By Nathan Tankus, a writer from New York City. Follow him on Twitter at @NathanTankus
Last week Mario Draghi held a press conference following the decision to raise ELA a paltry 900 million dollars for Greek banks. In that press conference he said many things but I’d like to focus on one passage that has gotten no attention:
There is an article in the Treaty that says that basically the ECB has the responsibility to promote the smooth functioning of the payment system. But this has to do with the functioning of TARGET2, the distribution of notes, coins. So not with the provision of liquidity, which actually is regulated by a different provision, in Article 18.1 in the ECB Statute: “In order to achieve the objectives of the ESCB, the ECB and the national central banks may conduct credit operations with credit institutions and other market participants, with lending based on adequate collateral.” This is the Treaty provision. But our operations were not monetary policy operations, but ELA operations, and so they are regulated by a separate agreement, which makes explicit reference to the necessity to have sufficient collateral. So, all in all, liquidity provision has never been unconditional and unlimited.
This is a truly shocking statement. To understand why, we need to go back to the basics of central banking. Banks have accounts at the central bank (I’m going to call the balances in these accounts “settlement balances” in line with non U.S. Conventions) which are primarily used to settle payments with other banks. When you use a debit card issued by one bank to pay someone with a bank account in another bank, your bank has to in turn send a payment using settlement balances to make that payment.
As should be obvious from that description, in order to make that payment your bank has to have sufficient settlement balances in its account at the central bank or the central bank must provide an overdraft. Thus, if the smooth functioning of the payments system is defined as the ability of depository institutions to clear payments, the central bank must ensure that settlement balances are available at some price.
The Federal Reserve explicitly recognizes this in its “Policy on Payment System Risk” by stating that “the Board recognizes that the Federal Reserve has an important role in providing intraday balances and credit to foster the smooth operation of the payment system”. Draghi is arguing that the ECB’s mandate to “promote the smooth functioning of the payments system” is defined differently than the Federal Reserve’s mandate and (as far as I can tell) every other Central Bank’s payment system mandate around the world. I can’t over-emphasize how radical a departure Draghi’s position is from the norms of central banking. Whatever else we may want to criticize the Federal Reserve’s and the government’s response to the financial crisis, they did preserve the the smooth functioning of the payments system with their alphabet soup of lending facilities and ultimately an FDIC guarantee on interbank lending. The problem was that they didn’t put Too Big To Fail banks in a form of receivership and didn’t prosecute bank executives, not that they made sure payments continued to take place.
As disturbing as the European Central Bank position already is, it becomes more frightening when we analyze why the Greek banking system has been cut off in detail. First, remember that the ECB’s official position has been that the Greek banking system is solvent as long as Greek government bonds preserve a certain value. Second, the ECB judges the value of those government bonds not be their market price but by their view of the Greek government’s “compliance” with the dictates of the EU and the IMF. As Vice President Constâncio said during the press conference:
when a country has a rating which is below the investment grade which is the minimum, then to access monetary policy operations, it has to have a waiver. And the waiver is granted if there are two conditions. The first condition is that the country must be under a programme with the EU and IMF; and second, we have to assess that there is credible compliance with such a programme.
The bigger picture here is that under this interpretation of the ECB’s operating mandates the European Central Bank can, at any time choose to exclude a particular country’s bonds from its monetary policy operations, watch its credit rating fall and eventually, force the country to choose between an IMF program and having a frozen banking system and no ability to borrow. Not only must that country enter an IMF program but it must be judged to be in “credible compliance” by the ECB at all times.
Being in credible compliance is a necessary not sufficient condition for borrowing. Recall that the statute Draghi quoted said that it “may”, not must, “conduct credit operations”. This is how they’ve justified keeping the Greek banking system on such a tight leash despite claiming that the Greek Government was in “credible compliance” up until recently and how they can justify not extending ELA by enough to restore normal operations in the current situation. The ECB is like an abusive spouse who believes marriage means they can beat their significant other for any reason and that previous beatings justify beatings in the future.
Even worse, if the Greek banking system is insolvent because of defaults from the private sector in Greece (very likely), the Troika has made the reduction in value of deposits (a bail-in) the preferred tool (along with privatization) to return solvency to the banking system. In other words, there is not only no guarantee of orderly clearing of payments but also no guarantee that depositors will eventually be made whole. It is official policy that at any time the value of a deposit in one bank does not equal the value of a deposit in another bank. Cyprus was not a fluke. It would be foolish for depositors in other countries to feel safe, except perhaps those in Germany and France. Their political leaders would likely suddenly discover the need for depositors to be fully protected in the Eurozone if they were ever forced to recognize insolvency.
