It‘s not long since the European Central Bank (ECB) enjoyed great respectability on account of its credible independence and stability-orientated monetary politics. Now, however, the ECB is in choppy waters because precisely this independence of (financial) politics could be lost. What is more, its rejection of Greek government bond refinancing is as disconcerting as its disproportionately heavy reliance on the verdicts of rating agencies.
Since its unprecedented May 2010 decision to purchase Greek government bonds, the ECB is on perilously thin ice. This policy reached a premature climax with its purchase of Spanish and Italian government bonds since the beginning of August 2011. All in all the ECB has around 115 billion Euros worth of sovereign papers from both these countries as well as Greece, Ireland and Portugal on its books.
Criticism of these purchases arises not so much from fear of inflation which would have resulted in a corresponding increase of this sum. The ECB operated a programmeof monetary sterilisation by extracting money back from the financial system in the form of loans to commercial banks. The principal concern is more that the ECB has become entangled in financial politics. The financing of national budgets has historically been a deadly sin of central banks. Political independence represents the most important constitutional characteristic of a viable reserve bank, and cracks are appearing in the ECB. Its May 2010 bond purchases could still be justified as an exceptional emergency measure, but since it gave its support to Italy the same excuse does not hold water. The risk premiums on government bonds send out clear signals of finance policy misconduct, and in this respect at least the financial markets serve their intended purpose. Of course, higher interest rates would force Italy to tighten its financial belt. But there are no grounds for conjuring up economic worst-case scenarios, because Italy paid high interest on bonds even before the monetary union, with no sign of collapse.
This is why the ECB needs to be relieved of its (probably unwilling) role as a financial substitute player. The EFSF stabilisation fund could take on the bond holdings in question.
The ECB’s conduct in discussions about Greek sovereign debt rescheduling poses questions, too. It is well-known that as soon as the rating agencies downgraded these papers to D, the ECB announced that it would no longer be accepting Greek government bonds. The president of the German Bundesbank may have explained how sensible and correct the participation of the private sector may be, however in the event of forcibly imposed refinancing and a consequent credit event the risk of contagion is too great.
This in turn raises the question of why the ECB sets so much store by the rating agencies verdicts. When one considers how poorly these organisations rated the creditworthiness of structured papers at the start of the financial crisis in 2008, the ECB would have done better also to rely on its own judgment, as it did when the "troika" group of lenders evaluated Greece. Besides, at a later date the ECB accepted Portugesebonds, despite the fact that one rating agency downgraded them to junk status. A transparent and comprehensible strategy would look somewhat different.