Ambrose Pritchard-Evans – Telegraph.co.uk August 4, 2011
Its refusal to act in the face of an existential threat to monetary union has set off violent tremors across the global financial system, raising the risk that the crisis will spiral out of control.
Bank shares crashed in Madrid and Milan, with Intesa Sanpaolo down 10pc and Italy’s MIB index reduced to its knees with a one-day fall of 5.2pc. Share trading was suspended at a string of bourses across Europe.
Yields on 10-day US debt fell to zero in a replay of panic flight to safety seen during the onset of the Lehman-AIG crisis three years ago.
Jean-Claude Trichet, the ECB’s president, said the bank had purchased eurozone bonds for the first time since March but this token gesture was confined to Ireland and Portugal, countries that have already been rescued.
Professor Willem Buiter, Citigroup’s chief economist, said the apparent ECB action was pointless. “The warped logic of intervening in two countries that don’t need it is as strange as it gets.”
Mr Buiter said Europe risks a disastrous chain of events and the worst financial collapse since the onset of the Great Depression unless Europe’s central bank steps in with sufficient muscle to back-stop the system.
“The ECB has yet so show it understands that it is the only institution that can save Italy and Spain from fundamentally unwarranted defaults. Everybody is afraid and real money investors are dumping their holdings. The ECB must step in to cap the yields at 6pc or 6.5pc and put a floor under the market,” he said.
Italian yields spiked to 6.21pc yesterday after a relief rally wilted. Spanish yields hit 6.3pc. The debt of both countries is hovering near 400 basis points over German Bunds, 50 points shy of the level used by central clearing house LCH.Clearnet to trigger margin calls. This was the point where the debt crises of Greece, Ireland and Portugal crossed the line of no return. Spain has cancelled further debt auctions in August.
“As long as the ECB stays on the sidelines, a speculative, fear-driven withdrawal of market funding can feed a self-fulfilling insolvency. Any number of banks and insurance companies would take huge hits. The ECB will have to come in, or accept the biggest banking crisis since 1931,” Mr Buiter said.
He said the “fundamental design flaw” in economic and monetary union is the lack of a lender of last resort.
EU leaders agreed in late July to boost the powers of the eurozone’s €440bn (£382bn) European Financial Stability Facility (EFSF) bail-out fund so that it may intervene pre-emptively in countries in trouble, but this has to be ratified by all national legislatures and may take months.
Mr Buiter said the fund needed to be increased five-fold to €2.5 trillion to be credible in the long run.
“It is quite irresponsible that the euro member states decided to send their parliaments on holiday this summer before they had enhanced the EFSF to effective scope and size. Crises can happen even during inconvenient periods,” he said.
While Spain’s leader, Jose Luis Zapatero, has suspended his holiday and Italy’s Silvio Berlusconi has pledged fresh crisis measures, German Chancellor Angela Merkel is on holiday in Austria and seemingly in no mood to revisit the summit battles of late July.
Jose Manuel Barroso, the European Commission’s chief, has called for “a rapid reassessment” of the EFSF in order to deal with contagion and a mounting systemic threat. “It is clear that we are no longer managing a crisis just in the euro-area periphery,” he said.
Key eurozone officials met yesterday to discuss raising the fund’s firepower to €1 trillion, perhaps using a manoeuvre that skirts legal restrictions, although Germany’s finance ministry shot down the proposal as pointless coming so soon after the July summit. Bail-out fatigue is becoming ever clearer in Germany, Holland, and Finland, where tempers are fraying.
Mr Trichet said the ECB’s governing council was divided over bond purchases but gave no further details. German sources said Bundesbank chief Jens Weidmann voted against intervention, repeating his well-known view that further “collectivisation of risks” poses a threat to monetary stability.
German-led hawks say the ECB lacks treaty authority to keep amassing a portfolio of bonds, is on a slippery slope towards debt monetisation and is being drawn deeper into tasks that belong to fiscal authorities.
ECB officials are aware token purchases of Spanish and Italian bonds would soon be tested by the markets, pulling the bank ever deeper into a monetary swamp. The two countries’ tradable public debt is more than €2 trillion.
The ECB has purchased almost a fifth of the combined debt of Greece, Ireland, and Portugal yet still failed to stem the crises in these countries. Any intervention in Italy and Spain would have to be on the sort of overwhelming scale undertaken by the US Federal Reserve.
“Italy is the third-biggest bond market in the world: the idea that a bit of ECB buying can make any long-term difference is very misplaced,” said Marc Ostwald from Monument Securities.
Mr Ostwald said the ECB appeared to have bought some Irish bonds today. “This is their way of giving Ireland a pat on the back for delivering on austerity, to show that Ireland really starts to divorce itself from others in crisis.”
The ECB increased liquidity for banks, offering unlimited funds for six months to prevent the money markets freezing up. The bank also left interest rates unchanged at 1.5pc and signalled an end to its rate-rise cycle.