09 November 2011

Simon Nixon: Don't bank on ECB rescuing Italy

Commenting in the WSJ, Nixon says that given the eurozone's inadequate bailout facilities, many argue only an unlimited ECB commitment to buy Italian bonds can prevent the debt crisis spiraling out of control. But investors shouldn't bank on the ECB doing the market's bidding.

First, the central bank has repeatedly said it has no mandate to act as lender of last resort to countries. To do so would breach European law. The European treaty is unequivocal: Article 101 prohibits the ECB from lending to governments, while Article 103 says the eurozone shouldn't become liable for the debts of Member States.

The second reason the ECB may refuse to make huge bond purchases is moral hazard. The ECB would lose its leverage to drive fundamental reform in Italy. The discipline imposed by high interest rates currently offers the best hope of making the eurozone more competitive. And if the ECB accepts the role of lender of last resort to countries, it can't be rescinded. Its relationship with governments will have changed fundamentally, making it hard to resist future demands. The ECB effectively will have ceded a large slice of its cherished independence.

Third, what the ECB is being urged to do would expose it to huge balance-sheet risk. Acting as lender of last resort to a country is different from acting as lender of last resort to banks. Central banks only lend to banks against collateral. But when the ECB buys government bonds, it has no recourse to tax revenues. Some argue a new government in Rome committed to change would reduce the credit risk, giving cover for a change of ECB policy. But not all the credit risk is domestic: A Greek euro exit would seriously damage Italian creditworthiness, not to mention the ECB's balance sheet.

Full article 

© Wall Street Journal