Trichet’s greatest test

Each crisis requires its own solution, says the ECB president


Four days before the 110bn euro bail-out of Greece, president of the ECB Jean-Claude Trichet was airing his thoughts in Illinois about how best to deal with financial crises. He’s certainly seen a few in his time as a central banker par excellence.  

Here’s a short list of crises at which he sat around the table. There was the sovereign debt crisis of the mid-eighties when over 50 countries defaulted; the exchange-rate crises of the European Monetary System in 1992-1993; Mexico’s “tequila” crisis of 1994; the Asian crisis of 1997; the Russian crisis of 1998; America’s LTCM crisis in the same year followed by the collapse of 2001.

As he told his audience somewhat ruefully: “A large part of my professional career has involved dealing with episodes of financial disruption.”

And now Trichet has got the big disruption on his plate, probably the last of his career and the one by which he will be judged. The crisis is of course the repercussions for the eurozone of Greece’s profligacy. He’s got to hold the European Monetary Union together as the money markets tear apart its sovereign bonds over the next few months.

By general agreement, he’s made a bad start with a screeching U-turn on everything he’s supposed to stand for. By mandating the ECB to accept Greece’s junk-rated bonds as collateral. Throughout his career Trichet has been a stickler for monetary and fiscal rectitude. And here he is taking Greek paper that fund managers are unloading as fast as they can.

Predictably, the money markets – the new masters of the universe – went berserk at the ECB’s behaviour. Rumours flew about a Ä280bn IMF loan to Greece, margins on the bonds of Portugal, Ireland and Italy widened abruptly, sharemarkets plummeted.

There was a chorus of outrage. “[Accepting Greece’s bonds] threatens to dilute the ECB’s independence,” warned Tullett Prebon economist Lena Komileva. Germany’s conservative paper Die Welt tut-tutted that “the ECB has given a free ticket to all countries that are deficit offenders” and had “lost its innocence.”

In fact, if you look at the central banker’s crisis management technique, Trichet is behaving very much as you would expect. That is, unpredictably. Over the years he’s analysed the financial cataclysms that he’s helped fix and come to the firm conclusion that each one requires its own solution.

Take the financial crisis of the last two years. Hardly had it hit than the ECB pumped so much money into Europe that many economists thought Trichet had taken leave of his senses. He called it “enhanced credit support”; others said it was money down the drain.

In fact it was a master stroke. The maturity of ECB loans to liquidity-starved banks were lengthened to a year to give them stability. The central bank accepted all kinds of dubious paper – “eligible collateral” – and arranged foreign currency through swap arrangements with the US Fed and other central banks. In short, it did what it had to do and soon other central banks were following suit.

Trichet prides himself on the ECB’s willingness to break with convention. As he says, “unconventional measures [in the crisis] did not require modifications to the same extent as elsewhere and this flexibility enabled us to react very quickly.”

However behind closed doors he wields a big stick. According to insiders at negotiations with his emissaries in Athens over the price the Greek government and nation must pay for the bail-out, the atmosphere was “icy” as they demanded one cut after another to the public finances.

 He makes no apologies. “Other countries have demonstrated that a clear U-turn in national policy governance is achievable.” Translated from central-banker speak, Greece will just have to shut up and tighten its belt.