Mody: The ECB is much too stodgy – the euro fuelled a leveraged bet that went bad


13 replies on “Mody: The ECB is much too stodgy – the euro fuelled a leveraged bet that went bad”

Mody saw the Augean stables from the inside.

Chopra is similar. He was very good at the IFSC in May and gave a super overview. Nothing has really changed in the meantime

I noted this at the time

“Ajay Chopra, now IMF Mission chief for dear old Blighty got the ball rolling.
A very important topic. Talking to an Irish audience about banking union is “preaching to the converted”. He pointed the audience to Staff Discussion note 201301 on the IMF website.
Gave an overview of the ancient past pre Lehman in the EZ when the
interbank market functioned but with big capital flows as side effects- “Procyclicality was injected into the monetary transmission mechanism and there was no possibility of controlling local interest rates”. National bank regulators controlled their own patches and cross border effects were ignored.
The shopping list was revealed .
• Banking union with a single supervisor
• a single resolution authority
• a common safety net involving
o Deposit insurance
o fiscal backstops
o burden sharing and
o a credible Lender of Last Resort
Regarding financial regulation he observed that “power and resources must go hand in hand”. I wonder why they don’t.

Some work has been done at EU level but most of this infrastructure was missing when crisis struck. It takes time to set up the banking resolution framework. It’s like building new stables while a search party is out looking for the horse.

The IMF would like to see a banking union with supervision of all EZ banks to limit the scope for regulatory arbitrage- “consistent application of prudent norms”.. “would help with the promotion of financial services in the single market”

The revised system would need appropriate checks and balances and well designed structures, in contrast to the current system. There would be open questions regarding the balance of power between the ECB and local regulators. “Oversight and accountability are required so that incentives are appropriate”.
“Responsibility requires enforcement power”. CF John Hurley

The IMF would recommend joint inspections , peer reviews and cross country teams led by ECB head. He mentioned several times that incentives must be set appropriately. Richie B’s lending targets by volume probably wouldn’t have passed.

Fortis and Dexia mop ups were very messy especially with the cross border angles. A properly staffed and resourced regulatory system would over time build up expertise and we could move away from the current ad hoc late night panic driven response that has typified the crisis to date. Hanging over the whole speech was the sense that the Irish bailout was crap and way too expensive.

“If a bank becomes unviable and is non systemic it should be resolved at least cost”. Where fiscal space is limited then the ESM should step in so that banks in trouble would have an owner of unquestioned strength. The ESM could help to stabilise prices but would not make expected losses – rather it would aim for what a patient investor would expect over time. Capital would not be injected into non viable banks.

Regarding resolution he said that a hierarchy of claims must be defined in order to reduce uncertainty around the capital structure. Insured depositors are given clear preference in legislation. The system would be prefunded through risk based premiums but in times of crisis there might be a need for the involvement of the ECB: “Of course you always need a LOLR”. “The ECB in steady state should eliminate sovereign/banks links”

Legacy issues would be addressed by “creating the right incentives to identify losses. ”

A single supervisory mechanism would cover the top 3 banks in each jurisdiction. PROBLEMS WOULD BE IDENTIFIED SOONER

Cyprus was an example of a situation “precisely where a banking union would have been preferable to the ad hoc method actually applied” . A least cost method could have been used with either a good bank/bad bank or direct ESM recap, the response could have been faster, it would not have had to be dependent on the national system.

He summarised by saying the mess calls for a very complex endeavour, that issues of transition as well as steady state issues need to be addressed , that actions need to be forceful and determined with a strong legal foundation and that it is important to do it properly and quickly.”

They are still afraid of rattling the markets.

What a mess.


The ECB(undesbanke) is, quite simply, NOT a functioning and fully independent Central Bank; it was designed by, and remains fully captured by, ‘The German Ideology Mark II’.

The EU Citizenry will continue to suffer, and EU geo-political influence will continue to wane, until its design flaws and incomplete remit are rectified. That said, I do not see any political will to do so in the near term event horizon.

@Prudent Hans

Michael Crowley of BOI did a good presentation during the week.
One of his charts, no 4, showed GDP forecasts for 2013/14/15 for world, US, UK, Euro.
The euro area has clearly become the sick man of the globe.
His summary charts were very good and well put together.
The facts are catching up on the official EZ spin.

I dunno about the US, Joseph.
All the OECD countries are running the same economic memes.
Financialisation should have been put to death in 2009. Ohio could have done it in 28 minutes 😉

Lex in the FT say there is value in tweaking a projection or in a lower interest rate.
No, there isn’t.

I tend to agree wit h a lot of your observations, but everything is relative and the EZ is the sick relative.
There is now so much liquid money, totally unconnected to the ‘real economy’ (sic Draghi) except in its ability to destroy it, that any forecasts are very suspect.
There is simply too much wealth in the hands of too few. The pyramid is completely unstable and those with the money are as tight as Scrooge on Christmas eve.
Imho, they do not meet in Davos to decide who to give it to.

“the euro fuelled a leveraged bet that went bad”

One of the things about having the balls to take a financial position or throw up a shopping centre is that it doesn’t come with any right that says the price you lay is the right price for the long term.

If you like to gamble, I tell you I’m your man
You win some, lose some, it’s – all – the same to me
The pleasure is to play, it makes no difference what you say
I don’t share your greed, the only card I need is
The Ace Of Spades

Conservative systems such as the Bundesbank or Irish governance models change if at all only when there is a crisis.

The French pushed the euro project and adopting the Bundesbank model for the planned central bank was necessary to reassure the Germans.

France made it clear that support for the model was not superficial; the Banque de France became independent in 1993 and with Jean-Claude Trichet as its governor, it launched the ‘franc fort’ (strong franc) policy. When the euro fell to $0.87 in Sept 2000, the German chancellor viewed it as positive for exports while the French wanted a stronger euro.

The Bundesbank has gone along eventually with what it once viewed as radical – that is not going to change.

Burden sharing? Now, that could be a good thing if there were no strings attached. 😯

European Deal on Winding Down Failed Banks in Peril

‘Even before the deal was announced, members of Parliament and officials of the central bank, including Mario Draghi, its president, had argued that it was unnecessarily complicated and would slow decision making. They were also concerned that it would take 10 years for the resolution fund to reach its full strength of 55 billion euros, or about $75 billion, leaving questions about what would happen if a bank needed to be shut down before then. […]

[M]embers of Parliament have dug in their heels. They are particularly incensed by a provision, inserted at the insistence of Germany, that sets the legal basis of the resolution fund on treaties between member states, rather than European Union law.

German protectionism [highly regressive in EU terms] ensures that this ‘fudge’ is a dead fish.

Deflation is alive and well over quite a lot of the EU. The position at the moment is flattered in the statistics by the fact that consumer prices have been falling for only a few months in most of the countries affected, and by a pre-Christmas bump in prices that shows up in the most recent – December 2013 – data. However, if we get another few months of this without the ECB acting it will become even clearer that while it may be European it is not a Central Bank.

Negative inflation in crisis countries would be acceptable if it meant rapid gains in price competitiveness, but inflation is so slow in the rest of the eurozone that they are gaining price competitiveness within the EU at only a slow crawl. The ECB’s tight money policies in a world of loose money are further strangling crisis countries by making the euro artificially strong.

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