Putting all this together, Europe now has a system where liquidity and insolvency problems can occur and can be deliberately generated (at least in part) by the central bank. Then the Troika can force that country into an “IMF program” if it wants to continue having a functioning banking system. Alternatively, the central bank can choose to simply “suspend convertibility” to the unit of account and force the write down of deposits until the banks are solvent again. During this drawn out period payments grind to a halt and mass business disruptions and failures can and will be generated. In other words Europe has created a system where you either comply with the dictates of unelected bureaucrats or you accept a more disorderly version of the United States banking system before the Civil War. The bottom line is that if you feel inclined to visit Europe remember that the payments system can fail you at any time. Plan accordingly.
Are the Eurocrats completely ignorant of the events and steams leading to WW1?
It’s not WWI, but WWII that they should be worried about! During the 1920s German reparations payments under the Versailles system could only be made because the U.S. was providing more capital through lending than Germany was paying. Thus, the U.S. was making loans which had no chance of ever being repaid and Germany was then taking the money to repay the reparations to France and Britain, which were then sending the money back to Washington to repay wartime loans. A system Winston Churchill called “insane” in his book The Gathering Storm.
The collapse of this system in the Great Depression led directly to Fascism, Nazism and the collapse of Europe into the most destructive war in World history with 50 million dead and utter devastation of every European country.
We’re obviously heading down that road towards inevitable Grexit. Everything points to forced Grexit either later this year, or else early next. The worst aspect of the Greek crisis is not what happens to Greece, however horrible, it’s the emergence of extreme nationalist, racist and anti-Euro parties on the right, because all reformist hopes for a cooperative Euro have been ruthlessly crushed. That’s the story of the 1930s all over again.
And they have been crushed in large part because the Germans, led by Wolfgang Schäuble see the Eurozone as an inevitable failure and want to destroy it and replace it by a top-down politically integrated northern-European EU led by Germany, with an acting finance minister with real power, but without the Southern European countries like Spain, Italy, Greece or probably France. So, Grexit, Italexit, Spaixit, etc. That’s why Germany is acting so harshly.
What Mario Draghi’s sick and twisted personality disorder is, I cannot imagine, since Italy is going to be one of the sacrificial victims in all this. I suppose he identifies himself as a Euro-elite rather than an Italian. Forbes listed him in 2014 as the “8th most powerful person in the world.” I guess he just likes to throw his weight around and has zero concerns about who might suffer, like most of the world’s 1%.
This is so infuriating. It’s so obviously a political action on the part of the ECB. Mark Blyth made this point on Doug Henwood’s Podcast recently. He was flabbergasted at the ways that the ECB was acting and how it had diverged in function from every acceptable practice that reserve banks have generally agreed upon. I am failing to see how the adoption of the Euro could be managed any worse than it already has.
Better to look for those who benefit from this interpretation.
This strikes me as suspect:
Treaty that says that basically the ECB has the responsibility to promote the smooth functioning of the payment system.
and an interpretations, and interpretations are subjective:
the functioning of TARGET2, the distribution of notes, coins.
Interpreting “payments” as “cash money” not all the payment instruments.
I agree but I didn’t want to get into that in this piece. if the ECJ rules in favor of Draghi’s interpretation I think it will be lights out for the Eurozone. I would love a reporter to ask him why the TFEU has a much narrower definition of “smooth functioning of the payments system” in his view
Thanks for translating.
The bright light of day
Clears the ‘must’y ‘may’
And sunlight is the
I read the excellent post and comments below on IT challenges for Greece on leaving the Eurozone. Thought these difficulties would be one of Greece’s biggest challenges.
Then I read your excellent post – and nearly dropped my coffee cup. The ECB is not a central bank if it functions in the way you describe. It’s closer to a Wall St. TBTF bank. Which means Greece and the entire Eurozone have a much bigger problem than a county’s debt level. If it is as described then I question whether the Eurozone has an honest and functioning banking system at all.
It’s scary what the ECB can do.
Also from above:
I guess the lesson is to avoid being rated below investment grade. Then, the ECB can’t do all nasty things covered here. Or can they still???
The issue is they can’t avoid being rated below investment grade unless they can sustain their level of debt without central bank intervention at all. I’d contend there is no government in the Eurozone capable of that, including Germany. The difference between Greece and other countries is not that Greece has more debt, its that the central bank has declared their debt ineligible for monetary policy and thus helped facilitate them being blocked from bond markets and being downgraded.
Ah, I understand.
All are equal. Some are more equal than others.
Perhaps that explains
1. the insecurity-driven desire to export , export, export
2. to dominate the ECB.
If Germany can’t maintain a sustainable level of debt to avoid ECB intervention and a rating below investment grade.
The Eurozone is an opaque system set up by the elite of Europe with only a pretense of democratic participation. For a country like Greece it has turned out to be a death trap.
I think you have hit the nail on the hat. The ECB is becoming the problem in this whole saga.
I have three views on this from three finance and banking professors in Europe.
