One of the last remaining Germans at the ECB, Jens Weidmann, gave an interview to the FT earlier today, in which the president of the Bundesbank, shared some pragmatic responses to questions about the depths of ECB intervention in the capital markets. The man who on Tuesday clinically stated explicitly that the "ECB can't print money to finance public debt" (to which he adds today that "this is a very fundamental issue. If we now overstep that mandate, we call into question our own independence"... odd, never prevented the Fed from questioning its own independence), follows up with some much needed clarity on just where the ECB sees itself in the coming weeks and months, touches on the rumor that sent stocks surging on Friday, namely that it would proceed to fix interest rates (it won't), and shares some rather amusing observations on the recent revelation that the ECB has become a weapon of political (de)stabilization: after all it took the ECB's bond buying program - the SMP - just two days of not buying Italian bonds for Silvio Berlusconi to resign after BTPs hit an all time rock bottom price. Yet the most amusing slap in the face of the Eurocrats is precisely what we mock every single day, namely the perpetually changing nature of the EFSF on a day to day basis, confirming the cluelessness of the continent's leaders, and which has cost Europe all credibility in the face of capital markets, explaining why the EFSF has to resort to not only buying its own bonds, but issuing terse statements denying anything and everything: "EU governments have decided how to finance the EFSF. They agreed on guarantees for the EFSF and, in their last meeting, on two options on how to leverage the EFSF – by an insurance model or a special purpose vehicle. Instead of working on implementing these approaches, we now have the next idea that is completely out of the realm of what has been discussed previously. I don’t think it builds confidence in crisis resolution capabilities if from week to week, from one meeting to the next, you are questioning your last decision."
Ultimately, the whole interview boils down to two words: "Moral Hazard", even if unsaid: the ECB realizes that with each successful intervention it invites politicians to be ever more irresponsible in setting prudent fiscal policy because "the ECB will just come in and make it all better." Now that it finds itself smack in the middle, the ECB has no choice but to set an example with one or two transgressors (replacing them with its own apparatchiks naturally), in hopes that European governments will finally set off on being fiscally responsible. Which they can't, and that is the whole problem. The truth is, Europe's politicians know too well what has to be done to extricate Europe out of the current bond market inferno. However, ECB aside, it would involve political choices so unpopular that all Eurocrats would simply be voting for their own career suicides. And that is the whole problem: everyone knows what has to be done, but nobody wants to actually do it, so the ECB steps in and makes things better for one more day. It also explains why the ECB is demanding that European countries give up sovereignty to a European fiscal authority (ahem Germany), which will make sure Europe's trains all run on time. Good luck, however, explaining that to 250 million non-Germans.
Some select highlights from the Weidmann interview with the Financial Times:
On what would happen when Greece once again fails to generate any tax revenues and the deficit gap surges once again:
FT: If funding to Greece did stop, the ECB would have to decide how to deal with the Greek banking system. How should the ECB should act in that kind of case?
JW: I don’t want to speculate what would happen if somebody decided this way or another way. Regarding the role of the eurosystem [of eurozone central banks], I will just confirm to you that we will act according to our mandate and provide liquidity to solvent banks and ensure price stability – this is our task. It’s the task of governments to ensure that banks in Greece are solvent. We provide liquidity to solvent banks against adequate collateral.
On whether Italy needs a bailout, and how the ECB view 7%+ yields.
FT: What’s the way out now for Italy? Yields have risen to unsustainable levels. Does Italy need a bail-out?
JW: You are rushing to conclusions in saying that the interest rate levels are unsustainable. Of course this level may not be sustainable in the long run if there is a lack of fiscal discipline and economic growth remains low. But in the short run I do not think it is such a big an issue. What we are facing in Italy is an acute confidence crisis, and only the Italian government can resolve that crisis by implementing what has been announced. Italy is very different from Greece in a lot of respects. I’m confident that Italy will be able to deliver.
FT: Is the Italian bond market dysfunctional at the moment?
JW: What we see is a reaction to the political problems in Italy and the lack of implementation and I wouldn’t consider that as dysfunctional. You can argue whether there’s an overreaction or not, but the main reason is the political situation and the lack of implementation in Italy – and that we can’t fix.
Well, maybe "we can" - on whether the ECB is now the quiet engine of political changes that will enforce the European Winter follow up act to the Arab Spring.
FT: With its bond buying, is the ECB trying to help Rome, or put pressure on Rome?
