The Alchemists: Three Central Bankers and a World on Fire

by Neil Irwin

  Still, Ireland wasn’t Greece. Even with borrowing costs having skyrocketed, the Irish government actually had plenty of cash on hand, thanks to pension reserves. It had suspended issuing new bonds in hopes that rates would decline again, and it had enough money to last until the summer of 2011, according to internal estimates. But depositors in Irish banks, fearful that questions about the government’s solvency meant their deposits could be at risk, started pulling their money out. Irish banks then turned to the ECB—still fulfilling its role as lender of last resort to eurozone banks—to get the cash they needed to cover withdrawals. Because the ECB had lowered its collateral standards for emergency lending programs so that even downgraded government debt could be pledged in exchange for central-bank cash, those Irish banks were able to offer Irish bonds as loan security.

  By November 2010, Irish banks were relying on central-bank funding from elsewhere in Europe to the tune of €138 billion—equivalent to 89 percent of the country’s annual economic output. Spain, with more than ten times the population and a banking crisis of its own, was relying on about a third as much central-bank support for its banks. All this lending was making central bankers around Europe nervous: The more Irish banks relied on them for funding, the more the Bundesbank and the Banque de France and the others would be exposed if the Irish government ultimately defaulted on its debts.

  Trichet wrote a letter to the Irish government that expressed his unease, not so subtly suggesting that the ECB’s assistance for Irish banks wouldn’t be bottomless. He even said publicly that “it is not a normal situation to have institutions that are ‘addicted’ [to central-bank funding] and we are continually reflecting on how to deal progressively with this problem.” Comments like that made the Irish banking crisis worse, as depositors saw a risk that the ECB would start tightening up its emergency lending standards and leave the banks unable to pay off creditors with central-bank cash.

  Trichet proposed to Irish leaders that they restructure their banks, including putting new capital into them, as part of an ECB/IMF/European Commission–overseen program of the sort Greeks had enacted earlier in the year. The ECB mind-set was that the biggest failure of the Irish government had been an unwillingness to slash spending quickly enough to restore confidence among bond buyers. “We took all the opportunities to tell the Irish Government that they had to take bold actions very quickly,” said ECB Executive Board member Lorenzo Bini Smaghi in a later interview with the Irish Times. “In private conversations, Mr. Trichet mentioned this several times on the margins of the European council or the euro group. . . . In 2009 when the Government announced bold measures, this had a very strong impact on the markets. This kind of boldness was not repeated in 2010.”

  This is what Bini Smaghi was saying: In the middle of a year in which the Irish unemployment rate would rise five full percentage points in part because of budget cuts already being phased in, he wished that the government had doubled down on spending cuts and tax increases that may or may not have been enough to regain the confidence of bond investors. Clearly, Ireland couldn’t do much more on its own.

  It was time to call in the troika.

  On November 21, the Irish government formally acknowledged what was increasingly apparent: A troika-backed bailout was forthcoming. By November 28, negotiations concluded with an €85 billion assistance package. The IMF was willing to lend Ireland money at 3.1 percent, but European stability funds were at much higher rates, so the price Ireland would pay to borrow money worked out to 5.8 percent, hardly a bargain-basement rate—and a reflection of the ongoing effort to punish those countries receiving help. Britain, with its deep ties to Ireland and particularly to Irish banks, kicked in €3.8 billion, in contrast to its unwillingness to help pay for the Greek rescue.

  “I don’t believe there were any other real options,” Prime Minister Brian Cowen told reporters.

  In negotiations with the troika, Cowen’s government agreed to €15 billion in spending cuts by 2013—€6 billion of them introduced in 2011—a newly created property tax, a one-euro cut in the minimum wage to €7.65 an hour, and an elimination of twenty thousand public-sector jobs.

  But the real flashpoint of the talks was what to do about troubled banks Anglo Irish and the Irish Nationwide Building Society. Both were effectively insolvent and had been nationalized, and the government wanted bondholders who’d lent money to the institutions to share in the losses. Trichet and the ECB, focused on preventing a broader loss of confidence in European banks, wanted those creditors made whole.

