From time to time its is a good idea to stand back and ask how where we got to where we are. One of the disturbing aspects of the crisis in the Eurozone is that there has been far too little ‘time out’ to think. All too often the response has been fragmented and reactive. The whim of ‘the market’ has prevailed while governments, nations and the European community have muddled through.

The roots of the Eurozone crisis go back beyond the ‘credit crunch’ of 2007 or the collapse of Lehman Brothers in 2008. 

Some of the difficulties that we are experiencing lie in the foundation of the Eurozone itself. Other problems undoubtedly stem from the way individual member states have chosen to do their business. The manner in which the  and ECB was established, the narrow focus that was set for the bank from the outset and the fact that it lacks the full range of instruments typically available to central banks have all added to the problems.  

These weaknesses threaten not only the Euro but could undermine the very Union itself.

Still a Teenager

It is worth reminding ourselves that the ECB has existed for only 13 years: it is still a teenager.

Yet, the ECB has had to deal with some very tough challenges and by and large has acquitted itself well.

Six months after the ECB foundation 11 EU member states fixed their exchange rates. In January 2001 Greece became the 12th country to join the club. 

Twelve months later the Euro went into circulation. It quickly became and is stilla major world currency, albeit one facing serious challenges.  

In 2003 the Eurozone faced its first challenge – often overlooked. Member states were exceeding the Maastricht criteria. The issue was ‘resolved’  when the EU Commission, on the insistence of France and Germany, eased the criteria for public sector debt. It is interesting to speculate whether public debt would have gone quite so far out of line as it subsequently did had the criteria been left in place. 

The Eurozone and the ECB faced a crisis of a different scale in 2007 when the credit crunch struck.  This rocked the global banking system. The ECB cushioned   the blow for European banks by providing emergency loans.

When, less than a year later the American authorities let Lehman Brothers go under, the economic impact was immediate: credit dried up, trade was depressed, a major recession was on the cards and the global economy went into a spin. 

The ECB flooded the system with loans again propping up Europe’s troubled banks. While this stilled the panic the idea that banks that had walked themselves into a mess were being ‘bailed out’ did not go down well with all EU citizens.

In October 2009 another bombshell landed. The new Greek government announced that the country’s books had been cooked and its budget deficit would be more than double the forecast: a Eurozone state was in a deep crisis and confidence took a blow – if this could be the case in one member state could there be others with ‘creative accounts’. 

By May 2010 a bailout was in place – something never really contemplated by the Eurozone ‘architects. The ECB again played a major role. 

To help the Greek Government and Greek banks the ECB had to waive its own collateral rules buying sovereign bonds from private investors on the market – a move justified by the ECB as dampening rates that would be demanded by the market – but questioned by others.

Critics argued that ECB market interventions were wrong - preventing market from ‘operating effectively’: the  ‘hit’ would be taken by European citizens.

The principle of the buying bonds on the market raised the matter of ‘moral hazard’. 

 The most prominent critic, Axel Weber, the Bundesbank chief resigned from the ECB – effectively ruling himself out of contention as Trichet’s successor.

Late in 2010 Chancellor Merkel questioned the morality of allowing private investors to side step the impact of their actions. The Chancellor spoke of ‘moral hazard’.  

In Deauville in October 2010 President Sarkozy joined the Chancellor in insisting that private investors must contribute to future bailouts. 

 The logic of their position seems indisputable – people who ‘bet’ on the market and in particular those who manipulate the market have no moral entitlement to risk free profits: the ECB resisted. 

In spite of the fact that the Chancellor made the point that her focus was on the post 2013 period forces in the market chose to interpret her statement as having current application adding to the growing sense of instability. Whether this was incompetent reading of the Chancellor’s statement or a self-serving interpretation to spook an already nervous market one can only guess. It certainly put the issue of ‘selective default’ on the agenda.

In the closing weeks of 2010 ‘burn the bondholders’ became a headline grabber for the Irish Fine Gael, the sister party of Chancellor Merkel’s in the EPP group – a headline that helped the party to a famous election victory in February 2011.

Ireland’s Bailout 

While no two crises are ever identical what happened in the Irish case illustrates some of the fundamental problems that the Eurozone faces.

 As a small open economy dependent on exports the economic downturn in 2007 had a very direct impact on Ireland. 

The credit crunch came as a double whammy. 

Between 1995 and 2006 the Irish economy boomed, fuelled in part by cheap capital raised in the interbank market. The same period witnessed an influx of new operators in the banking sector with ‘less restrictive’ policies an issuing loans. The ‘new competition’ and ‘greater flexibility’ in banking was widely welcomed at the time.  

