MPI Gemeinschaftsgüter
Martin Hellwig
Governments, Banks, and Monetary
Policy in the Crisis
Berlin, DIW, September 2013
My Own Position on OMT
 Grudgingly in favour of OMT
 I consider the Fratzscher et al. statement in
favour of OMT to be too naively technocraticKeynesian – too little political eocnomy
 I also consider the fundamentalist opposition
of some German economists to be somewhat
hysterical and lacking in attention to the facts
of the situation
 I am strongly opposed to the idea that the
dispute about OMT should be treated as a
legal dispute
An Aside on the Legal Dispute 1
 The Treaty prohibits direct funding of
governments by the ECB
 The Treaty also permits open-market
operations – without restrictions
 Are secondary market purchases of
government debt allowed?
 Answer 1: No because this would be a way of
arbitraging the prohibition of direct funding
 Answer 2: Yes because the Treaty only
prohibits direct funding and allows opemmarket operations
An Aside on the Legal Dispute 2
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Both argument are legitimate legal arguments
The Treaty is unclear
Only a court can create clarity
The ECJ is the court in charge
The German Constitutional Court, which is not
in charge. has tried to make a distinction
according to the objectives of the
intervention: Illegal if intended to cirumvent
the prohibition of direct funding – legal if
intended to pursue monetary policy objectives
An Aside on the Legal Dispute 3
 Proceedings in Karlsruhe have focused on the
objectives of the ECB in OMT
 Giving the Court (in KA or LUX) the right to
assess objectives – beyond considerations of
arbitrariness – endangers the independence of
the ECB
 .... Especially in view of the fact that the
German Constitutional Court may decide that
independence of the central bank with only
the specification of price stability as an
objective may violate Art. 20 GG
An Aside on the Legal Dispute 4
 The Maastricht Judgment: Ceding sovereignty
over monetary policy violates Art. 20 GG, the
need for democratic legitimacy, except that
with independence and a clear objective there
is not much room for abuse.
 Now we have seen that the objective of price
stability leaves room for lots of decisions with
vast distributive effects...
 This is a problem within national boundaries
as well as beyond: Was the Bundesbank law
unconstitutional?
Distributive Effects of Monetary Policy
 Open-Market operations have distirbutive
effects
 The Treasury-Fed Accord
 Interest Rate Targets
 How about open market purchases of IBM shares?
 So do low interest rates
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The Greenspan turnaround in 1990
Central bank lending since 2008
LTROs
(... the greatest carry trade ever?)
OMT?
Hamlet without the Prince
 Assessments of OMT by public economists
tend to focus on public budget constraint
(distributive effects on governments)
 Monetary macroeconomists tend to focus on
inflation and the monetary base
 What about the role of banks and other
financial institutions as parts of the monetary
system?
 The money supply?
 The transmission mechanism?
How do we assess „contractiveness“ of
monetary policy?
 Friedman&Schwartz: Consider monetary
aggregates
 Base: + 15 % in 1929 – 33
 M1: - 33 % in 1929 - 33
 Contemporary critics of the ECB: Consider
monetary base
Base: doubling since 2008
M3: + 10 % since 2008
Prices: + 10 % since 2008
Bundesbank: Long and variable lags ... Who knows
what is to come?
 Exit?
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Beyond the crisis: What role for central
bank money in liquidity provision?
 Friedman 1969: (Real) central bank money is
costless; creation of a real return on this
central bank money enhances efficiency
 „Optimum quantity of money“ arguments
suggest a replacement of interbank markets
by central bank money as a source of liquidity
may be efficient!
 BUT: What collateral will private banks have?
Toxic securities? Government debt? We get
back to the problem of distributive effects and
moral hazard..... What to aim for in exit?
