How the European Stability Mechanism could turn into a bank

27th July 2012

With this in mind there seems to be plenty of scope for ambiguity over the latest statement from Mario Draghi, the president of the European Central Bank (ECB):

"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."

According to the Treaty of the European Union the primary role of the ECB is to "maintain price stability" and to "support the general economic policies in the Union" insofar as it does not impact the former objective. In relation to the current sovereign debt crisis in southern Europe, however, the following passage is more pertinent:

"Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States…in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments."

Any policy that involved the direct purchase of the government debt of eurozone states by the ECB would be a breach of the mandate. In other words, quantitative easing (QE) is out.

This helps explain why the Long Term Refinancing Operations (LTRO) had to use the banking system as a conduit to funnel money into struggling member states. It also provides clues as to why the policy failed to reassure bond markets – the LTRO money was required to meet current refinancing needs rather than unlimited liquidity supplied by QE, which stands as a guarantee against future uncertainty.

It was, however, playing rather fast and loose with the ECB's mandate. Unlike Jean-Claude Trichet, Draghi's predecessor, who famously said that the ECB had not even discussed direct purchases of government debt the incumbent has proven more creative in his approach to monetary policy.

If Ewald Nowotny, the governor of Austria's central bank and ECB Council member, is to be believed then we may soon see the biggest sleight of hand yet. Earlier this week he told Bloomberg that he could see arguments in favour of granting the European Stability Mechanism, the region's bailout fund, a banking license. In doing so the fund could circumvent the central bank's mandate to channel ECB funds into struggling states in a de facto QE programme.

The question is whether the use of such a flagrant work-around effectively renders the bank's mandate irrelevant. Given the sensitivities surrounding the federalisation of Europe and the collectivisation of debt obligations, these methods might look to some as a way to avoid democratic obstacles to policy initiatives.

Few in Brussels will complain if Draghi succeeds in bringing down debt yields in peripheral Europe. After the dust has settled, however, citizens of member states may find that they have sleepwalked into a federal Europe without ever having been consulted.


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20 thoughts on “How the European Stability Mechanism could turn into a bank”

  1. max says:

    Thanks Shaun. Is all this intervention the end of the old ‘capitalist’ world as we have known it? I think so.

    1. Anonymous says:

      Hi Max
      I am not so sure as I think that actually the era of crony capitalism led us into this mess. On that basis capitalism has found itself being ground down for quite some time and may have ended a while back.

  2. Justathought says:

    Hi Shaun,

    Considering the devastating effects from QE to savers and retired folks, knowing the aged pyramid from Japan (and western world in general). I wonder could this be of some deliberate attends for “gently” reducing the amount of older folks? I recall the end of the former Soviet Empire; the first victims were the older generation. By reducing their purchasing power to a minimum, their life spans were drastically reduced. Well it is just a though…Nothing is surprising me anymore…. Of course Japan might be “different” but when I read that “Spain’s social security pension fund was 90% allocated to Spanish sovereign debt”…I am slightly concern…When is the next flight with the Starship “Entreprise”???

    1. Anonymous says:

      Hi Justathought

      You pose an interesting idea about older people being disproportionately affected by inflation and of course the Japanese have a reputation for long lives particularly those who remain on its original fish based diet. So this negative impact from #QE will likely be stronger in a society which is relatively aged.

      As to the Spanish social security fund Bloomberg is reporting that 97% of it is now in Spanish government bonds! What was that about a wise investor diversifying? Also what about the other 3%?

      Here is what has happened

      “The bond-buying strategy enabled the fund to end 2012 with 63 billion euros, an amount equivalent to 6 percent of Spain’s gross domestic product. A 3 billion-euro gain offset part of the 7 billion euros used by Spain’s Cabinet starting from September to finance an increase in retirees’ pensions and Christmas bonuses, according to the report.

      Spain’s state-run social security system, also in charge of unemployment benefits, stopped registering surpluses in 2011. Its deficit was 1 percent of GDP last year, contributing to the nation’s total budget gap of 10.2 percent of GDP.”
      Letting politicians get their hands on such funds invariably ends in tears does it not?

  3. JW says:

    Hi Shaun
    Japan taking the ( temporary) lead in QE infinity. The rest will eventually catch up, even the ECB. Whatever they say its monetising debt. All the fiats will be devalued, more or less together, the 0.1% protected and the 99.9% poorer.

    You are right Shaun, they can’t all be that thick for so long, its co-ordinated by the ‘squid’.

    1. JW says:

      Hi Shaun

      I came across the attached which references the Euro Wealth commented on previously.

      1. forbin says:

        as far a wealth goes – who owes to most as well as the median and average wealth

        Italy cannot both be rich individually and broke as a country

        or is that where I’m missing the point ?

        so the top lot are increadably rich and the rest have all the debt?

        like the Middle ages again ?


        1. JW says:

          Hi Forbin
          Yes like the Middle Ages.
          Property numbers confuse the picture, but the depression of wages in Germany ( and Austria) for the last 15 years has produced very very divided societies. Part of the EZ problem is the lack of Germanic ‘spend’ by the majority, they just don’t have the disposable income. And this is a ‘success’! For whom I wonder.

        2. Anonymous says:

          Hi Forbin
          I am a fan of the Dune series of novels which in essence impose a feudal model aka the Middle Ages on the future. Your point there is making me wonder if that is the default setting for mankind?

