programs required by the International Monetary Fund and European leaders as the price of emergency aid.
One way or another, euro-zone taxpayers as a whole are going to end up bearing more of the burden for financing Italy and Spain — as they are doing for Greece, Ireland and Portugal. The issue is whether additional help for Italy and Spain, two of the continent’s largest economies, can be arranged without triggering another round of turbulence in global markets.
Royal Bank of Scotland analyst Jacques Cailloux said the crunch will come this fall when an international rescue fund backed by European governments can take over from the ECB and begin acting in the bond markets to keep down the borrowing costs of struggling countries. The fund, called the European Financial Stability Facility, would be able to do that because it can raise money by selling its own bonds with a top-notch AAA rating guaranteed largely by Germany’s powerful economy.
The fund is waiting for changes in its size and rules to take effect. Once that happens, the EFSF can begin buying the debt of any country that faces undue pressure from investors. Increasing the demand for a country’s debt holds down the interest rate the country has to pay.
With the markets distrustful of Italy and Spain, the ECB is spending billions of dollars a day to keep their interest rates at affordable levels so the two governments can continue to pay their bills. The total for the past two weeks has been estimated at $50 billion.
The government-backed fund is authorized to raise only $600 billion, and a portion of that is pledged to loans for Greece, Ireland and Portugal. If it has to buy bonds at the same pace as the ECB is doing, the fund could fast burn through its lending authority. Some analysts project that it would cost more than $1 trillion to stabilize the euro-zone economies.
This math contains the seeds
of the next crisis, according to Cailloux and some other analysts. The region’s political leaders could be headed for a fight over whether to increase the fund, while the ECB comes under its own pressure to intervene again in the bond markets.
So far, some of the largest European countries, notably Germany, have been reluctant to ante up more money.
“You’ll have the ECB putting pressure to increase the EFSF and the politicians resisting,” Cailloux said.
The ECB’s foray into unfamiliar territory is like that of the U.S. Federal Reserve, which also has made exceptional investments in the bond market since the onset of the financial crisis four years ago and taken other aggressive steps to bolster the financial system and boost economic growth.
But the Frankfurt-based ECB is a different creature. It follows in the tradition of Germany’s central bank, the Bundesbank, an institution that made its paramount concern controlling inflation and ensuring the stability of the German currency. That mandate was transferred to the ECB as part of the design of the euro-zone monetary union.
Straying from that path has previously stoked political opposition. Similar objections are certain to arise when parliaments in Germany, Finland, the Netherlands and other fiscally conservative countries vote in the coming weeks on the new set of rescue measures.
In Germany, some of Chancellor Angela Merkel’s coalition partners have said they will oppose the measures, possibly forcing her into a new alliance with the Social Democrat or Green parties.
“The essential thing is the continued breach of law by the ECB and the heads of state and government who are throwing all rules overboard,” said Frank Schaefller, a member of parliament from the pro-business Free Democratic Party, part of Merkel’s coalition.
Other critics argue that the bond purchases are an economic mistake.
“The bond buying may help stabilize the situation in the short run. It won’t stabilize it in the long run,” said Joerg Kramer, chief economist at Germany’s Commerzbank. “The ECB has taken the pressure off the politicians.”
The ECB’s initial move to begin buying bonds, which was made last year under pressure from European political leaders as a way to help Greece, contributed to the decision by the former head of Germany’s central bank, Axel Weber, to bow out as a leading candidate to head the ECB. Weber’s successor at the Bundesbank, Jens Weidmann, has also been critical of Europe’s approach to the crisis.
Trichet, the current ECB chief, is also eager to get the central bank back on familiar ground, looking to political leaders to muster an effective response to the debt crisis. European governments should come up with a program “fully and rapidly,” Trichet said at a recent news conference. “It would eliminate the reason why we, from time to time, intervene on the bond market.”