Not being an expert in either the Lisbon Treaty or the rules governing the ECB, I’m restricted in my ability to interpret an article in the Financial Times and the underlying position paper at the ECB on the legality of the Irish bailout. The Irish finance minister asked for a reading on the “draft law”, which is the Credit Institutions (Stabilisation) Bill 2010. There is a certain amount of grumpy harrumphing in the ECB response, namely, that it should have been consulted earlier and its preliminary reading has been made in more haste than it would like.
Regardless, it does not take a lot of expertise to get the drift of this gist:
In particular, the ECB has serious concerns that the draft law is insufficiently legally certain on a number of critical issues for the Eurosystem. For example, problems of legal uncertainty relate to the impact of, inter alia, Article 61 (effects of orders on certain other obligations) of the draft law on the rights of the Central Bank, the ECB and possibly other central banks within the ESCB, the scope of collateral rights of central banks given as security against ELA, as well as other issues. The ECB would expect that nothing in this Act would affect operations, rights or entitlements of the Central Bank or the European Central Bank, or any other central banks within the ESCB.
The FT reads the big issue as being the adequacy of collateral for lending:
The ECB’s concern is to ensure it holds enough collateral of sufficient quality to minimise its exposure were some of the funds it provides not paid back. The paper is the latest manifestation of the ECB’s worries about the risks it is carrying as it battles the eurozone’s mounting debt crisis.
This too should hardly be a surprise. The root of this wee problem is that central banks have taken to pretending that when banks keel over, all that is happening is a wee liquidity crunch and a bit of attendant market panic. Supply a lot dough and this will pass.
But as we have said from the get go, the rolling financial train wreck is at its root a solvency crisis. That means that the assets are worth less than the liabilities. So if you are going to preserve bondholders from taking losses (which had become the bizarre purpose of all these rescue operations, when bondholders are risk capital), and you get liquidity to do so from your friendly chump central bank, if you keep the game going long enough, you will quickly run out of good assets accurately priced for that central bank to lend against. The central bank will have to lend against overvalued assets. It’s inherent to this model.
But the embarrassing inquiry from the Irish, which is a bit like Toto pulling back on the curtain to expose the great Oz as a balding, short plump man, is that it also suggests that the Irish bailout as now structured might need to be retraded. If so, this could wind up being Bear Stearns redux?
Remember why that deal went from $2 a share to $10 a share? Because some hasty drafting resulted in an error which meant the contract had to be reopened. Now Bear management was mighty unhappy over the pricing of the deal to begin with, and being Wall Street types, they knew how to play the mistake to maximum advantage.
By contrast, the Irish knuckled under to the IMF/ECB/EU onslaught faster than they might have (they had wanted the rescue to be limited to the banks, and not to become a sovereign bailout). So even if this mistake leads to a renegotiation, it is not clear the Irish officialdom has the intestinal fortitude to exploit the opportunity as fully as they might.