by Neil Irwin
The banks those men led were the key transmission mechanism of the crisis from one country to the next, the institutions that made the difficulties of countries like Greece and Italy big problems for the likes Germany and France. The continental European banks had loaded up on government debt, and as its value fell, their financial stability came into question. Greek debt was to 2011 what subprime mortgage securities were to 2008—a once seemingly ironclad investment that turned out to be nearly worthless. And all sorts of red lights were flashing in November 2011, indicating that the European banks that owned the stuff were in trouble. They faced higher and higher borrowing costs, for example, suggesting that investors were losing confidence in the banks’ ability to repay them.
A major way to assuage fears about Europe, then, would be to reassure the world that European banks weren’t going to lose access to funding—that the ECB was still ready, willing, and able to serve as lender of last resort. And if the banks had greater assurance that they’d be able to fund themselves in the years ahead, the European bankers told Draghi over lunch, it could help stop the vicious cycle by which a sovereign debt crisis fueled a banking crisis.
At the same time, the leading central bankers outside of Europe were also trying to figure how to stop the never-ending crisis in the eurozone from continuing to sap global economic confidence. They had already deployed trillions of dollars and pounds in an earlier phase of the crisis and now faced new technical and legal limits on what they might do. (Bernanke and the Fed, for example, were subject to new restrictions on emergency lending under the Dodd-Frank Act.) What to do next was a topic that consumed Draghi, Bernanke, and Mervyn King, and they directed their staffs to work together to come up with possibilities. King in particular had become considerably more worried about what the eurozone’s problems would mean for the domestic economy than he had been even a few months earlier. He took the lead in engineering a global response, serving as a sort of go-between in helping the Fed and ECB agree on a coordinated approach.
Thursday, November 24, was Thanksgiving Day in the United States, but before Bernanke or New York Fed chief Bill Dudley could turn on football or eat turkey with their families, there was yet another international conference call to attend. Three years after the global central bankers had begun working in tandem to fight the post–Lehman Brothers panic, they had an idea of how to do it again. The swap lines that had been an unsung part of that international response were still open, but were barely being used. European banks were getting dollars through private markets rather than through the central banks, which is typically how it should be. But amid the global economic uncertainty of 2011, private funding was hardly a sure thing. Perhaps the Fed could make its terms more attractive and thus help the Europeans pump liquidity into their frozen banking system?
Bernanke and other Fed officials were more than willing to try. They would lower the interest rate charged on those swap lines to try to make dollars available more cheaply to European and other international banks. And the major central banks of the industrial world—the Fed, the ECB, the Bank of England, the Swiss National Bank, the Bank of Japan, and the Bank of Canada—would all announce the move in tandem. That part was merely theater—Japanese and Canadian banks weren’t really under any pressure, and the main purpose of the action was to funnel dollars from the Federal Reserve to banks in the eurozone. But the Lehman crisis had taught the world’s central bankers that they have more impact even when they merely appear to be acting in concert, so they all signed on.
The heads of the central banks all agreed verbally to the plan during the Thanksgiving Day conference call, but each had to assemble his policy committee to formally approve the action. That was particularly time-consuming for the Bank of Japan, which under its rules had to hold an in-person meeting rather than a videoconference of the sort the Fed used. The formalities took a few days to finalize, but at 8 a.m. New York time on November 30, the six central banks were able to announce “coordinated actions to enhance their capacity to provide liquidity support to the global financial system.”
Substantively, the move cut the cost international banks had to pay to get loans from their central banks by half a percentage point. Symbolically, it was something more. “Finally, global action!” exclaimed an analyst quoted in the Globe and Mail. “America rides to Eurozone rescue,” was the headline in the Daily Telegraph. Every major global stock market soared; the big American, French, and German stock indexes each rose by more than 4 percent.
The next day, Draghi made a prescheduled appearance before the European Parliament. First greeting the officials in Brussels in English, then French, German, and Italian, he then gave a none too subtle hint of what was to come. “What I believe our economic and monetary union needs is a new fiscal compact—a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made,” he said, hinting that the ECB would be cooperative in addressing market volatility. “Other elements might follow, but the sequencing matters,” he said. In other words, there would be more help forthcoming from the central bank—but only if a more permanent overarching arrangement for a common fiscal policy was put in place by the continent’s governments.
Many analysts thought at the time that Draghi was signaling that more bond purchases by the ECB would be the reward for decisive action by political authorities. In fact, there was by this point some bond-purchase fatigue in the ranks of the Governing Council, even among members who had initially supported them. There was a growing sense that while the purchases of Italian and Spanish bonds had helped alleviate immediate concerns in the markets, they weren’t doing anything to foster a long-term solution. Instead, the ECB was taking on risk and giving the politicians greater cover for their own inaction—and the longer the purchases continued, the truer that would be.