  As the lender of last resort keeping the Irish banking system afloat as well as a member of the troika, the ECB had the negotiating leverage to largely get its way. Whatever the benefits of Trichet’s hard line on overall economic stability, the politics—and even the morality—were terrible: At a time when the Irish economy was in shambles, with public employees being fired, taxes raised, and social welfare benefits slashed, the government was paying billions to investors in bank bonds.

  Cowen’s party, Fianna Fáil, suffered the worst results in its history in the February 2011 elections, and he was ousted as taoiseach, as the Irish call their head of government, in March. Cowen thus became the first national leader to be swept from office by the eurozone crisis. He wouldn’t be the last.

  Nine days before Ireland reached its bailout agreement, Ben Bernanke visited Frankfurt to speak at a conference at the ECB. In his remarks to the attendees, he observed that cooperation among international central bankers can be very helpful in addressing crises. “Indeed,” he said, “given the global integration of financial markets, such cooperation is essential.”

  But while cooperation among the major central banks continued as it had since that first breakdown in the money markets three years earlier, the greater part of the burden had now shifted from the Federal Reserve to the ECB. Bernanke and Trichet, by now veteran partners in crisis fighting, met privately earlier that day in the ECB president’s office in the Eurotower. The Fed chairman put his finger to the Frenchman’s chest and said, “Now, Jean-Claude, it is your turn.”

  The ECB escalated its aid to Ireland as well as Portugal at the start of December, resuming the “Securities Markets Programme” through which it bought sovereign debt. What had been so controversial in May was now accepted practice. And with an overarching rescue of Irish banks in place, the ECB said it would keep offering unlimited three-month loans to eurozone banks for at least another five months. It was a classic pattern for the wily Trichet: Hold back assistance until other actors—in this case, the Irish government and European authorities—take the steps you believe necessary. Had the ECB acted earlier, it would have reduced the pressure on the Irish to take the bailout, and left the ECB that much more exposed.

  At a December 16 European Council, there was a sense of relief, as well as renewed resolve. For all the negative reaction in the markets after Deauville, the Irish rescue and the new ECB interventions had once again eased the sense of panic. The leaders of Europe put together yet another grandiose statement of their mutual commitment, both to the idea of Europe and to the euro currency. “The heads of state or government of the euro area and the European Union institutions have made it clear that they stand ready to do whatever is required to ensure the stability of the euro area as a whole,” said the communiqué, which outlined seven key points of agreement. “The euro is and will remain a central part of European integration.”

  The year to come would test further still how much Europe was prepared to back that idea with more than words. Two of the GIPSI countries were now under the oversight of the continent’s central bank. Portugal was next in line, and little that had happened in either Athens or Dublin could have given much reason for hope in Lisbon.

  • • •

  The Eurovision Song Contest is the world’s oldest reality TV show. Since 1956, it has pitted singers from the nations of Europe against one another in a broadcast beamed acro
ss the continent, with viewers voting for the best performances. It was American Idol long before American Idol. In the May 2011 edition, Portugal had an unusual entry. Young people upset over their dismal economic prospects had overwhelmed the public voting for the nation’s nominee, so the country was represented not by the usual peppy pop number, but by “A Luta é Alegria,” an ironic protest song performed by Homens da Luta, a group of self-described “professionals of the struggle” dressed as Latin American revolutionaries.

  The song’s chorus was a rallying cry for the dispossessed—albeit one that must have mystified viewers who neither spoke Portuguese nor understood why this strange-looking group of singers had been elevated to the Eurovision semifinals. “Night or day / the struggle is joy / And people only go forward / Shouting in the streets,” the six members of Homens da Luta sang. It was an expression of frustration by Portugal’s geração à rascal, a “desperate generation” facing an age of diminished opportunity. “The only work we can get is ‘work experience,’ the only future we are offered is emigration,” said Inês Gregório, a twenty-nine-year-old university graduate turned café worker quoted by the Financial Times. One weekend in March, hundreds of thousands of them had taken to the streets of eleven Portuguese cities.