From Theory to the Real World:
Central Banking in the Crises
 Trichet: No relation between conventional
monetary policy/price stability orientation and
unorthodox monetary policy/financial stability
orientation on the crisis
 High rates in 2007/8, 2011
 Relaxation of collateral standards
 Draghi: Lowering of interest rates, LTROs,
announcement of OMT
LTROs
 Summer 2011: Prospect of Greek haircut
suggests many European banks may become
insolvent (Dexia did)
 Funding broke away
 Stock markets went into decline
 Announcement of recapitalization exercise
generated more pressure on markets,
significant deleveraging by banks (November)
 LTRO indicated ECB readiness to ensure bank
funding (whar about solvency problems)?
OMT
 Summer of 2012: Banks in periphery
countries, especially weak banks, lend to
governments but not to firms
 Recession is deepened by a lack of funding for
nonfinancial firms
 OMT as an attempt to address problems in the
„transmission mechanism“?
Where do we come from ?
 April/May 2010: Greece has a liquidity
problem, no market access
 October 2010: Deauville: Private Sector
Involvement, not now, from 2013
 November 2010: PSI only in cases of
insolvency, not in cases of illiquidity
 March 2011/July 2012: PSI now, but only 20%
 October 2011/March 2012: PSI now, over
50%
 June 2012: Spanish banks will be bailed out
by ESM – without haircuts for creditors?
The Multiplicity of Crises
 Not a currency crisis! A combination of
 A traditional sovereign debt crisis in Greece,
Portugal, and perhaps Italy,
 A traditional real-estate and banking crisis, in
Ireland and Spain,
 And a latent banking crisis in Germany and
France where banks are poorly capitalized and
the mess of 2008 has never been cleaned up
Sovereign Debt Crises and Banking
Crises
 Sovereigns that don‘t make ends meet.
 ... ask/coerce banks into funding them
 ... cause bank insolvency from haircuts – Argentina,
Greece
 Rescuing banks that are indebted in „foreign“
currency can overtax the power of the
sovereign
 ... and cause sovereign a debt crisis (Iceland,
Ireland)
 ... Which may cause the sovereign to lean on
healthier banks....
A look in the mirror: Weimar
 The myth of the reparations burden (Schuker
1988)
 Lacking identification of elites with the state
 Lacking acceptance of impoverishment by war
 Fiscal irresponsibility: the civil service pay
„reform“ of 1928
 Powerlessness of the Agent General under the
Dawes Plan
 Banking crisis 1931
French and German Banks
 Poorly capitalized
 Excess capacity
 No cleanup in 2008/2009, rescue of everybody
(except WestLB)
 Significant exposure to..... toxic assets,
sovereign debt, cross-border bank debt,
shipping loans...
 Sales of Greek debt to .... Cypriot banks
 Borrowing from ECB on collateral using...
Problems today
 Excessive Indebtedness: Greece, Spanish
Cajas and Provinces, Banks
 Interconnectedness: French banks – Greek
banks, German banks – Spanish banks, Greek
sovereign debt
 Lack of viable institutions and liability
(Maastricht, SGP, Bank Bailouts)
 The Japanese temptation - „only a liquidity
problem“
 Mix of politics – banking – banking supervision
Why is there no progress?
 Lack of workable national discourse
 Elimination of parliaments from discussion
 Conflicts of agendas, within governments, between
governments and opposition, between government,
banks, the public, between the federal government
and the Länder (Landesbanken)
 Illusions and populisms, lack of analysis
 What are the problems? What are feasible stratgies?
What are the tradeoffs?
 Example: should Greece leave the euro? ... What
does that mean? .... A banking crisis, breakdown of
the payments system, breakdown of...?
Why is there no progress?
 Lack of a workable supranational discourse
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Conflicts of creditors and debtotrs,
Clashes of personalities
Conflict Commission – Member States
Turf wars
 Lack of legitimacy
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Elites versus public
Legal Tricks Banking Union as an example: Art 127 (6)
„apply all EU law“ .... What does that mean for (not
directly applicable) directives
Where are we going?
