How the ECB became a central player


EUROPE’S EPIC DEBT crisis is stretching its bloodied leaders and institutions to the limit, and none more so than the Frankfurt-based European Central Bank. The saga reached new depths this week when it took down two prime ministers in three days, the culmination of the pressure brewing for months in Italy and Greece.

The growing threat to Italy, the third-largest euro-zone economy, means one of the gravest moments yet in the debacle. The situation is akin to an economic war, with the existence of the single currency, the crowning achievement of Europe’s postwar integration, on the line.

Brooding like a colossus in the centre of the fray stands the European Central Bank, an innately conservative institution that has ditched one sacred cow after another in the chaotic struggle to calm the disruption. Albeit with great reluctance, the ECB has thrown hundreds of billions of euro at the problem. It may yet have to do a lot more.

The ECB is not without its critics, but it is the last line of defence in the euro zone, making copious use of its treasured independence to expand its operations radically. Yet these desperate interventions in markets have sparked division and dissent in its top echelon, setting off debate around Europe about the nature and scope of the ECB’s mission.


In the best of times central banks are supposed to be staid, predictable places where nothing by way of drama attracts attention from the outside world. That’s not the way today. Central banks across the globe have taken a pre-eminent role in the financial crisis.

The ECB has thrown out its internal rulebook to provide emergency loans to banks and to buy up the sovereign bonds of stricken countries. There is pressure from euro member states for the bank to go much further, faster, but it argues that it cannot replace governments when it comes to policy.

At the same time the ECB has refused to deviate from its core inflation-fighting mandate. To the astonishment of critics, the bank raised its core interest rate twice this year, even as the debt crisis worsened. A rate cut last week – three days after the bank’s new president, Mario Draghi, took office – is seen as an implicit recognition that the rate increases were wrong.

Although the turmoil in the euro zone dates back two years, to the eruption of the Greek crisis, the ECB’s first interventions go back to August 2007, when the credit crunch first struck the banking system. The ECB took emergency action at that time to prop up troubled banks. It has been a roller-coaster ride ever since, with the crisis aggravated first by the Lehman Brothers bankruptcy, in September 2008, and then by the Greek debt earthquake.

It is widely agreed that ECB’s interventions prevented the implosion of the euro-zone banking system. Indeed, when critics talk about the EU’s failure to deal with the debacle, some officials respond that the avoidance of disaster at the outset of the crisis is being overlooked.

That danger passed eventually, but it was only the beginning of the crisis. When Greece admitted its public accounts were falsified, it sent the euro zone into a spiral of panic and the ECB took many momentous decisions. The bank waived its collateral rules, something it insisted it would never do, permitting it to continue helping Greece and its banks even if their credit ratings were slashed. A similar move followed in respect of Irish banks.

When the euro-zone leaders set up a bailout fund in May last year, the ECB moved to buy sovereign bonds from private investors. The aim was to provide a last-resort market for debt that no private buyer would want, thereby limiting the sky-high interest rates set by the interaction of supply and demand.

The ECB’s most conservative members recoiled in horror at this manoeuvre, but its then president, Jean-Claude Trichet, insisted that such measures were necessary to ensure stability in the financial system.

The bank insists the initiative is temporary, and it will not pledge to buy unlimited quantities of bonds. In the eyes of its critics, however, this has blunted the effectiveness of the campaign.There are limits to the bank’s influence. Trichet resisted International Monetary Fund involvement in the euro-zone rescue, but he capitulated in the end. The ECB now works with the IMF and the European Commission in the bailout troika, overseeing the recovery programmes of Greece, Ireland and Portugal. However, reports frequently surface of tension between ECB and IMF officials. Generally, the IMF is perceived to be more open to haircuts, or losses, for private creditors than the ECB, which sees the potential for Lehman-like contagion in any move to impose bailout costs on private investors.

Trichet rigidly held the line for months against German pressure for private-sector involvement in the Greek rescue, arguing that there was no such thing as a risk-free managed default. In July, however, EU leaders overrode his objections.

Advocates say such moves are the only way to solve its crisis. The ECB, however, says such efforts are an invitation for trouble.


The ECB remains implacably opposed to any “monetary financing” of the public sector, the formal description of printing money to give to governments. The US Federal Reserve and the Bank of England have used such measures, termed quantitative easing, in an effort to stimulate the American and British economies. The ECB, backed by Germany, argues that such action is illegal under European law, which prohibits the bank from providing any form of credit to national governments.

