Colm McCarthy and Kevin O’Rourke rightly point today to the damage that a sense of grievance towards the ECB does to political support for necessary domestic adjustment efforts (see Kevin’s post below). While few would disagree that the ECB has been remiss on the public relations front, I think the all-things-considered case against it has been overdone.
Two main charges have dominated the recent discussion: that the ECB “bounced” Ireland unnecessarily into a bailout; and that it has unfairly insisted that Irish taxpayers bear the burden bank losses that are rightly the responsibility of senior bondholders.
I think it is fair to say that the bailout of Ireland was actually well advanced before the formal EU/IMF programme. Borrowing from the ECB by the six main banks had risen from €30 billion in August to €66 billion by November (with overall borrowing from the Central Bank of Ireland rising from €14 billion to €45 billion over the same period) as wholesale deposits fled. This slow motion bailout was taking place without formal conditionality, and was leaving the ECB with default risk that any central bank would be loath to take on. Can we really blame it for pressuring for a formal deal that would put in place a more credible banking and fiscal adjustment strategy and force official lenders to shoulder a significant part of the default risk?
I doubt if anyone on this site disagrees with the principle that taxpayers should not be on the hook for the losses of investors in private institutions. But the mistake of the original blanket guarantee, the systemic importance of AIB and BOI to the Irish credit and payments system, and the legal equality of depositors and senior bondholders under Irish law (which contrasts with depositor preference in the U.S.) were always going to make loss imposition problematic. In the hope that it would facilitate a degree of loss sharing, many of us argued for a new bank resolution regime to be in place for when the original guarantee expired last September, but it was always obvious that such loss imposition through retrospective legislative changes was not going to be easy.
In any event, the needed resolution regime was not put in place and so the practical potential for loss sharing was limited even without the ECB’s objections. Moreover, with a significant (if unfortunately indeterminate) fraction of the bonds held by Irish residents, and so a real danger of domestic financial contagion, the practical opportunities for loss imposition on unguaranteed seniors – at least beyond Anglo and Irish Nationwide — was likely limited.
Against these lost opportunities for loss sharing we should, in fairness, weigh the value of the extraordinary funding support the Irish banks are receiving, and recognise that the ECB has legitmate goals that go beyond the rescue of the Irish banking system. The funding support is now coming with an interest rate of 1.25 percent. It is not obvious how much of a subsidy in contained in this rate, but I don’t think it comes close to compensating for the continuing default risk being faced by the ECB, and nowhere near the rate that would need to be paid for these funds to be secured on the market – if they could be secured at all. One might argue that the ECB is only doing its job as lender of last resort. But this classic function is to provide liquidity support for short durations to solvent banks on adequate collateral. Even the ECB’s sternest critics must recognise that it has gone well beyond this role.
All things considered, it seems to me the strength of the case for a major grievance against the ECB is less than many suppose.