Wednesday 19 June 2019

Colm McCarthy: 'Hubris of the bankers left an imbalance at heart of EU'

The unaccountable power of the European Central Bank should be tempered lest it threaten solidarity

CYNICAL: Jean-Claude Trichet refused to appear at the Oireachtas banking inquiry, but instead turned up at an event in Kilmainham to tell TDs that the ECB punishment was for our own good
CYNICAL: Jean-Claude Trichet refused to appear at the Oireachtas banking inquiry, but instead turned up at an event in Kilmainham to tell TDs that the ECB punishment was for our own good
Colm McCarthy

Colm McCarthy

Europe's common currency, the euro, is 20 years old this month, as is its custodian, the European Central Bank. On January 1, 1999, 11 EU members, including Ireland, abolished their national currencies, effectively an irreversible sacrifice of national sovereignty.

They substituted the new common unit, under the aspirational banner of Economic and Monetary Union. Five further adherents had joined by 2007 and things appeared to go well, contradicting the pessimists who had criticised weaknesses in the design of the system. Inflation was low, interest rates had fallen and the initial portents of the great financial crash to follow were only dimly visible.

Banking failures in the US and a few European countries through 2008 were insufficient to cause alarm and the new currency's first decade was declared a triumph. The European Commission flagged the happy event in a pre-Christmas message: "On 1 January 2009, the euro will be 10 years old. Like the process of European integration as a whole, Economic and Monetary Union was a simultaneously visionary yet pragmatic project. A major step towards fulfilling the ideal of an 'ever closer union' among the peoples of Europe, it was achieved through close co-ordination and convergence of economic policies within the EU, and careful technical preparations."

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Speaking at Osnabruck a few weeks later, European Central Bank president Jean-Claude Trichet was even more effusive: 'When we look back over the first 10 years of the euro, then we can do this with satisfaction. The sceptical forecasts before its birth have not materialised. The euro is a historic achievement. Its first 10 years have been a success. This is also seen, noticeably so, from outside our Continent. Europe can be very proud of what it has achieved."

The hallelujahs 10 years later have been more restrained. Trichet's remarks were made when the financial crisis was still seen by European decision-makers as essentially an American problem. The existential threat to the common currency was delayed until 2010 when the sceptical warnings materialised, to encounter a floundering response from both the European Commission and the ECB. The ideal of an "ever closer union among the peoples of Europe" had been compromised by the premature common currency experiment, poorly designed and poorly managed by, among others, Jean-Claude Trichet.

The Eurosystem was, by conscious design, an incomplete monetary union. There was no centralised coordination of macroeconomic policy, no centralised supervision of banks and no agreed arrangements for dealing with failing financial institutions. The 'doom-loop' between banks and governments was a design feature, not a bug. But the European and American banking systems had been courting financial instability through an unprecedented build-up of leverage and excess credit.

Prior to the establishment of the common currency, prescient warnings about its vulnerability had been available - but even in early 2009, with the melt-down already under way, complacency ruled.

Trichet, again from his Osnabruck speech, on the apparently flawless performance of the eurozone: "This was only possible because the ECB and the national central banks of the Eurosystem have solid institutional foundations. These foundations are the treaty negotiated in Maastricht in 1991 and the Statute of the European System of Central Banks.

"The treaty and the Statute of the ESCB are clear: the primary objective of the Eurosystem is to ensure price stability. The ECB and the national central banks of the Eurosystem are independent so that they can pursue this goal. Neither the ECB, nor the national central banks, nor the members of their decision-making bodies may seek or receive any instructions from anybody. This applies to European as well as national institutions. They, for their part, are obliged to respect the principle of central bank independence."

As the crisis intensified, the Olympian complacency of Trichet and his counterparts in EU political decision-making exacted a heavy toll on member-state solidarity.

Three European countries, Greece, Ireland and Portugal, ended up in emergency lending programmes, including reliance on the IMF, a body whose services had not been required in western Europe for a generation. It was not until 2012 that decisive monetary policy action was initiated by Trichet's successor at the controls in Frankfurt, Mario Draghi.

The ECB's exercise of central bank independence included direct interference in the domestic politics of Greece, Italy and Spain; the closure of the commercial banks in Greece and Cyprus; and the arbitrary imposition of fiscal costs on the Irish Exchequer, forced to pay billions to unguaranteed bondholders in bust banks to whom it owed nothing. Some of these abuses, to be fair, have occurred under Trichet's successor, notably the bullying of Cyprus, solemnly endorsed by a group of 'adults in the room' which included Christine Lagarde, the sainted managing director of the IMF.

One of the ignored pessimists who warned about the euro's designer weaknesses was the University of California's Barry Eichengreen. In his recent volume The Populist Temptation, Eichengreen is succinct: "The ECB is the least politically accountable central bank in the world."

If central bank independence was a guarantee of financial stability, there would have been no eurozone banking crisis, no troika bailouts and less fuel for the populist backlash across the continent, including Brexit. There have been reforms since the scale of the crisis was finally acknowledged, notably the centralisation of bank supervision, but the eurozone is still not a proper monetary union and further necessary reforms are being resisted (until the next crisis).

Ireland has unfinished business with the European Central Bank. It was never clear whether Trichet's interventions in Ireland were within the powers conferred by the statute on the ECB's governing council. As in Cyprus and Greece, the Irish Government which assumed office early in 2011 felt unable to challenge the ECB's actions at the European Court of Justice. Had it done so, the court would have struggled to find in the statute specific authorisation for the selective imposition of uncontracted fiscal costs on an individual member state.

Cynics contend that the court would have succeeded in the struggle, but we can never know. Trichet refused to testify at the Oireachtas banking inquiry, appearing instead at a contrived event in Kilmainham where he explained to the assembled deputies that the punishment was for their own good.

It is a basic flaw in the asymmetric architecture of the eurozone that the countries most needful of testing the ECB's powers in court can be intimidated out of doing so by the ECB.

The ECB's unaccountable power derives from the murky system called emergency liquidity assistance (ELA), where national central banks provide funds to struggling domestic lenders. The ECB can forbid this manoeuvre or can impose conditions. This is how undeserving Anglo bondholders got paid in Ireland, and how solvent commercial banks in Cyprus and Greece were sent on holidays.

It is also clear that the ECB pressured both Nama and the Irish banks to dispose of distressed assets too rapidly during the weakest years of the property cycle, at considerable cost to taxpayers.

The Irish authorities should campaign for a centralised system of dealing with failing banks, which in turn means a pooled resolution capacity and a system-wide deposit insurance scheme. It should also seek to curtail the ECB's vaunted independence from accountable political oversight.

Sunday Independent

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