Treasury Secretary Timothy F. Geithner is pushing to make the European Central Bank the ultimate guarantor of bonds issued by the 17 countries that share the euro, a fundamental shift he maintains is the only sure way to solve a crisis threatening the global recovery.
In meetings in recent weeks in France, Poland and now Washington, Geithner has made the case that without strong backing from their central bank, governments in the euro area will be hampered for years by suspicion that their bonds are risky bets for investors. That lack of confidence has rocked global markets in recent weeks and could continue to threaten the European economy and banking system.
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Sept. 23 (Bloomberg) -- European Union Monetary Affairs Commissioner Olli Rehn talks about how two dozen of Europe's banks need to present plans to recapitalize following stress tests earlier this year. He speaks with Sara Eisen on Bloomberg Television's "Street Smart." (Source: Bloomberg)
The proposal to expand the ECB’s role has divided European officials and bankers. Supporters agree that euro-zone governments need stronger support from the central bank, while skeptics worry such an arrangement would encourage undisciplined countries to spend.
The idea Geithner is advocating would make the ECB more like the U.S. Federal Reserve and other central banks, which provide a last-resort guarantee that a government will not run out of money.
The role can be controversial — as have been the steps taken by the Fed in response to the U.S. financial crisis and recession — and can fuel inflation when excessive.
In Europe, the individual countries of the euro monetary union cannot rely on the ECB the same way. Investors have increasingly recognized that nations such asGreece, Portugal and Italy do not have the same sort of backstop that the United States has with the Fed and have driven up the borrowing costs for those countries.
The ECB was set up with a narrower mission — to control inflation — and its governing board has been hesitant to expand that role. While the bank has been buying government bonds in recent weeks to lower the interest rates paid by Italy andSpain, even that limited step has caused dissension on the ECB board. The bank’s leaders have said they hope to stop the practice as soon as possible.
Geithner’s argument is relatively new, but it is an extension of one he made unsuccessfully early last year to European finance ministers when he urged them to act quickly and with massive financial resources to extinguish the debt crisis then emerging in Greece.
With Europe’s crisis now threatening global financial stability and European countries receiving emergency bailouts, the politics of the discussion have shifted. Top leaders in Europe now acknowledge they need to make dramatic changes in how the euro zone operates.
Olli Rehn, European economic and monetary affairs commissioner, said Geithner’s role in recent discussions had been “very constructive” and that euro-zone leaders were intensely studying the role of the Fed in responding to the U.S. financial crisis.
Other major nations have picked up the call. The prospect of continued crisis and the potential for Europe’s ills to trigger a new recession prompted the Group of 20 major economic nations on Thursday to express impatience with the euro-zone countries’ inability to solve their problems.
The meeting Thursday night ended with a communique saying that euro-zone leaders had pledged to act decisively over the next three to six weeks.
U.S. officials did not publicly discuss Geithner’s proposals, but European and Asian officials familiar with the debate said it would amount to a major change in the relationship between the ECB and the 17 euro-zone countries.
“Geithner is right. You have to hit the problem on the head with a sledgehammer,” said one Asian official familiar with the G-20 discussion, who asked not to be identified.
British treasury chief George Osborne said the G-20 meeting and communique were meant as a message to the euro zone that time is running out.
“What is required is a sense that there is enough government and central-bank firepower” to guarantee banks and governments in the region will not fail, Osborne said. “It is fairly clear that patience has been running out in the international community.”
Britain is not part of the euro zone and maintains its own currency.
The ultimate role of the ECB is one of many contentious issues the euro area needs to confront. Euro-zone countries are struggling to ensure Greece does not default and are pressuring the Mediterranean nation to make good on spending cuts in return for international loans. The region’s leaders, meanwhile, are pressing nations such as Italy and Spain to keep their budgets on track as well and are debating how to deal with a possible banking crisis arising from the large sum of risky government bonds held by financial firms.
The European countries have set up a rescue fund, the European Financial Stability Facility, that could raise around $600 billion to support governments and banks. The fund must be approved by the euro area’s 17 national parliaments, a process expected to be completed by Oct. 14.
But the amount of money is not considered enough to prop up Italy if it was to founder, or to stand behind the region’s financial system if banks begin to falter.
Officials from the United States, theInternational Monetary Fund and the G-20 are pressing euro-zone leaders to drastically expand what the rescue fund can do and, in the words of the G-20, “maximize its impact.”
That could be done in a variety of ways, including an approach that would use money from the rescue fund in concert with the ECB.
Geithner has supplied an example that dates to the financial crisis. When he was head of the New York Fed, he combined money from the Treasury Department and the Fed to create a $200 billion program to buy troubled securities.
Using similar techniques, the ECB could turn the rescue fund’s $600 billion into several trillion dollars, in effect putting the central bank’s unlimited financial power behind European governments and financial firms.
It won’t be an easy sell at the central bank. According to European officials, ECB authorities said at the meeting in Wroclaw, Poland, that they thought such ideas violated European laws that forbid the bank from financing governments or “monetizing” government debt.
But European officials such as Rehn, in principle, have supported the need to expand the rescue fund’s fire power. There is, however, a reluctance to discuss the idea openly until national legislatures have approved the fund, for fear that fiscal conservatives in Germany or elsewhere might worry they are writing a blank check.
Private analysts have begun to argue for the idea as well, saying that, ultimately, without a central bank behind them, governments such as Greece and Italy will be viewed no differently than a company or individual that wants to borrow money.
“It is the government’s recourse to the central bank’s printing press that separates sovereign debt from other forms of debt,” Morgan Stanley analysts wrote in a recent paper on the euro zone. “An end to the crisis is unlikely without an unlimited lender of last resort.”