  Across the continent, the economic strains of the crisis were becoming social and political strains, tearing at the ideals of European unity. Borrowing costs were again on the rise in the GIPSI countries, and in Portugal, Prime Minister José Sócrates had put forward his plan of what to do about it. On March 23, 2011, with the desperate generation in the streets and the unemployment rate at 12 percent, he lost a crucial parliamentary vote on the plan and promptly resigned pending new elections.

  What came next was all too predictable: The troika arrived. Portugal formally requested a bailout package. Negotiations commenced. By May 3, a third nation had its IMF/EU/ECB bailout, along with commitments to imminent and aggressive spending cuts and tax increases. And a second national leader had been forced from office amid the economic despair arising from austerity.

  In Greece, on May 11, an estimated twenty thousand people marched through the streets of Athens to protest austerity, some of them throwing rocks and Molotov cocktails. The country’s labor unions had called a strike, and the nation’s transportation and public services were at a standstill. The unemployment rate was 16.8 percent and climbing—fast. “Enough is enough!” said Litsa Papadaki, a sixty-year-old housewife quoted by the BBC. “They are killing us and our children.” It wasn’t entirely an exaggeration: The suicide rate in Greece in 2011 was estimated to be double the precrisis level.

  The discontent wasn’t just on the streets. Tensions between the troika and Prime Minister George Papandreou’s government were growing as the lenders found Greece failing to live up to its commitments, particularly in privatizing state-run concerns such as telecommunications firm OTE and the ports of Piraeus and Thessaloniki. Reforms to the labor market designed to give employers greater flexibility to fire or cut the pay of workers were drawn up by representatives of the IMF and the ECB, translated into Greek legalese by an Athens law firm, and delivered to the government as legislation that was to be passed.

  That was the situation in the debtor countries of Europe. But social strains had emerged in the creditor countries as well. In Finland, the nationalist True Finns party had shocking success in parliamentary elections on April 17 after campaigning on an anti-EU, anti-immigrant platform. The party, which has long been accused of thinly veiled racism, won 19 percent of the vote and thirty-nine seats in the two-hundred-member Finnish parliament, its strongest ever results. True Finns leader Timo Soini appeared on television denouncing the rescue plan for Portugal, which Finland could potentially veto: “The package that is there, I do not believe it will remain.”

  Protests on the streets. Clashes in the halls of government. Nationalist fervor in the voting booth. All of these were connected to the strategy pursued by the ECB and Jean-Claude Trichet. But Trichet’s time as among Europe’s most powerful men was nearing an end, his eight-year term set to end on October 31. Who would follow him?

  The chairman of the Federal Reserve is nominated by the president of the United States and must be confirmed by the Senate. The procedure is straightforward. The process for naming a new European Central Bank president is anything but. Theoretically, it’s a decision made by a majority vote of the twenty-seven nations in the European Union. In practice, however, only the seventeen EU members that make up the eurozone really matter. Nations that don’t use the euro stay out of it. Technically, it’s one country, one vote—though few would argue that Malta’s view actually carries the same weight as Germany’s.

  The reality of selecting an ECB president is this: It’s a matter of horse trading among the prime ministers and presidents of Europe. Each leader would, all else being equal, most likely prefer one of his or her nationals to run the central bank. But heads of government must weigh their desire to have one of their own countrymen in the job with the “cost” in terms of political capital of making it happen—what they might have to give up in some other negotiation, whether in a directly related area of economic policy or some other area entirely, from agriculture to arms control. Do they even have a candidate who’s viewed as capable and credible enough to attract support from other countries? Whose “turn” is it? There could hardly be two Frenchmen serving two consecutive eight-year terms, and often officials from larger and smaller countries alternate in such jobs. Trichet, for example, followed Dutchman Wim Duisenberg.

