Europe's Central Bank Maneuvers Crisis Intervention

The European Central Bank has ruled out large scale bond purchases to save struggling countries from their mounting debts. But the ECB has said it will extend unlimited credit to European banks. Some observers say these low-interest bank loans could be a back door way to address the debt crisis. National banks would have a new source of cash to buy their home country's sovereign debt.

Copyright © 2011 NPR. For personal, noncommercial use only. See Terms of Use. For other uses, prior permission required.

RENEE MONTAGNE, HOST:

The European debt crisis continues to weigh on financial markets. Investors are disappointed at the steps European leaders took at their summit last Friday to address their spiraling debt crisis. And investors are even more disappointed that the European Central Bank has not stepped in to keep countries from defaulting. But as NPR's John Ydstie reports, the ECB may have slyly opened a backdoor to significant intervention.

JOHN YDSTIE, BYLINE: The backdoor is a program that Mario Draghi, president of the European Central Bank, announced last week, just as the summit frenzy was mounting. He said the ECB was lowering its official lending rate to just 1 percent, and he said the ECB would make unlimited loans available to European commercial banks at that rate for up to three years. It was mostly viewed as a way to prop up Europe's commercial banks and avoid a Lehman-style collapse. But it could have another important effect.

SIMON JOHNSON: It is potentially a way for the European Central Bank to support government debt throughout the eurozone.

YDSTIE: That's MIT professor Simon Johnson, a former chief economist at the IMF.

JOHNSON: The ECB is allowed to lend to banks, and the banks can then go buy government debt. The ECB is not supposed to lend directly to governments.

YDSTIE: And, Johnson says, it could be a very attractive deal for Europe's troubled banks.

JOHNSON: The banks could, in the short-run, make very good money by borrowing cheaply from the European Central Bank - let's say borrowing at 1 percent, or thereabouts - and buying government debt that yields perhaps 6 percent.

YDSTIE: That's a lucrative deal - unless, for instance, you buy Italian bonds and then Italy defaults. If that thought makes the banks a bit skittish, well, economist Jacob Kirkegaard says maybe they'll be convinced by some arm-twisting from their national government.

JACOB KIRKEGAARD: There is a potential, if you like, that banks get a phone call from national treasuries asking them to do their, sort-of quote, unquote, "patriotic duty" and spend this ECB money on supporting their national government bonds.

YDSTIE: In fact, after the announcement of the ECB program, French President Nicolas Sarkozy said, quote, "This means that each state can turn to its banks, which ill have liquidity at their disposal."

We don't know yet how the banks will react. The ECB will hold its first auction for these three-year loans in about a week. Kirkegaard, who's a fellow at the Peterson Institute for International Economics, says the ECB could provide a good deal of support for European government bonds through this back door, but it's not a long-term fix.

KIRKEGAARD: Having very weak banks buy the bonds of weak governments, well, that doesn't add stability to the over-all system. So this is, at very best, a very short-term fix that can only buy quite a limited amount of time.

YDSTIE: Kirkegaard thinks the ECB's Draghi may be trying to buy time, hoping for a bailout by the IMF. If that doesn't work, Kirkegaard believes the ECB will ultimately step in directly. But Simon Johnson says if the ECB decides to essentially print money to support government budget deficits, it will be self-defeating.

JOHNSON: The Germans are not going to like that, and I think that the euro, as we know it, will break up for that reason. So if the ECB really does pursue this strategy, they create the risk of euro break-up.

YDSTIE: John Ydstie, NPR News, Washington.

Copyright © 2011 NPR. All rights reserved. No quotes from the materials contained herein may be used in any media without attribution to NPR. This transcript is provided for personal, noncommercial use only, pursuant to our Terms of Use. Any other use requires NPR's prior permission. Visit our permissions page for further information.

NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR's programming is the audio.

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and terms of use, and will be moderated prior to posting. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.