The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (47 page)

The fear on the other side of Frankfurt, at the Bundesbank, was
Gelddrucken
, money printing. From the outset, Germany had been reassured that the euro was a reincarnation of the German currency, a ‘euromark’. Anti-inflation discipline and targets had been inherited directly from the Bundesbank, and hardwired into the Maastricht Treaty. Bundesbank personnel such as Otmar Issing had been transplanted to the ECB. For the first few years, even the old-school German monetarist tradition of targeting monetary growth was included as part of the way that the ECB did business. The ECB successfully kept inflation below 2 per cent – at 1.97 per cent in its first decade or so – a better record of monetary stability than even the Bundesbank. Periodically the ECB would lambast its constituent nation-states for fiscal indiscipline. No one took much notice.

Then came the crisis: Greece, Ireland, Portugal, Italy, Spanish banks and then Cyprus. Europe was paralysed, given the choice between Germany’s ‘smallest loan possible, at the last possible moment’ strategy, and the collapse of its periphery. Elsewhere, in the USA and UK, central bankers had used quantitative-easing programmes to lower long-term interest rates by gobbling up their own government’s debt by the mountain-load. But the Eurozone was different. Only some smaller nations were in trouble, while the core nations were seeing their interest rates going down because of the crisis. It was like a spontaneous, naturally occurring quantitative easing for the rich Eurozone nations, caused by the collapse of the poorer ones. For many in Germany, this was the natural order of things – market discipline at work. An ECB intervention would be illegal under the Maastricht Treaty prohibition on ‘monetary financing’. Maastricht anticipated and forbade governments funding themselves using money magically created by their central bank. Even putting that aside, for the ECB to intervene in a manner routine in London and Washington would have required value judgements to be made and risks to be taken on Greek debt, Irish debt and Italian debt. In the year before Draghi’s presidency began, two high-profile protectors of Germanic instincts on the governing council, Jürgen Stark and Axel Weber, resigned amid concern about the bank purchasing such debts. Their only answer was ‘
Nein
’.

‘The ECB is not here to bail out Silvio Berlusconi,’ one leading ECB figure told me in private. The previous year, 2011, relations between the ECB and the mercurial Italian leader had been torrid. In the Italian budget crises of the 1960s and 70s, the Bank of Italy, the country’s central bank, could be relied on and was legally obliged to buy up Italian government bonds – a form of monetary financing. In 1973 Governor Guido Carli wrote in the Bank of Italy’s annual report that to abstain from buying his government’s debt ‘would be a seditious act… refusal would make it impossible for the government to pay the salaries of civil servants and the pensions of most citizens’. So Berlusconi’s 2011 gambit that the ECB would buy up Italian bonds had a grounding in Italian history, even if it was entirely at odds with the German conception of what the bank should be doing. In May 2010, at the beginning of the Greek crisis, the ECB had created the Securities Markets Programme (SMP) to buy Greek government debt for about a month, with the aim of lowering effective borrowing rates and defusing the panic in bond markets.

A year on, the conflagration had spread to Italy, with its stagnant economy, its dysfunctional political system mired in sleaze and its giant mountain of public debt. Italian and Spanish bond yields were rising dangerously above 6 per cent against a backdrop of possible Greek euro exit. The gold price was surging, the USA was about to lose its AAA rating. At its August meeting in Frankfurt, the ECB governing council discussed Italy’s problems, but no consensus was reached on whether or not to resume the purchase of Italian bonds.

The following day the ECB’s then and future presidents, Trichet and Draghi, wrote an extraordinary secret letter, in English, to Berlusconi, outlining steps they required the Italian government to take in order ‘to urgently underpin the standing of its sovereign signature’. Existing budget plans were ‘important steps, but not sufficient’. Large-scale privatisations, reform of wage bargaining, a review of hiring and firing laws, and a speeding up of spending cuts were all specified as ‘essential’ for something – implicitly the ECB’s purchase of Italian bonds – though that was left unsaid. For good measure the letter also specified the legal method through which Berlusconi should make the changes: ‘as soon as possible with decree-laws, followed by parliamentary ratification by end September 2011’. The letter concluded with a terse sign-off: ‘We trust that the government will take all appropriate actions. Mario Draghi, Jean-Claude Trichet’. On the same day Berlusconi announced at a press conference that Italy would balance its budget one year early, by 2013, a key demand of the ECB letter. Italy’s economic sovereignty seemed at a low ebb at this point. (Three months later the European Commission’s Olli Rehn would outdo even Draghi and Trichet when he sent Berlusconi a thirty-nine-point questionnaire about his reform plans, with a request that the Italian leader append his answers and send them back to Brussels by return.)

