Thursday, December 22, 2011

Chronicle of a crisis diffused?

My perception as a semi-informed layman of the latest chapter in the Eurozone crisis has been singular, and maybe worth recording.

For months, the supremely knowledgeable columnists on my favorite opinion page, the FT, along with many other observers, have played Greek chorus to an EU tragedy unfolding in several acts. Most recently, in the runup to the early December EU summit, Wolfgang Munchau, Martin Wolf, Philip Stephens and others have warned that the Eurozone is on the brink of avoidable doom. The most recent lament has been that the European Central Bank could at any given time end at least the immediate existential crisis by buying bonds Italian and Spanish government debt -- on the secondary market, since the EU charter apparently bans the ECB from buying the bonds directly. But the ECB's new president, Mario Draghi, like his predecessor, has demurred. The summit yielded only a pact for stricter enforcement of budget austerity standards, which does nothing to ease the pressure of rising interest rates.

Then, yesterday, I pick up some uncertainly-sourced snippet to the effect that banks are buying Italian and Spanish debt, those countries' interest rates are falling, and some are saying that the crisis may be over.  Yeahrright....

This morning, however, the Times' Floyd Norris brings those glimmers into focus:


Talk tough, and open the vaults.”

That should be the slogan of Mario Draghi, the president of the European Central Bank.

In recent weeks, the new president publicly insisted the central bank would never do any of the things that Germany opposed. The bank would not drastically step up its purchases of Spanish and Italian government bonds. It would not directly finance European governments. It would not backstop European rescue funds or print money that the International Monetary Fund could use to bail out governments.

It would do only what central banks normally do. It would lend to banks.

It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.

Well, rub your eyes -- is it morning it Europe?  It seems that giving almost free money to the banks may effectively bail out their home governments:

There is no assurance that the banks will use all, or even most, of the money they borrowed, to buy government securities. It would be nice if some of it were lent to the private sector to spur growth and investment. But the logic of putting it in two- or three-year government notes is obvious.

Spanish two-year securities now yield about 3.6 percent, while Italian ones offer 5.1 percent. A bank that uses central bank money to buy them will clear the difference between those rates and 1 percent. The spread will be a little larger when the central bank lowers rates in a month or two. The securities will mature well before the loans come due.

What can go wrong for a bank that follows that course? The obvious one is that the governments default. But for a Spanish bank owning Spanish bonds, or an Italian one with bonds from its government, that is really not a risk worth worrying about. They would be dead whether or not they had bought more bonds. 

Then, compounding the epistemological miracle, Paul Cassandra Krugman not only ratifies Norris's narrative, but effectively admits, that he, Krugman, was wrong -- or, if you prefer (or Krugman prefers!), that he was snookered by Draghi:
Regular readers may recall that I and others were adamant that it was essential for the ECB to step in and buy the debt of troubled governments, to head off what looked very much like self-fulfilling panic. The ECB refused to do that, and many of us took that refusal at face value — but the argument is that in reality it did the functional equivalent, lending very large sums to banks with sovereign debt as collateral, so that it was in effect doing the purchases we wanted, but laundering those purchases through banks...

The bottom line seems to be that Mario Draghi is a consummate eurocrat. I’ve always kind of enjoyed talking to eurocrats, who always seem to be implying something they aren’t saying; in this case he may have managed to say one thing while doing something else, and the thing he actually did was just what people like me have been urging.
If the pressure on the bond yields of stressed  Eurozone countries really is durably eased, that could be an even greater Christmas present to Obama than the House's hissy fit over the payroll tax cut extension. Perhaps the Euro will still prove a failure, as Martin Feldstein argues at length in the current Foreign Affairs (behind a paywall, and I'm putting off finishing it until this evening).  All I ask for the present is that the EU stave off collapse until Nov. 7, 2012.

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