The massive inflow of cheap capital and of the dumping of traditional banking standards fed a property bubble of historic proportions.

From the mid 1990s to 2007 property prices rose to astronomical levels. This in turn triggered an explosive expansion in the building industry, particularly home building. 

In spite of record building output property prices continued to escalate leading to ever-higher prices. The ‘law’ of supply and demand was stood on its head – a classic property bubble. 

Employment in the building industry rose to historic levels. The state’s tax take from the sector boomed – there where demands for cuts in taxes, a move akin to throwing petrol on the flames.    

Ireland’s ‘Celtic tiger’ lost its stride in 2007 and came to a juddering halt in 2008. Following the credit crunch and the Lehmans debacle credit virtually disappeared. Banks that had been pushing loans would not part with a cent. 

With credit gone building projects were abandoned, property sales crashed, prices plummeted, major developers failed and tens of thousands of building workers lost their jobs. State tax revenues went through the floor.  

Irish public finances that had been in a state of rude good health for years became terminally ill.

From mid 2007 the Irish banking system experienced serious difficulty financing day-to-day operations.  Alarm amongst senior bankers grew and as the summer of 2008 drew to an end, turned to outright panic.

A final coup de grace for the ‘Celtic tiger’ came in Sept 2008. Inadequate and lax supervision by the Irish regulatory bodies and the criminally irresponsible behavior of some bankers had undermined the entire banking system. 

The Irish Government was asked to rescue the banks. Faced with the prospect of a bank meltdown, the probable loss of major financial institutions, business chaos and tragedy for citizens who stood to loose their life’s savings and investments the Irish Government introduced its controversial bank guarantee scheme.

Between 2008–2010, Irish banking was on life support from the ECB while the Irish authorities struggled to find out exactly how big the hole in the Irish banking system was. The process of effectively dismantling Anglo-Irish and Irish Nationwide, another rogue operator, got underway.  

As summer turned to autumn in 2010 a ‘slimmed down Irish banking sector was being kept afloat through ECB intervention, by state recapitalization, by selling off non core businesses and by being relieved its assets (including some regarded as ‘toxic’) at written down prices by the creation of a state asset management agency. None Irish players were getting out. 

Dramatic and painful steps were also taken on Ireland’s public expenditure. 

Total adjustments in public expenditure of close on €15 billion had already been implemented. Ireland’s deficit for 2010, estimated on an underlying basis at 11.9 per cent of GDP, was broadly in line with Budget day targets.

Exchequer returns for end October showed tax take ahead (1%) of profile, & exchequer spending was below expectations. 

In addition Ireland was committed to frontloading another  €6 billion in spending adjustments in Budget 2011. 

By December 2011 it was planned that Ireland would be 2/3 of the way to meeting the 3% EU deficit target by 2014.

As October 2010 drew to a close the Irish government was fully funded until mid 2011. There was a cash balance of €22b in NTMA and an additional €25 Bn in the National Pension reserve.

Work was underway on a four year Plan intended to map out a way forward to national recovery.  There was even a degree of political consensus amongst the main political parties as to what had to be done. 

The efforts by Ireland to halt the slide were widely acknowledged. 

Commissioner Olli Rehn pointed out that Ireland had formidable strengths; strong economic fundamentals; well educated labour force, strong export growth and a strong private sector. 

The communiqué issue following the early November Ecofin acknowledged the ‘significant efforts of Ireland’ to address its problems, welcomed the four year budgetary strategy, expressing  ‘full confidence’ that it would “firmly anchor the 2014 date for correcting the Irish deficit.

The Council also noted approvingly that Ireland intended frontloading a further €6billion in adjustments in 2011 and acknowledged that with the Government’s proposed ‘structural reforms’ would result in Ireland being able to ‘return to a strong and sustainable growth path.

It also welcomed the bank guarantee, the bank recapitalisation and the establishment of NAMA [‘asset segregation’].

In spite of all of the apparent progress there were still problems. Things had been looking up in April and May on the banking side. With the measures that were put in place on the public finances there was even talk that Ireland could be was pulling out of the woods. For a time it looked as if even the markets were happy. In mid October 2010 the spread on Irish bond yields fell. 

The improvement was momentary and masked what was happening in the background. 

The Whispering Campaign

The narrative changed dramatically as the November Ecofin meeting approached. 

It is hard to say precisely why this happened when it did. Greek sovereign issues were back as a hot topic. By September there was significant pressure on Irish bank deposits. The spotlight moved back onto Irish back and the difficulties with the very high-ticket price for credit

Speculation also undoubtedly played a part. In part that speculation arose  from concerns about defaults that followed on from the Merkal & Sarkozy references to the private sector carrying some of the cost.  

