While the outcome of the European summit was very disappointing, there was one chink of light: that the agreement, and particularly the fiscal compact, would be used as a cover under which the ECB could abandon its reticence to support distressed sovereign debt markets, which was justified by the ‘moral hazard’ of bailing out allegedly congenitally incontinent governments. With a compact in place, it was hoped that it could decisively act as lender of last resort, buying distressed sovereign debt in a big way and that the imminent threat of crisis and the implosion of the euro area could be averted.
As I noted, the problem was that while the fiscal compact was set in stone, the ECB was not formally tied in to the agreement. Any action was left entirely to its discretion. But perhaps a ‘gentle(wo)mens’ agreement’ had been struck behind the scenes.
We now have the first evidence regarding the ECB’s intentions. It does not look good.
In a keynote speech given yesterday in Berlin, ECB President Mario Draghi, declared, on the one hand, his satisfaction with the fiscal compact, while on the subject of ECB support for sovereigns, he said … nothing. Literally.
He praised at length the four ‘far-reaching’ decisions recently taken by the ECB. Interest rates have been cut. Banks can refinance at the ECB at a longer maturity (three years). Collateral requirements have been loosened and reserve requirements reduced. These measures will:
support the flow of credit to firms and households in the euro area economy.
And what about the flow of credit to sovereigns? Many (Italy, Spain, France among others) face substantial refinancing needs in the coming weeks, which in the current environment, and lacking a clear lender of last resort, will almost certainly be possible, if at all, only at punitive rates of interest. In this environment, in a speech entitled ‘The euro, monetary policy and the design of a fiscal compact’, and a few days after the fiscal compact has been agreed to his satisfaction, Mr. Draghi does not mention the issue at all.
What can one say?
The four measures are welcome. But the interest rate cut only reverses the insane hikes of earlier in the year. The other measures will doubtless aid the banking sector and, indirectly, the real economy. Fine. But can there be a shadow of doubt that all this counts for nothing if, despite the agreement at the Council (with its pernicious longer-term consequences), the ECB does not decisively and visibly allay fears on sovereign bond markets.
Faced with a house that is burning from end to end, Draghi is claiming credit for sprinkling water on the garage (having earlier in the year turned off the water supply).
The ECB seems determined to prove the pessimists right and those – and I admit to being one – who were trying their hardest to see a light at the end of the tunnel wrong. All this alters not one iota the fundamental fact: every single day the ECB faces the choice between committing institutional suicide and changing its policy. It is still only a question of when. Draghi’s speech pushes that day further into the future and makes the former outcome likelier.