      2. Anonymous says:

        Thanks JW

        So looking at the dates Germany was led by Austria one more time….Oh and I raised a wry smile at the bit which stated that some countries with-hold average wealth stats as they do not like the numbers! Or more specifically what these numbers imply about their population.

        For those who have not followed this debate then I quote a paragraph which raises the issue at hand below.

        “What the Austrian National Bank found was not pretty (20-page PDF). The considerable wealth in Austria was very unevenly distributed. The wealthiest 5% owned nearly half of the country’s wealth. Their median wealth was €1.7 million in diversified assets. The lower 50% owned only 4% of the country’s wealth. Of them, 83% rented their homes. Their median wealth was a measly €11,000 consisting usually of a car and a savings account. That’s half of the people! And 10% had a net wealth of less than €1,000.”

  4. forbin says:

    Hello Shaun,

    Will it work ? in short no , it hasn’t worked before and it will not work now

    mind you define “work”

    If its to bail out the banks with new printed money because we all know they’ve been broke since 2008 and nothing has changed since , in any way shape or form

    And if the issue is to print until all that debt is monetized – then we are pleanty short of the Trillions required ….

    the current bubble is set with stocks – the game have been laid with reduced to nothing rates for savers and the market primed with QE – once you have the saver fleeing to the stock market with stock ISAs or other methods of money destruction , then the bubble will briefly flare then burst – with the banks walking off again with the loot .


  5. forbin says:

    Hello Shaun

    Wowzer ! I can see tomorrows subject already !

    France contraction and Germany stagflation

    glug glug goes the lifeboat……

    is it just Finland that doing ok these days ?

    and BoE – no more QE yet but they’re still re-investing the “profits” from the last lot ?


  6. Rods says:

    Hi Shaun,

    Another excellent analysis.

    Where Japan has a 200%+ debt to GDP level that can never be paid back, they are just further ahead with their plans to inflate the debts away. The US and UK will be following this path, sooner or later! The Eurozone countries with high debt levels are the ones with the problems as Germany won’t allow such inflation.

    I see the OBR were saying yesterday that using international calculations (I presume OECD) that our debt to GDP is now over 90%. With current borrowing projections this will be 113% by 2016, so we are rapidly catching up Ireland, Italy and Cyprus. I see North Sea oil and gas declined by over 14% in 2012 compared to 2011, the City flat lined, but other sectors grew (hence expanding employment), but can we expect a further decline in North Sea output in 2013, which will wipe out any growth gains, so all we have again is stagflation?

    1. Anonymous says:

      Hi Rods

      Thank you. On the other side of the ledger Japan has a lot of private savings which will be affected by any inflation that is caused here so we already have a mechanism for this to go wrong.

      As for the UK I recognise the numbers which is our equivalent to the Maastricht or Eurostat ones and they are essentially what the ratings agencies use. If I recall correctly we top out at around 100% on the OBR’s (dubious) numbers so yes tick tock tick tock….
      Its a good job Gilt yields are so low having had yet another safe haven run as I fear in the end they will rise and cause us plenty of trouble.

  7. Drf says:

    Hi Shaun,

    “Rather than try harder I suggest that they think harder although I fear that they are simply not capable of it.” That just about sums it up eloquently!

    1. Anonymous says:

      Hi Drf
      My thoughts were confirmed by today’s ECB press conference where the main issues you might think would be economic depression in some part of the Euro area and how business lending can be encouraged.
      What we got was some boasting about the success of the Outright Monetary Purchases or OMTs so financial economy over real economy one more time.
      Oh and there was one bit where Mario Draghi actually told the truth when her said that the original EuroGroup plan for Cyprus was “not smart”,so he doesn’t think much of their collective intelligence either!.

      1. HarryA says:

        There was also a point late on – when answering a question posed by Zerohedge – when he stated that there is no (need for) plan B regarding Europe. He must have some exceptional beer goggles on when evaluating plan A!

  8. Anonymous says:

    Hi shaun..Still enjoy reading your blog everyday (though its not fun news!)

    Wonder if you have seen/heard kyle bass’s take on japan..its not good news for japan at he keeps saying lets hope he’s wrong. heres the link ..bit long at @45min (and frustrating that the charts he allude to arn’t visable) however a compelling and scary analysis +prognosis none the less..¥1-quadrillion-in-debt-the-japanese-zone-of-insolvency-theyre-finished/

    .. i wonder which order of dominoe k bass thinks the uk is! Not sure i want to know really (the lemming paradox) ..

    1. Anonymous says:

      Hi Sue
      Sorry about the news! I don’t control it and sometimes I am reminded of the Elton John LP (as it was then..)
      Don’t shoot me I am only the piano player
      Kyle Bass is an interesting fund manager who played a cunning hand for his investors in the credit crunch and deserves respect for that. Mr.Kowalski used to regularly post his views on here about Japan and the fact that Kyle put his mortgage in Yen as he is confident it will collapse. Well after a grim hard run he is seeing some possible daylight as the Yen plummets.

  9. quelgeek says:

    You write: “…if a market is forced to a price level by official intervention the
    effects are not the same as if it went there of its own accord.”

    You are citing an instance of Goodhart’s Law: “Once a social or economic indicator or other surrogate measure is made a target for the purpose of conducting social or economic policy, then it will lose the information content that would qualify it to play such a role.”

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