That sort of skepticism was, as always, strongest at the Bundesbank—and Draghi was looking for ways to keep Bundesbank president Jens Weidmann and the other German central bankers on his side. The Bundesbank had all along been far more comfortable with taking measures to pump money into the European banks than it had with buying government bonds—recall that in May 2010, Axel Weber was comfortable with new bank liquidity actions even as he vociferously objected to bond buying.
Since August 9, 2007, when the European money markets first froze up, a key to the ECB’s strategy had been making money available to the continent’s banks on more relaxed terms—with looser collateral requirements, and over a longer period of time. But the longest banks had been able to get ECB cash was for thirteen months. If the European banks could get assurance that they would have access to euros for much longer than that—three years, say—they would feel less need to sell off Italian and Spanish bonds. In effect, if the ECB were to make money available on looser, longer terms to the banks, the banks would do the work of propping up the government bond markets. And the ECB could retain some purity, serving as lender of last resort to banks, but not to governments directly.
Weidmann and the Bundesbank preferred extending the terms to perhaps only two years, and with tighter collateral requirements than what the majority of the Governing Council wanted. They didn’t want commercial banks to become too dependent on central-bank financing. But this was a routine disagreement over details, not the kind of matter of deep principle that the dispute over bond buying had been. At its December 8 meeting, the council debated, held a vote, and agreed to announce that the ECB would enact two “longer-term refinancing operations” with looser collateral requirements and a longer maturity of thirty-six months.
Similarly, Germans—including Jürgen Stark, who was in his final meeting as the ECB’s chief economist—were reluctant to cut interest rates for the second straight month and fully reverse Trichet’s rate hikes from earlier in the year. Stark and a handful of others were inclined to hold off on a rate cut until the ECB had more definitive evidence that the eurozone economies
were slowing and inflation was coming down. Indeed, the text for Draghi’s press conference had been predrafted under the assumption that there would be no rate cut. But a majority of the Governing Council saw compelling enough evidence to cut immediately, and Draghi allowed the majority to prevail. Trichet and Stark would usually agree between themselves on what the policy move would be in advance, then steer the committee toward that decision. That Thursday, though, Stark had to scramble to revise the text for Draghi’s announcement in the two hours between the end of the meeting and the press conference. Draghi even conceded to reporters that “it was a lively discussion—and one should not abuse the word ‘lively,’ because we are central-bank governors after all”—and that opinions were divided “not in terms of the substance but in terms of the timing.”
Draghi’s great victory at his second monetary policy meeting as ECB president wasn’t merely that the bank introduced both an interest rate cut and a giant new backstop for the European banking system. It was that he pivoted policy away from the divisive bond-purchase program and toward actions that drew support from the powerful Germans on the committee, even when they disagreed with their specifics.
The long-term refinancing operations were a greater success than even ECB insiders had expected. Banks, seeing the opportunity to lock in funding for three years for only a 1 percent annual interest rate, took advantage on a massive scale. During the first operation in December, 523 banks took out a combined €489 billion in ECB financing. In a second operation, eight hundred banks took out another €530 billion.
The technical details were different, but Draghi and the ECB had in essence done exactly what Bernanke and the Fed did during the 2008 phase of the crisis: erected a massive firewall of central-bank money to stand between the world and the flames.
One day after Draghi’s bold moves and exactly twenty years after the start of the summit in Maastricht that created the euro, the leaders of Europe once again gathered in Brussels to try to rework the financial architecture of their currency union. It was yet another meeting of only halting progress toward a plan for how the nations of Europe might collectively back each other. The major headlines coming out of the gathering were about clashes between British prime minister David Cameron and Nicolas Sarkozy over financial regulation, with the former wanting to ensure that new rules didn’t threaten London’s status as a world financial capital. But that was a sideshow. The main event was as unexciting as ever.
The thing is, though, it didn’t matter. Thanks to the work of the Super Mario Brothers, the winter and spring were a period of optimism. Yes, the longer-range question of European financial integration was unsettled, but the ECB’s wall of money had stabilized the banking system. And Mario Monti was carrying out fiscal reforms in Italy that had been mere empty promises for Berlusconi. The country’s ten-year borrowing cost, 6.57 percent on November 25, 2011, was down to 4.19 percent on March 9, 2012. Meanwhile, Ireland and Portugal continued enacting their bailout agreements, painful though they were, with a remarkable degree of political cohesiveness. And Spain, under its new center-right government, went through its own series of painful reforms. Once more, Greece was the outlier.
Papademos was an accomplished economist and central banker, with a doctorate from MIT and the wisdom accumulated over three decades of working in the highest reaches of European policymaking and as a professor at Columbia. He was not, however, a politician. He spoke quietly and without obvious charisma, and he viewed the challenges his country faced mainly as complicated technical problems. Typically for a central banker, Papademos made decisions with cold analysis rather than a politician’s instinctive sense for public opinion. His job, though, was one that would challenge even the most skilled of politicians: He had to assemble a cabinet on the fly in December 2011, taking care to bring together leaders from both of the parties that had formed the coalition, then lead a group of ministers who were normally at each other’s throats.