 Indebtedness of states, banks, private
households is very high
 Some cut of debt will be necessary
 Through resolution? Risk of further crisis; the
BRRD is a copout
 Through monetization? Much easier: The ECB
is weak because it is so strong!
 .... With or without institutional reform?
An example
 Treatment of sovereign debt in banking
regulation
 Sovereign carve-out in large exposure and
equity regulation
 „Sovereign debt is riskless“
 „If it is not riskless, banking regulation is
unsuitable for reducing the risk“
 „ESM will do the job“
 „If not, we must have eurobonds“
 ... or the ECB will bail us out
„..only a liquidity problem“
 Interest rates are high because markets see a
problem
 „The problem is only serious because interest
rates are so high. If markets believes that ....“
 Sachsen LB 2007, Dexia, HRE 2008, Greece
2010: „only a problem of market access“
 Dexia, HRE would be insolvent without state
aid
 Hausmann 2012: Greece does not have what
it takes to be as rich as Greeks are
On the ECB
 German Paradox: The ECB is independent but
it must not do anything different from the
Bundesbank, especially not anything we dislike
 Legalisms: Prohibition of direct lending to
governments versus license to do open market
policy.
 Price stability as an objective – viability of the
monetary and financial system not?
On the ECB 2
 However the central bank introduces money
into the economy, it produces windfalls
 Banks
 Issuers of securities
 LTROs
 Inflationary?
 Saving insolvent banks?
 Costs of intervention? Not only inflation!
 Central bank versus interbank markets as
providers of liquidity
On the ECB 3
 Moral hazard from ECB availability: The
Greenspan put
 Many politicians have learnt that inspite of
Maastricht they can get access to the printing
press if they borrow from banks and th ebanks
get into difficulties
 Banks are seen as a source of funds rather
than a source of risks
 Strength of the ECB is a weakness
 Conditionality? Banking union?
Banks and States
 Spain: We want your help but we do not really
need it and we definitely do not want you to
meddle.
 Recapitalizing banks by ESM? How much?
 With liability of the Spanish state? With
conditionality?
 What about liability of/for preferred stock in
Spanish cajas where courts say these
contracts never were valid?
 Problems arising from the symbiosis of local
elites, banks and supervision
What do we want?
 Overcome the crisis
 Establish a sustainable regime
What went wrong?
 Lack of fiscal discipline
 Maastricht? SGP? New pact?
 Lack of Market discipline
 PSI?
 Lack of effective supervision
 Supervision as a tool for making banks cough up
money
Fiscal discipline by imposition?
 Lack of political legitimacy
 Illusions about enforcement (SGP, Agent
General)
 Differences in fiscal traditions
 Financial Repression, monetary funding of
government in G-I-S-P
 Differences in traditions as to what is the role
of the state
 Industrial policy, services publiques in France
Lack of market discipline
 No exchange rate discipline (exchange rate as
an indicator of current developments, brake
on foreign borrowing)
 No consciousness of risk on the side of
creditors (zero risk weights as a basis for
asking for bailouts)
 Separate goods markets, inflation rates and
real interest rates as a main driver of
imbalances
 What market discipline in a regime where the
supervisor represents funding interests o f the
state?
Effective Supervision through the
SSM?
 Supervision without resolution?
 Asset quality review?
 „In the case of directives, the ECB will apply
the national laws implementing the directives“
German attitude
 Control of risks for ESM , ECB
 ... But also for own competence in banking
supervision?
 ... And the competence of Spanish authorities
in dealing with the cajas?
 The wonderful consistency of insisting that
ECB must check on the real estate valuations
in the books of the cajas, but not on the ship
valuations in the books of HSH Nordbank
What is missing?
 Strategic thinking
 Comprehensive Assessment of situation
 Risks and exposures
 Ability to pay
 Assessment of Alternatives without Illusions
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On
On
On
On
institution design
sustainability of rules and sanctions
liquidity versus solvency
the effects of what is being done