JW: It’s not about helping Italy or penalising Italy. The ECB Governing Council has always stressed that the Securities Markets Programme is about ensuring the monetary policy transmission process., But it comes with risks. The risks are reflected in our balance sheet. There’s also a risk that you mute the incentives that come from the market. Recent experience has shown that market interest rates do play a role in pushing governments towards reforms. You have seen that in the case of Italy quite clearly.
On fixing interest rates:
FT: In principle, the ECB could buy up a lot more bonds and keep the yields where it wanted ...
JW: We have a mandate and we have to stick to our mandate. Fixing an interest rate for a country is certainly not compatible with our mandate. You would guarantee a certain refinancing cost for a government and you could not argue that this was not monetary financing.
The stated purpose of the SMP is to cope with dysfunctional markets and it’s not to ensure a specific spread for a specific country.
On why the ECB has to step up and be the only parent in the European room:
FT: Isn’t the problem with the eurozone that there is no stabilising anchor and only the European Central Bank can perform that function?
JW: There was such an anchor, the stability and growth pact. It was just that this pact was not respected, it was softened.
On why the ECB will not be a lender of last resort:
FT: Can you explain why the ECB cannot be lender of last resort?
JW: The eurosystem is a lender of last resort – for solvent but illiquid banks. It must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty [prohibiting monetary financing – or central bank funding of governments]. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions.
I think the prohibition of monetary financing is very important in ensuring the credibility and independence of the central bank, which allow us to deliver on our primary objective of price stability. This is a very fundamental issue. If we now overstep that mandate, we call into question our own independence.
Apparently it is not an issue for the Fed...
On who should fund the EFSF:
FT: How should the EFSF be financed? Should European countries pool their special drawing rights at the IMF?
JW: EU governments have decided how to finance the EFSF. They agreed on guarantees for the EFSF and, in their last meeting, on two options on how to leverage the EFSF – by an insurance model or a special purpose vehicle. Instead of working on implementing these approaches, we now have the next idea that is completely out of the realm of what has been discussed previously. I don’t think it builds confidence in crisis resolution capabilities if from week to week, from one meeting to the next, you are questioning your last decision.
SDRs are a part of our foreign exchange reserves. Using foreign reserves as capital of an SPV whose only purpose of is to fund governments is just a thinly-veiled form of monetary financing. For exactly that reason, the IMF itself is not allowed to do this operation.
It gets worse for the EFSF:
FT: How big do you think the EFSF’s lending capacity has to be to be effective?
JW: I think the EFSF has the resources to deal with the problems in the eurozone. I don’t want to say that leverage is not useful, but you just have to be aware that this is not a magic wand. Markets will look through financial engineering and it is clear that all the leverage will in the end increase the expected loss on the guarantees.
What matters is whether there is political will in the countries standing behind the EFSF to honour the guarantees.
FT: Do you think the insurance model of leverage is credible to the markets?
JW: My main concern is the credibility of the construction and the assessment of whether the guarantees are honoured. I think the insurance model has been put into question by the recent decisions on the PSI.
Will there be a recession in Germany?
JW: Because of reforms in the past, Germany is in a better position if you look at the growth figures. The labour market is also in a more robust position than in many other euro area countries and this is again the effect of those past reforms. The third quarter of German growth is still quite robust, but we will experience a moderation of growth in the fourth quarter of this year and the first quarter of next year. However, downside risks have clearly increased.
And lastly, on the endgame for the Eurozone: a forced fiscal union issuing Eurobonds over the will of the non-Germans:
FT: Does your idea of fiscal union involve eurobonds?
JW: It does not necessarily involve eurobonds. If there was a political decision in favour of fiscal union, you could of course issue eurobonds at the end of the integration process. But this is not something I’m asking for.
In both models, you would penalise rule violations. In the Maastricht model, the rules would be the stability and growth pact, with automatic sanctions for violations and the no bail-out clause. In the fiscal union model you also need strict rules for deficit and debt. If you breached those rules you would need to delegate your national sovereignty on fiscal policy to a supranational level. I think the true question at the heart of this is: are governments, parliaments, and people ready to accept a supranational level, a European level that assumes the ultimate responsibility for fiscal policy, at least in case of a breach of the rules?
In my view, the declaration from leaders at the last EU summit was not clear enough. They talked about minor treaty changes. But this is not a minor change – this is a major change with follow-up changes in national constitutions. Without clear answers, you might not have the basis for a stability-orientated monetary union.
In yet other words, following all this insight, we are right back to square one, where the ECB wants European governments to give up their sovereignty to Germany so all shall be well, while European governments promise that all shall be well, in just a little while, just as soon as the latest set of Keynesian reforms are enacted... some time tomorrow... but giving up our sovereignty to Germany? Fuggedaboutit.