That made the January and February 2012 negotiations over a “second memorandum”—a revised set of conditions for Greece to fulfill in order to receive its bailout money—particularly onerous. That Papademos had personal credibility didn’t suddenly make the Greek political system more accepting of troika-ordered pay cuts and privatization. Neither did it make the European Commission and the ECB more flexible in their demands. And with Dominique Strauss-Kahn out of the picture, the IMF was less inclined to move slowly on tightening fiscal policy. Papademos and his team first had to negotiate with the troika over what unpleasant wage cuts and unpopular privatization measures would take place, then turn around and bargain with the two coalition parties to get them both on board. The talks often went until four or five in the morning.
The eventual result was two documents totaling eighty-two pages and spelling out the newest round of Greek concessions. The government got its bailout deal and would be able to meet its financial obligations come March. But it had to pay a terrible political price.
Some eighty thousand people took to the streets of Athens on February 13, protesting the wage and pension cuts the nation’s parliament had just agreed to. There were 150 stores looted, 45 buildings burned, and 104 police officers injured. “It felt like war,” a doorman named Dimitris Arvanitis told the New York Times. “I could not believe I was in Athens. I have never seen this in my almost 60 years of life, and I have been working here all my life.” One Greek newspaper, Dimokratia, published on its front page a photo of Angela Merkel manipulated so she appeared to be dressed like Nazi official, swastika and all.
It was the beginning of the end for the unity government, then just three months old. The right-leaning New Democracy party saw its opening and demanded new elections—after all, the left-leaning Panhellenic Socialist Movement, or PASOK, was widely loathed, blamed for an unemployment rate that was at 21.7 percent and climbing as well as the various austerity measures the Greek populace had already endured. It was a startlingly shortsighted decision. With more economic pain to come, it would have made more sense to allow Papademos—who had no political ambitions of his own—to remain in power and endure popular discontent, and then call for elections once the worst was over.
But Papademos wasn’t the only Greek official who had trouble with political calculus. Antonis Samaras and New Democracy were too eager to be back in power. Elections there would be.
• • •
The success of the ECB’s wall of money didn’t mean that all was well. Huge chunks of the continent were in recession that spring, and even those that continued to grow did so at a glacial pace. Italy’s economy contracted at an annual rate of 3 percent in the first half of 2012, Spain’s by about 1.5 percent. France’s economic growth flatlined. Of the large countries, only Germany’s economy was growing, and at a tepid 1.5 percent annual rate. There was unemployment on a mass scale—in April 2012, 10.1 percent in France, 10.5 percent in Italy, 14.9 percent in Ireland, and a shocking 24.4 percent in Spain. In countries with stronger economies—Germany, the Netherlands—the rate was a bit above 5 percent, and even lower in Austria.
It was a bifurcated continent, with those living in a handful of nations experiencing either mild economic growth or mild recession while millions of their neighbors were in dire straits. And the ECB could set only one interest rate policy for all of them, which meant that the great fear of the Euroskeptics of the 1990s had come to pass.
What was increasingly clear that spring was that even against the backdrop of more stable financial markets, the status quo couldn’t endure. With the GIPSI countries going through with their agreed-upon austerity, their economies were shrinking without the benefit of a countervailing force such as dramatic ECB rate cuts. Across the continent, the conversation started to shift from austerity to growth. How might countries like Italy and Spain find their way back to a path of expansion that would make their fiscal problems all the more manageable?
Draghi in particular emerged as a voice urgi
ng governments to focus not merely on reforms that would save money in the present, but also those that would strengthen economic growth in the future. Governments, he told the European Parliament on April 25, “must undertake determined policy actions to address major weaknesses in the fiscal, financial and structural domains,” adding that steps already under way “need to be complemented by growth-enhancing structural reforms to facilitate entrepreneurial activities, the start-up of new firms and job creation. Here, governments should be more ambitious.”
Translation: Given that we at the ECB (1) can’t tailor our monetary policy for the various countries of Europe individually and (2) aren’t willing to accept the high inflation in stronger European countries that might help the GIPSI nations get out from under their heavy debt loads, it’s on you elected officials to find policies that will get European growth going. It was quite a shift in tone from the ECB, which under Trichet had emphasized the urgency of governments cutting their deficits above all else.
But nowhere was the shift in emphasis from austerity to growth more dramatic than in France. Its presidential election, held in two rounds on April 22 and May 6, pitted Sarkozy against François Hollande, who had emerged as the Socialist Party standard-bearer after Strauss-Kahn’s arrest in New York. Sarkozy had spent the previous three years attached at the hip to Merkel—“Merkozy,” the headline writers enjoyed calling them—and their partnership had significantly shaped Europe’s response to the crisis.
Within that partnership, the French president frequently argued for greater European unity and more generous accommodation of the countries in need of help. But Sarkozy often seemed more committed to maintaining good relations with Merkel than to any specific policy. And he could give the impression of being more attuned to coming up with a splashy announcement than coming up with the right answer.