The Alchemists: Three Central Bankers and a World on Fire

by Neil Irwin

  About the same time as the Flash Crash, Trichet and his colleagues on the ECB Governing Council gathered to eat at the Palácio da Bacalhoa, a fifteenth-century estate south of Lisbon. At the moment of the crash, a bit before 8 p.m. Lisbon time, many of the central bankers’ BlackBerrys started vibrating simultaneously. They couldn’t really attend to the confidential business of the ECB during the dinner itself. Their Portuguese hosts were present; so were many of the men’s’ wives. Nonetheless, in one pointed moment, German Bundesbank president Axel Weber, who was more concerned than most members of the Governing Council that nations like Portugal weren’t cutting their budget deficits enough, asked a Portuguese official about what his country was doing to reduce spending. His answer? Portugal was thinking of taxing public employees’ thirteenth- and fourteenth-month’s salaries, the bonuses that Portuguese workers received just like their Greek counterparts. They’d been tax-free.

  Weber was astonished. Forget taxing them. “Why should public employees receive thirteenth and fourteenth payments at all?” he asked. “We got rid of them in Germany years ago.”

  Trichet waited until dinner was over, about 10 p.m., to convene a secret meeting to discuss the Governing Council’s next move. With interest rates spiraling every which way—upward in the GIPSIs, downward in stronger countries like Germany, France, and the Netherlands—the ECB was losing control over monetary policy. Suddenly, ten-year interest rates in Germany (2.79 percent on May 6), were more than three percentage points lower than in Portugal (6.14 percent). The gap with Greece was widening into a chasm. That meant that different European companies and households, even if otherwise identical, were facing dramatically different financial conditions. Trichet asked for the officials to brainstorm ways they might address the crisis.

  One spoke up. “We could buy government bonds,” he said. The ECB could go into bond markets and buy securities to try to get rates down in the countries where they were climbing skyward. It might not even take much in the way of purchases to change the psychology of the markets. It wouldn’t be the printing of money to fund governments per se. That was forbidden, after all. It would simply be ensuring that the central bank’s monetary policy was working. Ensuring, to use the technical term, the functioning of the “monetary transmission mechanism.”

  There were people who spoke up against the idea that night in Lisbon, for example, ECB Executive Board member Jürgen Stark, he of the Greek mission earlier in the spring. But the identity of the man who broached the idea of bond buying gave Trichet some inkling that he could make the move with the broad support of his committee?

  It was Axel Weber.

  Weber was a forceful presence in the ECB’s decision-making body. This came in part by virtue of his job as leader of the national bank of the largest eurozone economy, which was also the trading desk that carried out more of the ECB’s decisions than any other. It came in part by virtue of his status as heir apparent to Trichet. The Germans had not yet had one of their own occupy the ECB presidency, and Weber seemed the likeliest candidate to take up the job when Trichet’s term was to end October 31, 2011. And Weber’s stature came in part from his personal manner and background. He was a more accomplished economist than most of his counterparts on the Governing Council, and he wasn’t shy about expressing his views. Weber relished the give-and-take of a vigorous debate on economic theory. Big and barrel-chested, with a certain erect Teutonic posture, he looked a little like the television gangster Tony Soprano.

  Trichet knew that the Germans would be the biggest obstacle to starting up bond purchases. The prohibition against central banks financing governments was rooted in their experience under Rudolf von Havenstein’s Reichsbank in the 1920s, the most vivid illustration of what can go wrong when that practice is carried to extremes. The prohibition against monetization is a foremost principle of the Bundesbank. But if Weber would be comfortable with a limited, strategic use of ECB bond purchases to ease the crisis, Trichet would have more room to move without coming in for criticism from his more hawkish committee members.

  But when Weber awoke the next morning, Friday May 7, he reconsidered the idea that he had seemed open to the evening before. Maybe he was reevaluating in the cold light of day something that he’d merely kicked around in a more academic, theoretical way the night before. Maybe he realized how much internal blowback he would face at the Bundesbank if he endorsed even limited bond purchases. Hell, maybe the ghost of Rudolf von Havenstein had visited him in the middle of the night.

