Heiner Flassbeck in the FTD reminded me of a development that Sarkozy had hinted at – or hoped for really – back in December already (am not finding that quote). Namely, that banks are using the ECB’s new liquidity providing rules in order to pull in a healthy profit on European governments’ debt. Thus at a time when those governments could very well use those profits themselves the ECB effectively is subsidizing commercial banks’ net gains at an – indirect – cost to taxpayers. Why are they doing? Mostly for – German – ideological reasons it seems.
Let’s expound. The ECB announced last December that it would give out unlimited long-term – up to three years now – loans to commercial banks at a refinancing rate of 1% and while accepting as collateral virtually anything tradeable – de iure not de facto – on the markets. In other words if I own a Greek government bond currently trading at somewhere around 30%, I may use it as collateral to receive a loan from the ECB of 100% – Disclaimer: I am not sure about this part. Please let me have it if you know any better – of its value at an interest rate of 1%. Now, if I were to invest that money in, say, Italian government bonds currently yielding at somewhere around 6% it’s easy to see, that I will be able to pull in a healthy profit on this transaction. This especially as this operation really functions as a sort of financial perpetuum mobile as I can now use my newly acquired Italian bonds as collateral with the ECB in order to acquire a new loan.
There is a risk involved of course, namely that Italy (or whichever country is involved in any particular scenario) will default or that the Eurozone will fail. If we’re abstracting from Greece though, how likely is that really? And seeing as lots of European commercial banks will go bankrupt anyway, wouldn’t it be worth it to double down and potentially significantly expanding on their profits, while not fundamentally changing their position in a default scenario?
Why is this a problem then? After all this sort of subsidized speculation attenuates the Eurozone crisis by increasing demand for periphery debt on secondary markets. Check Italy, Portugal, Ireland, or Spain bond yields. Think those improved numbers are due to the Fiscal Pact Treaty being discussed? Didn’t think so either. While this effect of the ECB’s increased lending – close to 500 billion € in the first week alone – seems to be rather limited according to Barclay’s, it is the best case scenario that I have laid out here.
To sum up then, the ECB has initiated a long-term, low-interest lending program that a) doesn’t really work and b) lower yields for governments bonds to some extent when it does function properly while creating a subsidized profit to commercial banks. Now let’s say the ECB were instead to spend most of that money on buying up sovereign debt itself. Not only would yields go down far more than they have but the profits accrued on these operations – assuming the Eurozone holds and Italy (or whoever else) does not default – would benefit the ECB itself, which in turn means the European national central banks of course and finally European governments and indirectly their taxpayers.
But then why should one do what makes sense when – German and other – ideology opposes this kind of monetary policy. After all ideological purity is more important than obtaining results. Right?
As Merkozy said today negotiations on the so-called Fiscal Pact (really: International Treaty on a Reinforced Economic Union) are advancing and it is expected to be signed by March at the latest. A second draft of said treaty has been leaked meanwhile. Open Europe has put forward a discussion of the revisions between the first and second draft treaties circulating. I believe that the most important change between the two versions lies in the expanded role of the European Court of Justice (ECJ) in the second draft. As Open Europe puts it:
Article 8 stipulates that the ECJ would have jurisdiction over any violation of the entire Title III, i.e. on all the provisions of the so-called “fiscal compact”. In the previous draft, the ECJ only had a say on Article 3(2), i.e. on whether national governments have correctly transposed the balanced budget rule into their national legislation;
Furthermore, according the revised text the Commission “may, on behalf of Contracting Parties, bring an action for an alleged infringement of Title III” before the ECJ.
In the previous draft the ECJ effectively only would have had the power to judge the validity of the national implementation of a debt brake or golden rule of ‘constitutional or equivalent nature.’ This time around it has additionally been be given a de facto veto over national budgets! Signatories of the Fiscal Pact will have to ‘apply the following […]: The budgetary position of the general government shall be balanced or in surplus.’
In other words any country having signed the pact (including non-Eurozone states in my understanding) or the Commission may take any other signatory in front of the ECJ if that first country’s budget is not ‘balanced or in surplus.’ The ECJ will have to allow for ‘the budgetary impact of the economic cycle […] and […] exceptional economic circumstances, or […] periods of a severe economic downturn,’ but in principle it will have the power to declare a sovereign country’s budget invalid. Think about this for a second.
Obviously the vague definitions and circumstances laid out above hardly make this kind of judicial enforcement fool proof and for normative reason that is probably for the better. Still, the symbolism of the heart of national parliamentary sovereignty to undergo supra-national control represents another step towards increased integration.