Accordingly, the ECB will not buy bonds directly from euro-zone governments, though it has shown its willingness to intervene in secondary bond markets, in which government debt is traded between investors after it has been issued. The thinking here is guided by the fear that the availability of ECB loans would encourage political leaders to run huge deficits and build up debts instead of taking difficult decisions to control their finances.

One concern is that the old European rules of economic discipline were not strict enough, while a new set of rules remains untested. Germany wants to go further still, with a strengthening of EU treaties, but that is a deeply contentious issue and cannot be achieved overnight.

A further worry is the increased risk of inflation in a scenario in which a central bank prints money. Above all, the ECB’s core legal mandate is to keep inflation “below but close to” 2 per cent. It will not waver from that, even if it means increasing interest rates while a financial crisis is in full swing.

Critics argue, however, that the debt debacle may now be reaching a stage at which building an overwhelming wall of money might be necessary. There are fears that Italy would overwhelm the current bailout fund if it needed rescue aid. The crisis could still to go out of control.


Ireland has benefited hugely from ECB aid to the domestic banking sector, whose reliance on its emergency loans now amounts to €180 billion. It was at the ECB’s insistence, however, that the Government repaid some €700 million to the holders of senior unsecured unguaranteed bonds in the former Anglo Irish Bank.

In spite of expectations in diplomatic circles that the ECB might waver, it still frets that burning senior bondholders in euro-zone banks would undermine confidence in the banking system. The late Brian Lenihan criticised senior ECB figures for bouncing Ireland into its bailout last year, but Trichet dismissed that.


Trichet, a Frenchman, dominated the ECB for eight years before his retirement last week. His successor, Mario Draghi, is Italian.

Draghi’s true form remains to be seen, but his decision to back an interest-rate cut at his first meeting last week was seen as a demonstration of his pragmatic streak. The new man is not expected to be much different from Trichet, although it is said he may be less dogmatic.

The ECB chief presides over the bank’s governing council, which is made up of the central-bank governors of the 17 euro-zone countries and a five-man executive board. The governors meet twice a month, once to set interest rates. Conference calls outside this schedule are frequent. The governors meet high up in the ECB’s 36-storey headquarters in Frankfurt. Exchanges can be robust, although shouting matches are not the norm.

The former German Bundestag chief Axel Weber repeatedly took public issue with the bond-buying campaign, souring his relations with Trichet. He was not alone in his reservations, but a consensus of governors prevailed. Weber could be quite unpleasant in debate, it is understood. He had been hot favourite to succeed Trichet, but he abruptly left the Bundesbank – and therefore the ECB – earlier this year. He was succeeded by Jürgen Stark, who remains close to Trichet.

All told, about 1,500 people work at the ECB. Between 100 and 200 of those are engaged in the battle against the debt crisis. It is stressful, around-the-clock work. Some senior people are known to take only four hours’ sleep per night.

Crisis manager: The ECB moves centre stage

June 1998The ECB is established, six months before the exchange rates of EU currencies are fixed in 11 countries.

January 2001Greece becomes the 12th country to join the euro.

January 2002Euro cash is circulated.

August 2007The credit crunch rocks banks and the ECB provides emergency loans.

September 2008Lehman Brothers collapses and the ECB floods the banking system with loans.

October 2009Greece says its budget deficit will be more than double the forecast, setting off the debt crisis.

May 2010The Greek bailout is agreed. The ECB starts buying sovereign bonds. Interventions in succeeding months are limited to Greece, Ireland and Portugal.

October 2010Angela Merkel and Nicolas Sarkozy declare in Deauville that private investors must contribute to future bailouts.

November 2010The Irish bailout is agreed. The ECB blocks efforts to burn senior bank bondholders as part of the deal.

February 2011German Bundesbank chief Axel Weber resigns after opposing the ECB’s bond-buying campaign.

March 2011A deal is made to create a permanent bailout fund.

May 2011A Portuguese bailout is agreed.

July 2011A second Greek bailout is agreed. In defiance of Trichet, it includes a 21 per cent haircut, or loss, for private investors.

August 2011The crisis intensifies and the ECB starts buying Italian and Spanish bonds.

October 2011A further Greek bailout deal involves a 50 per cent bond haircut.

November 2011Mario Draghi takes over from Jean-Claude Trichet as ECB president.