  Whatever truly drove his shift in thinking, Weber boarded a plane from Lisbon to Frankfurt and began typing out an e-mail during the three-hour flight. He laid out several key ideas. (Sources described the content of the message in detail but wouldn’t provide a written copy.) If the ECB were to buy government bonds without the governments themselves having made an ironclad commitment to back each other’s’ finances, it would make the central bank, not elected officials, ultimately responsible for Europe’s financial well-being. Greece was fundamentally insolvent, not just illiquid, and bond buying by the ECB wouldn’t change that reality. In any case, such purchases would violate the spirit of the Maastricht Treaty that created the central bank, even if they’d be technically legal. The ECB could perhaps provide more lending to European banks to ensure the financial system is sufficiently liquid, but it was up to political authorities to worry about solvency. It could take a few more days of scary moves in the markets to force the politicians to take action, so if the ECB intervened now, they might not ever make the sort of fundamental changes needed.

  If the Governing Council were to begin bond purchases, Weber continued, the Bundesbank president would want his opposition noted publicly, contrary to the ECB’s usual practice. If Trichet failed to make that known in his press conference, Weber suggested, he would make it known to the world on his own.

  Weber’s plane landed in Frankfurt. He hit send, instantly depositing the e-mail in the inboxes of the twenty-two members of the ECB Governing Council. Weber’s words made clear that if his colleagues outvoted him and decided to buy the bonds of Greece and other troubled nations, it would come at a cost.

  While Weber made his way to Frankfurt, Trichet was bound for Brussels. The heads of European governments were scheduled to meet on the seventh floor of the Justus Lipsius building, a giant glass-and-concrete monument to European unity that looks like a convention center. Trichet’s mission was to persuade them that the Greek bailout of the previous weekend wasn’t enough. The bond markets were turning on a wide swath of European nations, not just Greece.

  Going in, many of the prime ministers and presidents of Europe seemed not to comprehend the degree of risk. Trichet presented a chart showing the selloff of GIPSI bonds that had accelerated over the previous several days. “My main message for the governments was: Some of you have behaved very improperly and created an element of vulnerability for your own country, and by way of consequence for Europe,” Trichet later told Bloomberg News. “Now the situation calls for taking up responsibilities.”

  The responsibilities he had in mind: creating a credible assurance that the governments of Europe would stand behind each other, that they would act collectively to ensure none would become unable to pay its bills. Trichet was confident after the late-night meeting in Lisbon that he had the votes on the Governing Council to begin buying bonds. But that wouldn’t offer a permanent solution to Europe’s dilemma. He needed to dangle the possibility of ECB bond purchases as a carrot, a reward for government action. At the same time, Trichet didn’t want to be explicit about the possibility; after all, the whole point of a central bank is that it makes the decisions it thinks best independently, not as part of a give-and-take with elected officials. So the discussion in Brussels became an exercise in insinuation, a negotiation in which the terms of the talks were unstated—a quid pro quo in which the quid could not be named.

  “We will see what we do,” said Trichet, his cha
rts looming behind him on a screen. “But we cannot be responsible for ourselves and you. We need your action; we have an absolute need for your action,” he said according to people present, becoming louder and more animated and his hair more unkempt as he progressed. One of the less financially savvy heads of government tried to pin Trichet down on exactly what the ECB might do; he remained vague and noncommittal. But most of the leaders, over a dinner of asparagus and turbot, understood exactly what he was getting across: The ECB will buy bonds to ease the pressure from markets, but if and only if you do your part as well.

  Trichet received an earful from some of the heads of state, particularly Nicolas Sarkozy, who had consistently pressured the ECB to be more activist. But Trichet got their attention. The attendees set their finance ministers to work to try to create a mechanism to guarantee Europe. The ever bombastic Italian prime minister Silvio Berlusconi stopped by the press room after the dinner and told reporters, with excessive confidence, that a rescue deal would come that very weekend. “When a house is burning, it doesn’t matter where the water comes from,” he said. Unsaid was that he and many of the heads of government were counting on Trichet to lead the fire brigade.

