Consider it a parting gift.
After eight years as head of the European Central Bank,
Jean-Claude Trichet firmly blocked efforts by French President
Nicolas Sarkozy to make the central bank promise to keep buying
Italian and Spanish bonds as part of Europes debt
agreement last month. Trichet, who began the controversial bond
purchases with Greece in 2010 only to see two German ECB board
members resign in protest, was determined to extricate the
central bank from the bond market and put the burden of
rescuing the euro zone periphery back on the Treasuries of
Berlin, Paris and other capitals.
In practice, however, the ECB and its new president, Mario
Draghi, will find it much harder to pull back. As Trichet
himself demonstrated, the central bank is the only European
Union institution with the capacity to act swiftly and boldly
in a crisis.
The latest EU agreement includes a big increase in the
haircut on Greek debt for private investors, to 50 percent,
designed to restore Greeces solvency; a deal to leverage
the EUs bailout fund, the European Financial Stability
Facility, by as much as 5-to-1; and increased capital
requirements for banks.
The package initially eased market fears and prompted a
rally in the euro, but the deal still faces some big obstacles.
Banks and other investors could balk at the new haircut, which
would only reduce Athenss debt-to-GDP ratio to 120
percent. Hans-Werner Sinn, president of the Munich-based Ifo
Institute for Economic Research, says Greece needs nothing less
than a major devaluation to regain competitiveness. They
have no chance to prosper in the euro zone, he says.
EU leaders failed to spell out exactly how they would
leverage the EFSF by using it to provide first-loss
guarantees to bond investors or buttressing the facility with
money from China and sovereign wealth funds. But even leveraged
resources of about 1 trillion ($1.4 trillion) could
be quickly exhausted in a panic given that the Italian bond
market alone is worth 1.9 trillion.
They wont have overwhelming firepower,
says Paul De Grauwe, an economist at the Catholic University of
Leuven in Belgium. Its only when you have that that
you acquire credibility. Only the ECB can make unlimited
interventions in the bond market, he says. So far, however, the
bank has put itself in no-mans-land, insisting that its
sole job is to prevent inflation, then intervening reluctantly
in a crisis to prevent a breakup of the euro area.
Draghi needs to embrace the lender-of-last-resort role for
the ECB to stem the crisis, De Grauwe says, adding, The
toughest job is still to come."