When questioned about their intrusions into national sovereignty, the executive members of the ECB’s governing council are rather defensive. ‘I don’t accept the premise of your question,’ one told me. ‘We were not aiming to interfere in any way with the political process of any country. We were, as we should be, providing advice. We were saying what could be useful for the countries themselves to improve their situation in markets. Our role is to provide advice, so we could not impose anything.’ His words seemed rather inconsistent with the tone of the peremptory letter sent to Berlusconi.

At the IMF, officials looked on with interest. ‘The ECB made desperate attempts to solve the problem by relaunching the SMP for Italy, with some “conditionality” being negotiated directly,’ one of them reflected. ‘Of course Berlusconi would say yes to everything, the ECB would buy the bonds, and then suddenly the next day [he] would renege on all his promises.’ The ECB at that point was effectively underwriting Berlusconi in office. He had survived a budget vote after a month, but had severe trouble over other elements of Italian economic reform, and then began backtracking on unpopular elements of the package. The ECB essentially stopped buying Italian bonds.

On 19 October 2011, 200,000 Greeks protested outside the Greek parliament, amidst Molotov cocktails, tear gas and riot police. In Paris on the same day, President Sarkozy’s wife Carla Bruni went into labour, while the president himself was attempting to give birth to a new European order. The unwieldy management of the euro crisis was to be replaced with an executive ‘economic government’. Sarkozy flew straight from Carla Bruni’s maternity ward in Paris to a meeting at Frankfurt’s Old Opera House. The day had been set aside as a formal farewell to the departing ECB president, his fellow countryman Jean-Claude Trichet. Some 1,800 guests, including a host of luminaries, paid various degrees of tribute. The former German chancellor, Helmut Schmidt, warned of the ‘dramatic failure up until now of the European Union’s political bodies to contain the dangerous turbulence and uncertainty’. He continued: ‘What we have, in fact, is a crisis of the ability of the European Union’s political bodies to act. This glaring weakness of action is a much greater threat to the future of Europe than the excessive debt levels of individual euro area countries.’ The incumbent German chancellor, Angela Merkel, put it like this: ‘If the euro fails, then Europe fails. But we will not allow that, for the future of Germany was, is and remains for us connected with the future of Europe.’ The celebration ended with a ceremonial handing over of the ECB chairman’s bell from Jean-Claude Trichet to Mario Draghi.

In the evening the ECB had arranged the opening gala of a month of Italian cultural events, ironically coinciding with the moment that Italian political dysfunction seemed on the verge of bringing down the entire project. The Treaty of Rome created the European project, yet in Rome that project now floundered. In the programme notes, Mario Draghi reminded concert-goers that ‘one of the first seeds of the idea of a united, federal Europe was the Ventotene Manifesto, drafted in 1941 by Ernesto Rossi and Altiero Spinelli, two ardent Italian anti-fascists who were confined by the regime to the little island of Ventotene’. He reminded his listeners that 2011 was also the 150th anniversary of Italian political unity, ‘after a lengthy process that led to the formation of a single conscience’.

At a more private leaving party for ECB president Trichet, the sound of Claudio Abbado conducting Rossini’s
Barber of Seville
floated through the Old Opera House. President Sarkozy, obsessed with the notion of ‘economic government’ for Europe, developed the concept of the ‘Groupe de Francfort’ (GdF), a tight executive of elected leaders and unelected eurocrats to drive forward decisive action to end the crisis. It would be a political and fiscal foil to the European Central Bank. However, Sarkozy faced strong resistance to his plan to give Europe’s bailout fund, the EFSF, a banking licence and therefore access to ECB funding, a move that would have increased the bailout fund’s firepower into the trillions. Undeterred, at a subsequent summit Sarkozy arranged for GdF pin badges to be distributed to his selected crisis A-team. President Obama dropped in on one meeting. The GdF also seemed to take against Berlusconi, who was publicly laughed at by Merkel and Sarkozy at a summit meeting. In Brussels, they joked that the ‘Groupe’ existed mainly in Sarkozy’s head. Financial markets continued to test Europe’s capacity to provide rescues for too-big-to-fail Spain and too-big-to-bail Italy.

