The Alchemists: Three Central Bankers and a World on Fire (48 page)

The leaders of Brazil, Australia, and any number of other countries blamed Europe for their own economic weakness. Chinese head of government Hu Jintao was particularly assertive, suggesting that his nation wouldn’t deploy its massive cash reserves to help Europe until the continent had a credible plan to help itself.

If Merkel, Sarkozy, and Draghi ever had any doubts that the world was waiting for them to move, they knew better now.

The following week, the talks that led to Papademos and Monti taking over from Papandreou and Berlusconi came to a head. Some reports portrayed those appointments as having been made effectively in Frankfurt, Brussels, and Berlin instead of Athens and Rome, suggesting that the ECB, the European Commission, and the German government were dictating to those countries who could lead them. It was subtler than that. Well-placed sources in Greece and Italy said that they didn’t receive any specific instructions from European authorities as to who would be an acceptable prime minister. Nor did outsiders meddle in the details of the selection process. But at the same time, the party leaders negotiating over who would succeed Papandreou and Berlusconi did so knowing that the whole point was to put in place a leader who could negotiate credibly with the troika and the other European governments.

More concretely, markets were putting more pressure on Italian government leaders than Angela Merkel ever could: Ten-year borrowing costs for Italy started October at below 5 percent. By November 9, just before Berlusconi’s resignation, they reached 6.56 percent. If sustained, rates that high would be enough to render the country insolvent. That spike reflected the influence of Draghi and the ECB:
In the week ending November 11
, the central bank bought only €3 billion in bonds, compared with €10 billion the previous week. Less ECB buying meant higher rates, which meant more pressure on members of the Italian parliament to dump Berlusconi as their leader. Draghi didn’t have to tell the Italian government what to do; the ECB’s decision to buy bonds, or not, did it for him.

The appointment of Monti as prime minister of the eurozone’s third largest economy gave instant credibility to a country that had been less influential than its size would suggest during negotiations among European leaders, simply because Merkel and Sarkozy didn’t particularly respect Berlusconi. With Monti in place, Italy was poised to join France as a counterweight to German sway over Europe. Within two weeks, there were two Italians with significant influence over the course of the eurozone crisis where before there had been none: Monti and Draghi—the Super Mario Brothers, as the press gleefully nicknamed them.

An overwhelming victory for Mariano Rajoy’s center-right People’s Party in Spanish elections on November 20 completed the sweep: The crisis had now brought down the prime ministers of all five GIPSI countries.

•   •   •

T
hey served white wine from the Pfalz region
of Germany, just west of Frankfurt, when the leading bankers of Europe came to lunch with Draghi on a Wednesday not long after he took office. As his guests sipped, they offered more than polite comments on the local viticulture—they offered the germ of a plan that could help quell the panic that had enveloped Europe and the world.

The banks those men led were the key transmission mechanism of the crisis from one country to the next, the institutions that made the difficulties of countries like Greece and Italy big problems for the likes Germany and France. The continental European banks had loaded up on government debt, and as its value fell, their financial stability came into question. Greek debt was to 2011 what subprime mortgage securities were to 2008—a once seemingly ironclad investment that turned out to be nearly worthless. And all sorts of red lights were flashing in November 2011, indicating that the European banks that owned the stuff were in trouble. They faced higher and higher borrowing costs, for example, suggesting that investors were losing confidence in the banks’ ability to repay them.

A major way to assuage fears about Europe, then, would be to reassure the world that European banks weren’t going to lose access to funding—that the ECB was still ready, willing, and able to serve as lender of last resort. And if the banks had greater assurance that they’d be able to fund themselves in the years ahead, the European bankers told Draghi over lunch, it could help stop the vicious cycle by which a sovereign debt crisis fueled a banking crisis.

At the same time, the leading central bankers outside of Europe were also trying to figure how to stop the never-ending crisis in the eurozone from continuing to sap global economic confidence. They had already deployed trillions of dollars and pounds in an earlier phase of the crisis and now faced new technical and legal limits on what they might do. (Bernanke and the Fed, for example, were subject to new restrictions on emergency lending under the Dodd-Frank Act.) What to do next was a topic that consumed Draghi, Bernanke, and Mervyn King, and they directed their staffs to work together to come up with possibilities. King in particular had become considerably more worried about what the eurozone’s problems would mean for the domestic economy than he had been even a few months earlier. He took the lead in engineering a global response, serving as a sort of go-between in helping the Fed and ECB agree on a coordinated approach.

Thursday, November 24, was Thanksgiving Day in the United States, but before Bernanke or New York Fed chief Bill Dudley could turn on football or eat turkey with their families, there was yet another international conference call to attend. Three years after the global central bankers had begun working in tandem to fight the post–Lehman Brothers panic, they had an idea of how to do it again. The swap lines that had been an unsung part of that international response were still open, but were barely being used. European banks were getting dollars through private markets rather than through the central banks, which is typically how it should be. But amid the global economic uncertainty of 2011, private funding was hardly a sure thing. Perhaps the Fed could make its terms more attractive and thus help the Europeans pump liquidity into their frozen banking system?

Bernanke and other Fed officials were more than willing to try. They would lower the interest rate charged on those swap lines to try to make dollars available more cheaply to European and other international banks. And the major central banks of the industrial world—the Fed, the ECB, the Bank of England, the Swiss National Bank, the Bank of Japan, and the Bank of Canada—would all announce the move in tandem. That part was merely theater—Japanese and Canadian banks weren’t really under any pressure, and the main purpose of the action was to funnel dollars from the Federal Reserve to banks in the eurozone. But the Lehman crisis had taught the world’s central bankers that they have more impact even when they merely appear to be acting in concert, so they all signed on.

