By Nathan Tankus, a writer from New York City. Follow him on Twitter at @NathanTankus
Last week following the decision to raise ELA a paltry 900 million dollars for Greek banks. In that press conference he said many things but I’d like to focus on one passage that has gotten no attention:
There is an article in the Treaty that says that basically the ECB has the responsibility to promote the smooth functioning of the payment system. But this has to do with the functioning of TARGET2, the distribution of notes, coins. So not with the provision of liquidity, which actually is regulated by a different provision, in Article 18.1 in the ECB Statute: “In order to achieve the objectives of the ESCB, the ECB and the national central banks may conduct credit operations with credit institutions and other market participants, with lending based on adequate collateral.” This is the Treaty provision. But our operations were not monetary policy operations, but ELA operations, and so they are regulated by a separate agreement, which makes explicit reference to the necessity to have sufficient collateral. So, all in all, liquidity provision has never been unconditional and unlimited.
This is a truly shocking statement. To understand why, we need to go back to the basics of central banking. Banks have accounts at the central bank (I’m going to call the balances in these accounts “settlement balances” in line with non U.S. Conventions) which are primarily used to settle payments with other banks. When you use a debit card issued by one bank to pay someone with a bank account in another bank, your bank has to in turn send a payment using settlement balances to make that payment.
As should be obvious from that description, in order to make that payment your bank has to have sufficient settlement balances in its account at the central bank or the central bank must provide an overdraft. Thus, if the smooth functioning of the payments system is defined as the ability of depository institutions to clear payments, the central bank must ensure that settlement balances are available at some price.
The Federal Reserve explicitly recognizes this in its by stating that “the Board recognizes that the Federal Reserve has an important role in providing intraday balances and credit to foster the smooth operation of the payment system”. Draghi is arguing that the ECB’s mandate to “promote the smooth functioning of the payments system” is defined differently than the Federal Reserve’s mandate and (as far as I can tell) every other Central Bank’s payment system mandate around the world. I can’t over-emphasize how radical a departure Draghi’s position is from the norms of central banking. Whatever else we may want to criticize the Federal Reserve’s and the government’s response to the financial crisis, they did preserve the the smooth functioning of the payments system and ultimately . The problem was that they didn’t put Too Big To Fail banks in a form of receivership and didn’t prosecute bank executives, not that they made sure payments continued to take place.
As disturbing as the European Central Bank position already is, it becomes more frightening when we analyze why the Greek banking system has been cut off in detail. First, remember that the ECB’s official position has been that the Greek banking system is solvent as long as Greek government bonds preserve a certain value. Second, the ECB judges the value of those government bonds not be their market price but by their view of the Greek government’s “compliance” with the dictates of the EU and the IMF. As Vice President Constâncio said during the press conference:
when a country has a rating which is below the investment grade which is the minimum, then to access monetary policy operations, it has to have a waiver. And the waiver is granted if there are two conditions. The first condition is that the country must be under a programme with the EU and IMF; and second, we have to assess that there is credible compliance with such a programme.
The bigger picture here is that under this interpretation of the ECB’s operating mandates the European Central Bank can, at any time choose to exclude a particular country’s bonds from its monetary policy operations, watch its credit rating fall and eventually, force the country to choose between an IMF program and having a frozen banking system and no ability to borrow. Not only must that country enter an IMF program but it must be judged to be in “credible compliance” by the ECB at all times.
Being in credible compliance is a necessary not sufficient condition for borrowing. Recall that the statute Draghi quoted said that it “may”, not must, “conduct credit operations”. This is how they’ve justified keeping the Greek banking system on such a tight leash despite claiming that the Greek Government was in “credible compliance” up until recently and how they can justify not extending ELA by enough to restore normal operations in the current situation. The ECB is like an abusive spouse who believes marriage means they can beat their significant other for any reason and that previous beatings justify beatings in the future.
Even worse, if the Greek banking system is insolvent because of defaults from the private sector in Greece (very likely), the Troika has made the reduction in value of deposits (a bail-in) the preferred tool (along with privatization) to return solvency to the banking system. In other words, there is not only no guarantee of orderly clearing of payments but also no guarantee that depositors will eventually be made whole. It is official policy that at any time the value of a deposit in one bank does not equal the value of a deposit in another bank. Cyprus was not a fluke. It would be foolish for depositors in other countries to feel safe, except perhaps those in Germany and France. Their political leaders would likely suddenly discover the need for depositors to be fully protected in the Eurozone if they were ever forced to recognize insolvency.
Putting all this together, Europe now has a system where liquidity and insolvency problems can occur and can be deliberately generated (at least in part) by the central bank. Then the Troika can force that country into an “IMF program” if it wants to continue having a functioning banking system. Alternatively, the central bank can choose to simply “suspend convertibility” to the unit of account and force the write down of deposits until the banks are solvent again. During this drawn out period payments grind to a halt and mass business disruptions and failures can and will be generated. In other words Europe has created a system where you either comply with the dictates of unelected bureaucrats or you accept a more disorderly version of the United States banking system before the Civil War. The bottom line is that if you feel inclined to visit Europe remember that the payments system can fail you at any time. Plan accordingly.