  • • •

  They had arrived jet-lagged and bleary-eyed, from all points of the earth, carrying sheaves of paper and emerging from black Mercedes sedans, some with a burly security guard or two in tow. For the central bankers, Basel—pronounced “Bahl” by the cognoscenti and like the name of a fragrant summer herb by everyone else—is supposed to be a place of refuge. They check into their preferred hotels—the Americans favor the Hilton; many of the Europeans the rather more grand Three Kings—and step temporarily into the close camaraderie of people who understand the unique burdens of a central banker. They head to a fortress of a building that might have been designed as a workplace for George Jetson: a cylindrical tower that looks as if someone squeezed it slightly in the middle, with a base that wraps around without a straight line in sight, as if the elegance of the curves can hide the imposing thickness of the blast-protected stone. The building may be steps from the Basel train station, but legally it isn’t on Swiss soil. Like the United Nations headquarters in New York, it’s an entity without a country, belonging to the world. The sign out front says BANK FOR INTERNATIONAL SETTLEMENTS, but the place might more easily be thought of as the central bank of central banks. This was where Trichet, Weber, and most of the other leading central bankers would spend the fateful hours of decision over how far they were willing to go to save Europe.

  Normally, at the Global Economy Meeting, about thirty governors of central banks in Europe, Asia, Africa, Australia, and North and South America, whose countries together account for 80 percent of the world’s economic output, enter a conference space and sit around a circular table. In the center are several big-screen TVs, facing outward for presentations. Each governor brings a deputy; they sit one row back, ringing the room. The head of the U.S. Federal Reserve usually starts, offering a briefing on the state of his country’s economy, the world’s largest, then answering a series of questions: How will U.S. authorities reduce their budget deficit? What exactly is going on with the American housing market? The discussion then pivots to Europe, and then to emerging nations like China and India. The session continues for hours, occupying these elite policymakers for an entire intellectually exhausting morning.

  On Sunday evenings, they feast. Think of the groups that peel off for dinner together as concentric circles of influence. On the outside, there are the deputies. Next are the governors of central banks of smaller countries. And finally, the innermost circle. Its official name is the “Informal Dinner for Governors of the Economic Consultative Committee.” In reality, it is the most exclusive regular dinner party on the planet. The heads of the world’s most important central banks gather to dine together, usually on the BIS’s eighteenth floor: the chairman of the Federal Reserve and president of the Fed’s New York outpost, the president of the European Central Bank, and the heads of the central banks of Japan, Britain, Germany, France, Italy, Canada, and Switzerland. The group was expanded in 2009 to include the central bankers of China, India, Brazil, and Mexico too, a signal that their countries had arrived on the global stage. The diners eat well, with black-clad waiters delivering a progression of precise, subtle dishes—lobster, duck, lamb—each in a rich, buttery sauce. They drink even better, with generous pours of Bordeaux and Burgundies, which Global Economy Meeting attendees jokingly refer to as “grand cru BIS.” Early on in his time as chairman of the Federal Reserve, Ben Bernanke, noting that the event is called an informal dinner, remarked to a colleague that “this is one of the four most formal meals I’ve had in my life.”

  The Basel club, complete with great food and wine and intimate conversation on Sunday nights, has existed since 1930. “These people have been concerned with their own problems without regard for the rights of anyone else,” said an American attendee in 1931. “As they sat down around the table for two days you could almost see their point of view change as they began to realize the effects of their own actions . . . the greatest use of the BIS is not in the specific action it may take but in the opportunity which it may afford for the gathering together of these central bank people and the development, as it were, of social pressure upon them to appreciate the problems of other countries.” It was just down the road from the present-day building where, soon after the creation of the BIS in 1930, the central bankers of that day failed to act with the decisiveness and mutual goodwill needed to combat the great panic of that day. And it was in Basel where Trichet would face his own greatest test.