The heads of the central banks all agreed verbally to the plan during the Thanksgiving Day conference call, but each had to assemble his policy committee to formally approve the action. That was particularly time-consuming for the Bank of Japan, which under its rules had to hold an in-person meeting rather than a videoconference of the sort the Fed used. The formalities took a few days to finalize, but at 8 a.m. New York time on November 30, the six central banks were able to announce “
coordinated actions to enhance their capacity
to provide liquidity support to the global financial system.”

Substantively, the move cut the cost international banks had to pay to get loans from their central banks by half a percentage point. Symbolically, it was something more. “
Finally, global action
!” exclaimed an analyst quoted in the
Globe and Mail
. “America rides to Eurozone rescue,” was the headline in the
Daily Telegraph
. Every major global stock market soared; the big American, French, and German stock indexes each rose by more than 4 percent.

The next day, Draghi made a prescheduled appearance before the European Parliament. First greeting the officials in Brussels in English, then French, German, and Italian, he then gave a none too subtle hint of what was to come. “What I believe our economic and monetary union needs is a new fiscal compact—a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made,” he said, hinting that the ECB would be cooperative in addressing market volatility. “Other elements might follow, but the sequencing matters,” he said. In other words, there would be more help forthcoming from the central bank—but only if a more permanent overarching arrangement for a common fiscal policy was put in place by the continent’s governments.

Many analysts thought at the time that Draghi was signaling that more bond purchases by the ECB would be the reward for decisive action by political authorities. In fact, there was by this point some bond-purchase fatigue in the ranks of the Governing Council, even among members who had initially supported them. There was a growing sense that while the purchases of Italian and Spanish bonds had helped alleviate immediate concerns in the markets, they weren’t doing anything to foster a long-term solution. Instead, the ECB was taking on risk and giving the politicians greater cover for their own inaction—and the longer the purchases continued, the truer that would be.

That sort of skepticism was, as always, strongest at the Bundesbank—and Draghi was looking for ways to keep Bundesbank president Jens Weidmann and the other German central bankers on his side. The Bundesbank had all along been far more comfortable with taking measures to pump money into the European banks than it had with buying government bonds—recall that in May 2010, Axel Weber was comfortable with new bank liquidity actions even as he vociferously objected to bond buying.

Since August 9, 2007, when the European money markets first froze up, a key to the ECB’s strategy had been making money available to the continent’s banks on more relaxed terms—with looser collateral requirements, and over a longer period of time. But the longest banks had been able to get ECB cash was for thirteen months. If the European banks could get assurance that they would have access to euros for much longer than that—three years, say—they would feel less need to sell off Italian and Spanish bonds. In effect, if the ECB were to make money available on looser, longer terms to the banks, the banks would do the work of propping up the government bond markets. And the ECB could retain some purity, serving as lender of last resort to banks, but not to governments directly.

Weidmann and the Bundesbank preferred extending the terms to perhaps only two years, and with tighter collateral requirements than what the majority of the Governing Council wanted. They didn’t want commercial banks to become too dependent on central-bank financing. But this was a routine disagreement over details, not the kind of matter of deep principle that the dispute over bond buying had been. At its December 8 meeting, the council debated, held a vote, and agreed to announce that the ECB would enact two “longer-term refinancing operations” with looser collateral requirements and a longer maturity of thirty-six months.

Similarly, Germans—including Jürgen Stark, who was in his final meeting as the ECB’s chief economist—were reluctant to cut interest rates for the second straight month and fully reverse Trichet’s rate hikes from earlier in the year. Stark and a handful of others were inclined to hold off on a rate cut until the ECB had more definitive evidence that the eurozone economies were slowing and inflation was coming down. Indeed, the text for Draghi’s press conference had been predrafted under the assumption that there would be no rate cut. But a majority of the Governing Council saw compelling enough evidence to cut immediately, and Draghi allowed the majority to prevail. Trichet and Stark would usually agree between themselves on what the policy move would be in advance, then steer the committee toward that decision. That Thursday, though, Stark had to scramble to revise the text for Draghi’s announcement in the two hours between the end of the meeting and the press conference. Draghi even conceded to reporters that “
it was a lively discussion
—and one should not abuse the word ‘lively,’ because we are central-bank governors after all”—and that opinions were divided “not in terms of the substance but in terms of the timing.”

Draghi’s great victory at his second monetary policy meeting as ECB president wasn’t merely that the bank introduced both an interest rate cut and a giant new backstop for the European banking system. It was that he pivoted policy away from the divisive bond-purchase program and toward actions that drew support from the powerful Germans on the committee, even when they disagreed with their specifics.

The long-term refinancing operations were a greater success than even ECB insiders had expected. Banks, seeing the opportunity to lock in funding for three years for only a 1 percent annual interest rate, took advantage on a massive scale. During the first operation in December, 523 banks took out a combined €489 billion in ECB financing. In a second operation, eight hundred banks took out another €530 billion.

The technical details were different, but Draghi and the ECB had in essence done exactly what Bernanke and the Fed did during the 2008 phase of the crisis: erected a massive firewall of central-bank money to stand between the world and the flames.

One day after Draghi’s bold moves and exactly twenty years after the start of the summit in Maastricht that created the euro, the leaders of Europe once again gathered in Brussels to try to rework the financial architecture of their currency union. It was yet another meeting of only halting progress toward a plan for how the nations of Europe might collectively back each other. The major headlines coming out of the gathering were about clashes between British prime minister David Cameron and Nicolas Sarkozy over financial regulation, with the former wanting to ensure that new rules didn’t threaten London’s status as a world financial capital. But that was a sideshow. The main event was as unexciting as ever.