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Ever since the ECB reluctantly agreed in May 2010 to launch its Securities Markets Programme to buy Greek government bonds—ostensibly as a monetary policy operation to lower domestic interest rates—it has been drawn deeper into the crisis. The ECB's bond-buying has given it the power to dictate policies to Member States, blurring the line between fiscal and monetary policy. It has used this power to demand the deep structural reforms and fiscal austerity, most notably when it punished former Italian Prime Minister Silvio Berlusconi's government for backpedalling on reforms by refusing to buy its bonds, eventually forcing him from office.
At the same time, as concerns over government finances have spread to the banking system, the ECB has also offered banks unlimited liquidity against ever-looser collateral requirements. These Long-Term Refinancing Operations removed the risk of a systemic bank collapse and took some of the pressure off sovereign bonds. But they also allowed the ECB to take over from private markets as the main source of funding of peripheral country current account deficits. This is illustrated in so-called Target 2 balances, which reflect outstanding debts between eurozone national central banks. Germany is currently owed €498 billion ($669.68); under the gold standard, the Bundesbank would have received gold from creditor countries to settle these balances, notes Dr Jorg Kramer, chief economist of Commerzbank. But in the euro system, it is simply entitled to a share of the peripheral country's collateral, which is unlikely to be worth much in a euro break-up.
As a result, the bigger the ECB's balance sheet gets, the more powerful it becomes. The more the ECB intervenes, the bigger the potential exposure of rich countries like Germany if the eurozone collapses. It is gradually becoming clear to Member States that it is in their interest to shield the ECB balance sheet from losses. The complexity of Greece's debt restructuring stems in large part from the need to avoid triggering losses for the ECB that might call into question the credibility of its balance sheet, particularly the €400 billion of bonds it has bought under the SMP. And the eurozone's decision to keep Greece in the euro largely stems from the fear of how the markets might react if the ECB said it was no longer able to buy bonds and feared it was likely to be hit by other losses.
Of course, there is not much the ECB can do if Greece decides to reject the bailout and leave the euro. But the ECB believes the bailout can be made to work and will continue to push Greece and other eurozone countries to try to make it work. That may not please national governments, who can feel themselves being sucked deeper into the crisis. But until they can resolve their differences and unite behind a clear political agenda to fix the deficiencies in the eurozone's economic and monetary union and reduce their reliance on the ECB's liquidity, they have little choice but to defer to the one European institution that has shown itself able to act in the crisis.
That is, until the ECB's balance sheet grows so large that its own credibility is called into question. But by then, it may be too late.
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