By Paul GOLDSCHMIDT, former Director at Goldman Sachs International, former Director at the European Commission (1993-2002), member of the Advisory Board of the Thomas More Institute.
When Philippe Maystadt or Michel Rocard recommend that the ECB consider loans to Eurozone Governments, it is necessary to examine carefully such proposals. Indeed, the increasing role of the ECB in the management of the financial crisis raises questions concerning the appropriateness of its mandate and the limits imposed on its interventions.
Initiated already under the presidency of Jean-Claude Trichet, through both standard and non-standard measures of implementing monetary policy, the interventions of the ECB have gathered momentum significantly since Mario Draghi has taken office. This was underscored in particular through the three year refinancing operation (LTRO), whose amount of €489 billion was instrumental in the smooth yearend transition as well as providing reassurance to markets with regard to the heavy bank refinancing calendar for 2012.
Despite the unequivocal success of this operation, its objective of resuscitating the interbank market has (so far) clearly not been achieved, since an equivalent amount of liquidity has been deposited with the ECB in the anticipation of meeting refinancing maturities; in the face of weak economic activity, there is indeed little expectation of a significant increase in loans to the productive economy.
This plethora of liquidity looking for a home is certainly not unrelated to proposals suggesting that the ECB consider loans to Eurozone Governments in difficulty. Such operations, at rates similar to the advances to the banking sector, have as main advantage to lower considerably the cost of (re)financing of sovereign debt, thus contributing significantly to lowering debt servicing costs – and thereby to restoring budgetary equilibrium – without having to impose additional sacrifices on taxpayers.
These proposals, that superficially seem grounded on basic common sense, do, however, raise a number of important questions. They concern, among others, the “credit risk” to be borne by the Central Bank (and its shareholders), the maturity profile of the loans as well as the potential effects of bank balance sheets.
With regard to credit risk, Mario Draghi admitted, during his latest press conference, that the expansion of the ECB’s balance sheet did increase risk. However, he is confident that the safeguards provided by the Bank’s “risk management” practices were sufficiently robust to assume this increased exposure. He also mentioned that he was committed to implement the extension of the new “collateral” eligibility rules to facilitate participation in the forthcoming second LTRO operation which he expects will be the subject of significant demand.
Making advances to Governments (or purchasing directly their securities) does however imply applying the appropriate risk management criteria, in particular with regard to the pledging of collateral to ensure the necessary security. This entails immediately a series of highly charged political questions: would the collateral (if any) offered by the borrowers be considered as of “equal quality” or would the Bank differentiate according to its internal evaluation procedures?
If, for political reasons concerning the need for “equality of treatment” the ECB decides (or is requested) to accept purely and simply the signature of the borrower without further security or conditionality, this would be tantamount to the 17 Eurozone Members (shareholders of the ECB) granting their “joint and several” guarantee to these loan; in so doing, they would be accepting in a convoluted way a risk that several Member States (in particular Germany) have so far categorically refused to entertain within the framework of the issuance of “Eurobonds”. If this structure was contemplated, it would be far more transparent to operate through the intermediation of a separate Debt Agency (See proposals of the Thomas More Institute contained in its contribution to the Commission consultation on Stability Bonds1.) as it would be unhealthy to put the ECB at the centre of conflicts that could jeopardize its independence.
With regard to the maturities of the loans, the Bank has extended its (temporary – non standard) refinancing operations to three years but, in order to protect itself, has insisted on a variable rate of interest. A similar condition should apply, mutatis mutandis, to loans to Governments in order to ensure an appropriate spread of maturities compatible with debt management requirements. Such a structure of sovereign debt issuance could significantly impact bank balance sheets if, as a result, the offer of short term securities would reduce both the “available amount” and the “quality” of their assets eligible as collateral. If, at a time when the appetite for credit is low, this does not necessarily entail any dramatic consequences, the situation might be very different in the event of an economic upturn, inhibiting the offer of credit and increasing its cost.
Simultaneously, one should consider the question of the “addiction” of Governments to ECB financing and the difficulties of being weaned off it, when the Central Bank, in pursuit of its priority mandate of price stability, will judge (independently) that it is appropriate to withdraw excess liquidity from the market.
It is therefore premature to conclude that ECB financing of Governments constitutes the miracle recipe for dealing with the financial crisis. The adaptation of the ECB’s mandate can undoubtedly be considered and prove beneficial within the scope of a revision of EU Treaty, but this should be considered as the outcome rather than the precondition of a process that necessarily entails a significant deepening of the integration (currently underway) of economic policies within EMU.
|(1) See proposals of the Thomas More Institute in Is the “Stability Bonds” introduction possible? A contribution, its contribution to the Commission consultation on Stability Bonds, December 27th, 2011.|
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