  Throughout the 2008 phase of the crisis, the leaders of the Federal Reserve often found themselves scrambling to come up with a major decision on a Sunday night, before financial markets in Tokyo, Hong Kong, and Sydney opened for their morning sessions. It happened so often that Ben Bernanke joked that he would title his memoir Before Asia Opens. Now it was the Europeans’ turn to race against the clock through a long weekend of talks.

  The finance ministers were in Brussels; ECB vice president Lucas Papademos, who would later serve a turn as Greek prime minister, was in there monitoring the talks, reporting back by cell phone to Trichet in Basel. Other ECB officials were in the Eurotower in Frankfurt. An open-line conference call connected finance ministries and central banks in capitals including London, Washington, and Tokyo to the action. Geithner made a series of private calls to European officials, attempting to apply whatever weight came by virtue of his being an experienced crisis manager and the finance minister of the world’s largest economy. Early in the conference call, there was discussion of putting together an emergency fund of perhaps €60 billion. Geithner, flabbergasted at the paltry amount, suggested that it wasn’t nearly enough. To persuade markets they were serious, the officials would need ten times as much, something on the order of the U.S. government’s TARP bank bailout during 2008. The Europeans reluctantly came to agree and set to work on a bigger package.

  Geithner was also in frequent touch with Trichet, speaking with him once at 1:30 p.m. Washington time Friday and again at 9:55 a.m. Sunday. Neither Geithner nor Trichet would discuss the substance of those calls. But other officials said that by the weekend it was well known within the U.S. government, among those who worked for or with Geithner, that the ECB had all but decided to begin buying bonds and was holding off any decision in order to push the governments toward action. Indeed, the Americans played an odd role of helping ensure that European finance ministers properly understood the coded messages Trichet had sent them. Did Trichet tell Geithner explicitly what he had planned? Only the two men know. But it is the case that Trichet and Geithner had a great deal in common as noneconomists who were nonetheless among the most important economic policymakers of their generation, immensely skilled at economic diplomacy and bureaucratic maneuvering. They’d spent countless dinners together in Basel during Geithner’s time at the New York Fed. Between
two men who understand each other so well, a great deal can be said without very many words at all being exchanged.

  Bernanke had dispatched his vice chairman, Donald Kohn, to represent the Fed in Basel while the chairman gave a commencement speech at the University of South Carolina, in his home state (topic: The Economics of Happiness). Around the time Bernanke was finishing his speech that Saturday, at 12:55 p.m. on the East Coast, he received an e-mail from an aide about a pressing message from Italy’s central bank governor, Mario Draghi, who was among the more respected and influential of the European central bankers. “Governor Draghi asked me to forward this to the chairman with suggestions that a statement like the following be issued jointly late Sunday or early Monday morning by the Fed, ECB, SNB, BOE, BOJ, BOC.” That is, the central banks of Switzerland, Britain, Japan, and Canada. “Major central banks stand ready to supply the financial system with adequate and immediate liquidity in the days ahead. Let’s work together to address foreign currency funding shortages.” The Europeans were looking for the Americans to step up and show their commitment to keeping the financial system from again coming unglued.

  On one hand, Bernanke and Kohn were eager to do whatever they could to help ease the financial pressures in Europe and signal the joint resolve of the global central banks to combat the crisis, but they also were in a delicate spot. They viewed the problems as fundamentally Europe’s to solve, with any globally coordinated steps as much symbolism as substance. And it came at a supremely delicate time politically, as the Senate was set to vote on a series of amendments in the following week on key aspects of the Dodd-Frank Act that affected the Fed. Headlines about the Fed offering billions of dollars in new loans to foreigners would hardly help things. Bernanke couldn’t even very well make a round of calls to key lawmakers in advance of a decision either, in hopes of receiving their blessings; the very principle he was fighting for was that the Fed must make its decisions separate from politics, away from interference by elected officials.