  All of this is considered in utmost secrecy, among the leaders themselves and perhaps a few trusted ministers, and never written down. The general public might not ever discover exactly what horse trading led to a given person’s becoming European commissioner or ECB president.

  Against that backdrop stood Axel Weber, who at the start of 2011 was considered the most likely successor to Trichet among ECB watchers. Angela Merkel had even seemed to hold off from nominating Germans for other international jobs over the previous couple of years, perhaps clearing the decks for the first German ECB president. But on February 11, Weber shocked the prognosticators when he announced he was resigning as Bundesbank head and removing himself from consideration as ECB president. How that came to be is a case study in the delicate game of intra-European politics.

  After Weber made public his dissent to the ECB’s bond-buying decision in May 2010, he spent the rest of the year in an uncharacteristically quiet mode. He was clearly in the minority of the Governing Council on one of the biggest decisions it had ever made, and his going public had made this fact widely known. He still played an important role within the ECB—he led the Bundesbank, after all, which carried out more of the central bank’s policies than any other national bank. But he told those close to him that he could never run the ECB so long as he was in a minority position on such a crucial issue. After all, it’s hard to be the effective leader of a committee on which you’re consistently outvoted. Whatever the public expectations, Weber saw his candidacy as untenable unless the Governing Council reversed course.

  He waited nine months before withdrawing. People close to him believe he was biding his time in part to see whether there was a reversal on the bond-buying issue, and in part because he didn’t want to be seen resigning from the Bundesbank during a period of acute crisis. He may have also been waiting to see just how aggressively Merkel was willing to act to secure the first German ECB president. For decades, Germany had enjoyed less representation in the top ranks of international organizations than its size and wealth would imply, reflecting a certain reluctance to act on the world stage that stems from the horrors of World War II.

  Merkel was eager to redress that imbalance. But she was also a savvy enough tactician to use her political capital carefully. The French government was signaling worry that Weber wouldn’t act with enough flexibility to save the eurozone. (“The euro area needs someone who can ch
ange his mind when the situation requires, of great intellectual agility,” an unnamed adviser to Sarkozy told French financial paper Les Echos.) Italian prime minister Silvio Berlusconi was openly endorsing Banca d’Italia governor Mario Draghi, a widely respected central banker who may well have preferred that Berlusconi keep his mouth shut. Other European leaders, Merkel especially, had deep disdain for Berlusconi, known for Mafia ties, “bunga bunga” parties with prostitutes, and a general lack of seriousness. (The crude insult he was reported to have made about her appearance was the least of it.)

  The Bundesbank president gave a speech at the German embassy in Paris in November 2010, meeting with (and reportedly impressing) French political and business elites. And at the annual gathering of global elites in Davos, Switzerland, for the World Economic Forum in January 2011, which both Weber and Merkel attended, Weber allies tried to rally support for the Bundesbank chief among the other political leaders present. But as the winter progressed, they saw little evidence that favor for Weber was growing enough among either European politicians or the other central bankers to make for a successful candidacy. They also saw Merkel playing a cagey game, supporting Weber while remaining noncommittal about twisting Sarkozy’s arm on his behalf. When Weber’s decision to withdraw from consideration leaked to the press before he informed Merkel of it, it came across publicly as nothing short of a rebuke to the chancellor. “Of course she is angry,” Der Spiegel reported, and the German newspapers painted a portrait of a government in chaos over the matter.

  There was still the matter of who would be the new ECB president, if not Weber. Although there were plenty of other capable economists in Germany, Merkel was left with no strong German candidates. Jürgen Stark was credible enough, but the rest of Europe viewed him as more “German”—that is to say, hardline and doctrinaire—than even Weber. And given that he was already near the end of a term on the ECB’s Executive Board, it was unclear whether his appointment to a new eight-year term as president was legal. Some dark-horse possibilities from small countries were floated—Erkki Liikanen of Finland, for example, and Yves Mersch of Luxembourg. But there was only one candidate who really had the skills and the credibility in financial markets to take on the ECB presidency in the midst of a crisis: the one preferred by Mr. Bunga Bunga.