ECB is right in refusing to magic away promissory notes


ECONOMICS:Conflict among board members was inevitable. As the stakes have risen with the heightening of the euro crisis, so have tensions

THE EUROPEAN Central Bank has not always covered itself in glory. It has been half-hearted in exercising its powers to purchase government bonds during the sovereign debt crisis. Had it used those powers at moments of acute tension, it might well have prevented the euro zone crisis reaching the point that it has.

But if the ECB has often under-reacted to the debt crisis, it has over-reacted to inflationary risks. Two interest rate hikes in April and July last year were misjudged and had to be reversed within months. These criticisms of the bank – and more besides – stand even when the difficult circumstances in which it operates are taken into account.

The financial crisis, ongoing for close to half a decade, has thrown up enormous challenges for central banks. If anything, they have been greater for the ECB than for others.

It is a relatively new institution. It makes monetary policy for 17 sovereign countries, from microstates such as Cyprus, Luxembourg and Malta to three G7 giants – France, Germany and Italy. Economic structures and conditions among the participating countries vary enormously.

Compounding these problems are unwieldy decision-making structures. There are 23 people on the bank’s governing council. That compares with just seven and nine respectively on the equivalent committees of the US and British central banks.

Of the board’s 23 members, 17 are the head of a national central bank. They are obliged to formulate policy on the basis of what is best for the euro zone as a whole. Their obligations are similar to those of European commissioners but with one very big difference. Central bank heads also have a loyalty to the institutions they lead in their own countries. Commissioners have no role in national institutions and live in Brussels at arm’s length from home influences.

Given all this, disagreement and conflict among board members was always inevitable. As the stakes have risen with the heightening of the euro crisis, so have tensions. Just last week ECB president Mario Draghi fired a warning shot across the bows of Frankfurt’s other central banker, the Bundesbank’s Jens Weidmann, over leaked German criticism of how the bank does its business, which, it was claimed, is threatening to Germany.

If there has been conflict among the board members on the issue of the €31 billion in Irish promissory notes, it has not leaked.

The ECB has been subject to criticism in this country for not letting Ireland off this portion of its debts. Difficult and all as it is for a taxpaying citizen of this State to concede, Frankfurt is entirely correct to refuse to magic away Ireland’s promissory notes.

To see why consider the context in which they were issued in 2010. Then the government needed tens of billions of euro to shore up Anglo Irish Bank and Irish Nationwide. But there was no prospect that the State could borrow such sums in the normal manner – by selling bonds to investors. Instead of selling bonds and using the cash raised to pay off the bondholders, it simply gave bonds to the rotten banks (calling them promissory notes).

This manoeuvre allowed the nationalised banks to use the notes as collateral to borrow from the central bank system. One does not have to be an ultra-orthodox Teutonic central banker to see that this is back-door financing of one branch of government by another.

If the ECB was to delete some of Ireland’s debts at the click of a button, as some people advocate, it would not be long before other governments started issuing promissory notes and looking to Frankfurt for some monetising magic. Having the ECB make an exception for Ireland may seem appealing, but it could never be justified by a central bank serious about preserving the currency.

The monetary authority in Frankfurt has always insisted that any relief on Ireland’s bank debt is done by the fiscal authorities – i.e. other euro area governments collectively.

The moral case for doing this is very strong. In terms of the collective interest of the euro zone, the case is almost as strong – ensuring Ireland exits its bailout will benefit everyone. Easing the repayment terms on the promissory notes will help to achieve that.

In the event that an easing is not granted, criticism should be directed at those who deserve it. That would be other euro area countries, not the ECB.

Tracker mortgages crucial to any deal on resolving bank debt crisis: page 7