Saturday 25 May 2019

Colm McCarthy: State should challenge legality of ECB's actions

Central bank needs overhaul and was acting outside its mandate when it forced unsecured debts on Ireland, writes Colm McCarthy

'DOOM LOOP': Policies of ECB, under Jean-Claude Trichet, towards Ireland helped spread the debt crisis
'DOOM LOOP': Policies of ECB, under Jean-Claude Trichet, towards Ireland helped spread the debt crisis

Ireland has been the author of its own misfortunes through failures in financial regulation and loose budgetary policy in the years leading up to the crash.

But the crisis in the eurozone is not due solely to policy failures of member states but also to the flawed design of the common currency and the weak policy response at European level. If the euro is to survive, the structure in place since 1999 needs an overhaul.

This must include centralised supervision of banks, a proper bank resolution system that protects taxpayers from bank failures and a more convincing system of deposit insurance to prevent capital flight. The European Central Bank needs extra powers, including explicit responsibilities for the maintenance of financial stability across the monetary union.

Since the credit bubble burst in 2008, the ECB has been reluctant to acknowledge the scale of the Europe-wide banking crisis and too quick to pronounce that the problem arose from excessive budget deficits in a few member states. The monetary and banking dimension was initially denied altogether and has yet to be addressed properly, four years into the crisis. The ECB is not responsible for the design of the single currency. It is constrained by treaty provisions and cannot fairly be criticised for declining to exercise powers which it does not enjoy. But even within these constraints, the response until recently has been unconvincing. In its punitive dealings with Ireland, there are grounds for believing that the ECB has in any event exceeded its statutory powers.

In the past few months its new president, Mario Draghi, has begun to reposition the ECB in response to the threat of national insolvency in the too-big-to-fail countries, Spain and Italy. Had the measures now contemplated in the face of calamities in Spain and Italy been pursued two years ago, Europe would be a lot closer to an exit from the crisis.

If it is difficult from a European perspective to award high marks to the ECB for its handling of the crisis; viewed from Ireland it is impossible. In the autumn of 2010, the ECB, under its then president Jean-Claude Trichet, pursued policies towards Ireland which resulted in the prevention of burden-sharing with unguaranteed bondholders of bust Irish banks, in defiance of the wishes of the Irish government and against the advice of the International Monetary Fund.

ECB officials have since acknowledged that the 100 per cent payouts to these lucky bondholders by the Irish Exchequer helped to prevent contagion not merely to the surviving Irish banks but also to the wider eurozone banking system. This was a temporary success, however, since bond finance for European banks dried up in 2011 and the ECB reversed the policy through granting low-cost three-year loans to all-comers. Such an arrangement for Irish banks 12 months earlier was deemed unthinkable.

The extra burden imposed by Trichet's ECB on the Irish Exchequer raised the spectre of a 'doom loop' between bust banks and distressed sovereign borrowers. The temporary prevention of contagion between banking systems at the expense of one country's Exchequer contributed to the spreading sovereign debt crisis. If this could be done to Ireland, thought the bond market, it could be done to others, especially Spain, whose banks were known to be fragile.

The ECB is entitled to pursue whatever policies are lawfully available to it in order to limit the contagious effects of bank failures. The fact that the policy failed does not diminish that entitlement. But the ECB does not enjoy unfettered powers in distributing the costs of these policies. In particular, it should now be clear that the imposition of these costs on Ireland, already in a difficult debt bind, served no useful purpose in European terms, as well as making things immeasurably more difficult in Ireland.

Neither the EU treaties nor any directive agreed by the member states forbids a state from pursuing policies to resolve bust banks. Specifically, the ECB has never been conferred with an explicit power to force 100 per cent compensation of unsecured bondholders in bust banks on to the national governments. Had such an explicit power been included in the ECB's initial design, nobody would have agreed to it. Countries which stayed out of the euro (Denmark is an example) have been able to impose haircuts on senior bank bondholders as they saw fit.

During the summer of 2010, as the insolvency of the Irish banks emerged ever more clearly, the ill-advised blanket guarantee issued at end of September 2008 was running out. It became feasible to avoid further payouts to holders of unsecured senior bonds in banks which had lost multiples of their capital. It has been alleged and never refuted that the Irish government was subjected to threats from the ECB, including the withdrawal of liquidity support from Irish banks, unless all of these unsecured bondholders were paid, at the cost of the Irish taxpayers. Collateral victims were the holders of Irish government bonds, since extra claims had been imposed on their already shaky debtor.

There are two distinct issues arising from the behaviour of the ECB on this occasion. The first is whether it achieved its principal objective: the protection of European banks' access to the unsecured bond market. We now know that it did not. The second is even more serious. Was the ECB acting within its mandate?

UCD economist Karl Whelan has addressed this question in a recent report for the European Parliament's Economic and Monetary Affairs Committee. His conclusion is that the ECB had no explicit mandate to behave in this manner. He notes that the 100 per cent payout to unsecured bondholders in bust banks is not a condition of the troika bailout programme for Ireland. Indeed the IMF would never have gone along with such a condition. The IMF does not lend money to bail out bondholders in insolvent financial institutions.

In the absence of an explicit power to forbid bank resolution, including haircuts for bondholders, was the ECB acting lawfully in inflicting additional debts on the Irish government, outside the conditionality of the EU/IMF rescue programme? If there is a doubt about this, what procedures are available to ascertain whether the ECB's actions were lawful?

All EU institutions are subject to legal provisions laid down in the treaties and can be brought before the European Court of Justice. The ECB's statute contains the following, at Article 35.1: "The acts or omissions of the ECB shall be open to review or interpretation by the Court of Justice of the European Union in the cases and under the conditions laid down in the Treaty on the Functioning of the European Union."

The latter treaty states, at Article 340: ". . . the European Central Bank shall, in accordance with the general principles common to the laws of the member states, make good any damage caused by it or by its servants in the performance of their duties."

These provisions constitute an invitation to the Government to seek clarification from the European Court of Justice as to the legality of the ECB's actions during October and November of 2010. These actions, in addition to imposing enormous financial burdens on Irish citizens, also marked a critical juncture in the intensification of the eurozone financial crisis. The link between the solvency of banks and the solvency of national treasuries was forcefully underlined by the ECB's behaviour towards Ireland. It is only recently, under pressure of events in Spain and Italy and under new ECB leadership, that this linkage has finally come to be seen as a critical policy mistake.

The incentive for Ireland to challenge the legality of the ECB's actions in the autumn of 2010 is clear: enormous costs, running to tens of billions, have been arbitrarily added to the Irish debt burden. There is a further imperative from a European rather than an exclusively Irish perspective. The mandate of the ECB needs to be clarified, particularly in view of the plans to broaden that mandate in a revamped banking union.

Ireland is the only eurozone member forced to absorb unsecured and unguaranteed debts of bust banks at the insistence of the ECB. The integrity of this institution is called into question by its actions in regard to Ireland and the Government should now proceed, in its own interests and as a contribution to the eurozone reform finally under way, to challenge what was done at the European Court of Justice.

Sunday Independent

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