After the ECB reduced its bond purchases, Italian yields shot back up to an even less sustainable 7 per cent. In a steamy and chaotic frenzy of plots and intrigue, Berlusconi eventually resigned. It seemed to be a direct result of the ECB. Senior figures in Italy say that this is an exaggeration, and that Berlusconi had already lost his coalition. Either way, Berlusconi would never forget the behaviour of the central bankers in Frankfurt. Evidently, refusing to buy Italian government bonds was no longer ‘seditious’. And at the ECB and in Berlin they would not forget the difficulty of enforcing conditionality on big European states. When asked if Italy had effectively taken the money and run, senior Berlin officials are clear: ‘Very nakedly it was this. It’s a clear expression that if you don’t have a system with reliable conditionality, you can’t give them the money.’

There are analogous stories about the power exercised by the ECB in Ireland, Spain and Cyprus. A former member of the Eurogroup of finance ministers estimates that 70 per cent of what is decided at their summits has been written in advance by the European Central Bank. Ireland thought it had done everything right. In the lead-up to the crisis it had mainly kept to its Brussels borrowing limits. Post-crisis, in its dealings with other members of the Troika, the Irish were lionised: ‘The Irish government was a delight,’ a senior Troika figure told me. ‘The Irish were extremely pragmatic, they wanted to put an agreement in place quickly. We never had to twist their arm or anything. And they always wanted to do the toughest stuff up-front, and they wanted to cut wages by 20 per cent across the board, which is unbelievable. So Ireland was not a problem at all.’

Across a table in Merrion Street, Dublin, in early 2011, the officials of Ireland’s department of finance debated with negotiators from the Troika. There was not much to negotiate, because there were 190 conditions laid down by the Troika, all of which the Irish government wanted to implement in any case. All the unpopular ones could now be blamed on ‘overlords’ from the IMF and ECB. It was political cover for a reboot of Ireland. But there was one giant cloud: its rotten banks – in particular, Anglo Irish Bank. It was a cloud that had lingered from the start of Ireland’s descent into the bailout club.

Anglo Irish was a basket-case bank, an all-encompassing bet on a never-ending Irish property bubble. Once awarded the title of ‘world’s best bank’, it was fairly close to being the worst, in a competitive field. The skeleton of Anglo’s flashy unfinished headquarters in the Dublin docklands, with a Ferrari dealership next door, is the symbol of Ireland’s excess. Still, that excess would have been a matter for Ireland’s coterie of corrupt, property-addled bankers, were it not for a disastrous decision made in 2008. That year the Irish government guaranteed all deposits, and then all lending, including the financial market bondholders who funded Ireland’s lending binge. Unlike ordinary depositors, they would have expected to reap the consequences of their commercial bets. No more. Free-market capitalism had been put on hold amidst the global financial panic. The bondholder bankers, most of them foreign, were guaranteed too – a blanket guarantee of €440 billion, about three times the size of Ireland’s entire annual economic output. It was, at first, an inexpensive way of stemming a bank run, as it cost little up-front. The late finance minister Brian Lenihan called it ‘the cheapest bank bailout in history’. In the UK it provoked official panic, as massive flows of deposits went west across the Irish Sea, in pursuit of those generous guarantees. But two years on, when the guarantees were called, the cheap talk proved to be fatally expensive.

‘If you knew it was going to cost €30 billion, the sensible thing for the Irish government to do would have been to have closed it down to depositors and for bondholders to have to taken a hit,’ one of Ireland’s most senior policymakers told me. ‘For the Irish authorities in retrospect, I think it was a very bad mistake.’ Anglo Irish did not have cash machines, and could not be considered systemic for the functioning of ordinary deposits or the payments system.

The first guarantee of September 2008 was an Irish sovereign decision. Indeed, the ‘Anglo Tapes’ of internal conversations of its bankers from just before this decision showed the contempt Anglo Irish had for Irish taxpayers. Not only was an initial negotiation of €7 billion a number ‘picked out of my arse’, but the senior bankers also plotted to lure a small amount of taxpayer funding, knowing that the government would never be able to stop and would not get its money back. It is true that it was in keeping with European policy that ‘no bank should fail’ after the Lehman Brothers crash, but the decision was made on flawed grounds, by Irish politicians. The second guarantee, made in November 2010, is more complex.