Jitters calmed and unity maintained as Central Bank role offers compromise

Analysis:The main worry was that the deal would be seen as illegal monetary financing

Mario Draghi’s assertion yesterday that the European Central Bank “unanimously took note” of the Anglo Irish Bank liquidation was as close as he came to confirming the deal to scrap the promissory note scheme was done.

The implicit message was clear. Despite some discomfort in Frankfurt at the new departure, no one on the ECB governing council was objecting. That is crucial.

After many long months of doubt and delay, this was sufficient to give the go-ahead for a complex plan to replace the dreaded notes with long-term government bonds.

If the main financial benefit for Ireland is to reduce the national borrowing requirement by €20 billion over the next 10 years, the essential kicker for the ECB is that former Anglo will no longer be leaning on it for €40 billion in short-term funding known as exceptional liquidity assistance.

The overnight liquidation of Irish Bank Resolution Corporation, as Anglo is now known, essentially means that the ECB gets to seize its collateral for these loans.

With the promissory notes now out of the picture, the ECB has the right to the long-term bonds the Government will issue in their place. These, however, will be held by the Central Bank of Ireland on behalf of the ECB.

Internal debate

Amid anxiety in Frankfurt that any deal with Ireland could trigger legal challenge in the German courts, the internal debate was essentially led by the two top Germans in the bank. The chief worry was that new arrangement for Ireland would be construed as illegal monetary financing, the technical term for the printing of money for a member state.

In the vanguard of those supporting a new deal for Ireland was Jörg Asmussen, the ECB executive board member who leads its engagement with bailout recipients. Chief of the sceptics was Jens Weidmann, Germany’s member of the ECB governing council via his presidency of the mighty Bundesbank.

Different strands

Both men served in the Merkel administration before entering the world of the ECB. Although sources in the eurosystem of central banks say it would be wrong to characterise the internal debate over Ireland as a face-off between the two Germans, each is said to represent different strands of the argument within the institution.

For Draghi, who has shown no great enthusiasm for the new arrangement, the essential task was to keep everyone on board.

Unity remains essential, particularly after Weidmann objected to a new bond-buying policy last September which brought the ECB to the limits of its legal mandate.

Everyone in the ECB remembers how Weidmann’s predecessor, Axel Weber, and Asmussen’s, Jurgen Stark, each left the central bank in protest at its previous bond-buying initiative. These public displays of internal disaffection did little for confidence in the ECB’s ability to fight the crisis.

Weidmann is now seen as the arch protector of the rules that the ECB should not engage in the illegal printing of money to finance member states, the ultimate bulwark against any watering down of the institution’s core principles.

By contrast, European sources say Asmussen became convinced relatively early that something should be done for the Irish. His declaration last September that negotiators were under “heavy time pressure” to settle the matter was seen in Dublin as a big step forward.

Slow progress

Progress was painfully slow, however. After the Government stepped up diplomatic pressure for a deal in the autumn, there was some anticipation in Coalition circles that a deal might be possible before the budget in December. It was not to be.

While Irish politicians and media may have a bottomless appetite for debate on the infamous “prom notes”, the question only recently rose to the top of the ECB’s agenda. The bank has a multitude of issues to tackle at any one time and there was no great rush to settle the Irish question long before the March 31st deadline.

But with the political temperature in Dublin rising relentlessly, the Government started agitating again for a breakthrough at the start of the year and kept the pressure on.

While the basic Irish proposal finally reached the governing council a fortnight ago, it fell foul of concerns that any initiative in which the Central Bank of Ireland would hold the new bonds to maturity could be read as straightforward monetary financing.

The compromise, tabled in recent days by Irish negotiators, was that the new bonds would be held as tradable instruments by the Central Bank in anticipation that they would be sold on later to private investors. The argument, therefore, is that the Central Bank is stepping into the breach temporarily.

Intense speculation

In Dublin on Wednesday afternoon, there was intense speculation that a dinner meeting of the governing council that night would back the deal (or not object to it). In the event, certain members of the council were said to have sought more time. It was only at noon in Dublin yesterday that word came through that the deal was definitively on.