“the gist of Prof. Werner’s argument is this: the ECB shoud just buy up non-performing assets of banks at face value and thereby give the banks the liquidity and solvency they need. That would allow the banks to lend. Also, Professor Werner argues, why should the taxpayer pay for it, the taxpayer did not create those bad debts? The argument is, before the crisis hit, it was the ECB’s fault, allowing credit creation, year on year of 25% to 40% growth. So the ECB should deal with the mess that it has created.”
summary of Boom bust on RT from last February
“The rule to lend money only to solvent banks, comes from the time when the central banks had to be ready to redeem their paper money for gold or foreign exchange. Concern for their gold and foreign exchange and the fear of a run caused the Reichsbank to take special care. This caution prevented an adequate monetary policy in the Great Depression.
Now, we have pure paper money, without any obligation to redeem. Central banks can support the monetary system and the banking system without worrying about their own ability to act. Should the EU Treaty, setting out the responsibility for the functioning of payment systems, not take precedence over an internal rule of the ECB, which dates back to the time of the gold standard and is not covered by the treaty?”
That is Prof Hellwig via Oekonomenstimme, a German blog
And another voice:
“If the ECB is truly legally bound to stop ELA, this means that the Eurozone architecture is deeply flawed.
If not, the ECB will have made a political decision of historical importance.
Either way, this is a disastrous step.
Whether it likes it or not, every central bank is a lender of last resort to commercial banks.
By not keeping the Greek banking system afloat, the ECB is failing on a core responsibility.
One explanation is that the ECB fears losses. This is partly incorrect, partly misguided. It is incorrect because the ELA loans are provided by the Central Bank of Greece. It is the Central Bank of Greece, and therefore the Greek people, which stands to suffer losses from defaults by commercial banks. It is misguided because central banks are not commercial entities.
Accepting losses is part of its public service mission. Keeping the banking system afloat is part of its core mission.”
That is Prof Wyplosz from the Swiss Centre of of Money and banking studies.
So these professors believe the ECB is not doing its job. And a Greek company has apparently taken the ECB to the European Court of Justice.
It is not looking great for the ECB.
These quotes be found on my blog, radicaleconomicthought.wordpress.com under the headings
“Bank rescue? Advice to Greece: Follow the Germans”
Tyler Durden, is that you?
(Just kidding because fortunately I don’t understand anything)
“I can’t under-emphasize how radical a departure Draghi’s position is from the norms of central banking.”
I think you mean you can’t over-emphasize…
d’oh, you’re right.
As a young lad, I had the good fortune to read of a wonderful little book known often as ‘Aesop’s Fables’. Does anyone else remember “The Wolf & the Crane”? The moral in that one roughly translates to “…when you serve evil people, expect no reward…” or something like that.
That this tragedy is being inflicted and that no one can seem to change course is maddening.
So, I’ve recently read Richard vauge’s book “the next economic crisis”. His claim is that private debt levels and growth rates of private debt are what best predict financial crises. More specifically, private debt of more than 150% of gdp combined with growth of (pdebt/gdp) ratio of 18% in five years will nearly always lead to a financial crisis. I should make it clear that I am not in a position to evaluate this claim.
However, if we assume for the moment that it is correct, this raises an interesting question in light of this post.* In the context of an ECB that can selectively decide to evaluate the value of nations’ bonds as if they were private debt**, what should we consider Euro government debts in Vague’s model; public, or private? Euro governments might be considered as private monopolies, since they cannot print Euros.
*i’ m not trying to make an assignment here, and I don’t expect an answer from NC. Just tring to think through this.
**I know that’s not what you said, but it seems like the way the ECB might fr.ame things, or even think of them.
His claim is that private debt levels and growth rates of private debt are what best predict financial crises.
That what Wray, and MMT theory predicts in a unquantified manner.
More specifically, private debt of more than 150% of gdp combined with growth of (pdebt/gdp) ratio of 18% in five years will nearly always lead to a financial crisis
And here’s the quantification, except for the “nearly always”. Is “nearly always a probability of 70%, 80% or 90%? My guess is 80%, based on no data at all.
“Draghi is arguing that the ECB’s mandate to “promote the smooth functioning of the payments system” is defined differently than the Federal Reserve’s mandate and (as far as I can tell) every other Central Bank’s payment system mandate around the world.”.
Of course it is: the EU is _not_ a federal state: when will our US friends understand this point once and for all? There are several other differences between the ECB and state central banks, the most important being that those are lenders of last resort, but the ECB is not.
EU will not become a federation anytime soon: the northern Europeans (not only the Germans) know very well that such transformation would imply underwriting the deficits of the Mediterranean countries, and quite rightly they balk at the very idea of it. Greeks, Italians etc. don’t like it? Too bad: the door under the big “EXIT” sign is always wide open.