In Dublin there were concerns as to how the Chancellor’s comments were being interpreted. The Finance Minister, the late Brian Lenihan, spoke on 11th November 2010 of “the continuing rise in the cost of borrowing for Ireland (due) to uncertainty surrounding European Union plans for future debt’. 

Something more sinister and ‘Ireland specific’ was happening in the background. In late October and early November a round of intensive off the record briefings in Brussels & Frankfurt to the media by ECB personnel predicted that Ireland would have no choice but to apply for an IMF/ECB bailout.

These briefings completely undermined the Irish Government’s position.  News of the briefings to appear in the news media in the early days of November.  By the weekend of 13 – 14 November 2010 speculation was at fever pitch. 

By that time officials from Dublin were already in contact with their EU counterparts. On 16th November in a vain attempt to dampen the developing story the Department of Finance issued a statement insisting that no application for external financial aid. That if anything had a counter effect. 

 The reports that an IMF/ECB/EU bailout may be necessary sent a huge shock through Irish society. Irish political opposition and media accused the Irish Government of lying, of saying that bailout talks were not underway when they in fact were. 

The Government was aware that the battle was lost by 21st November 2010 when it was announced that it has submitted  a request for financial assistance from the EU and International Monetary Fund.

The Reasons Why.

Two questions came to the fore:-

if things were going so well – why was the Irish bailout needed? 

Why did the Irish Government resist triggering a bailout request until 21 November?

The answer to the first question is straightforward: the harsh reality was that irrespective of the actions taken by Ireland the concerns about the extent of the ‘hole’ in the banking system had not been stilled.

Those concerns were most pronounced in the ECB, which had put huge resources into supporting the Irish banking system. Deposits were flowing out as fast as the ECB was pumping money in and nobody knew when the hemorrhage would stop.  

It was to take some time until the full extent of the problem in the banks could be tied down – not least because of a lack of cooperation from bankers, some of their clients and the extraordinarily complex not to say crooked deals that had been put together during the ‘Celtic tiger’ years. 

By September 2010 government support for the banks covered by the guarantee introduced in 2008 was equivalent to 32% of GDP.  This made the markets nervous. The yields on government bonds started to raise. As the end of October approached yields were above 7%.  Concern that the deficit was now unsustainable meant that Ireland was being priced out of the market: fear of an Irish default stalked the markets & more importantly started to haunt key players in the ECB.

If, in spite of all the hard work if Ireland were to go under who would it drag down? What banks and in which member states would also go under? National pride or sentiment counted for little with those–particularly in the ECB – who were determined that concerns about sovereignty would not be allowed to stand in the way of protecting the euro project. 

[In April 2011, not long before his death Brian Lenihan told a BBC radio documentary that it was at ECB insistence that Ireland accepted EU-IMF loans. At the time, he said, the European Commission was more open-minded. He and others also blamed ECB intransigence as preventing an element of compulsory  ‘burden sharing ‘ by bondholders. While the IMF were sanguine on the issue the ECB (said by some to be supported by Timothy Geitner) were insistent that no bond holders would ‘be burned.’ 

The  question as to why the Government didn’t trigger the formal request for IMF/ECB/EU intervention is a little more complex – was it in denial or as political opponents suggested was it simply lying to the people. 

 The Government position was rather more nuanced than critics allow. The Government felt that

Ireland was in a different position than other countries that had to call in the IMF or trigger the EU rescue package. 

Ireland had shown willingness to take necessary decisions to put her house in order. In terms of the national finances all that had been asked of Ireland had been delivered.

The big issue for the Government, however, was the conditions that would apply if Ireland called for a rescue package. The government didn’t want to be tied to pre-determined outcome. There are vital national interests at stake.  If Ireland were to enter into negotiations it would be irresponsible to set out a negotiating position before the discussions commenced.  

Before making any formal decision the Irish Government wished to explore fully what would be involved. Would, for example, Ireland’s taxation system be brought into the discussions – as the French Finance Minister was to suggest.  When these questions were answered the Irish yielded to the inevitable.

The Fundamental Problems with the Eurozone

The crises that engulfed Ireland, Portugal, Greece, Italy & Spain illustrates some fundamental flaws in the Eurozone project that must be addressed. 

 The architects of the Euro zone 

1. Failed to anticipate the consequences the huge expansion of credit in ‘peripheral economies’.

2. Failed to anticipate the consequences of a banking system so interconnected that when things start to unravel nobody can say stop. 

3. Never anticipated the anything like collapse of Lehman Bros. The ECB’s nightmare was a European Lehman. 

4. Did not allow the ECB to operate as the lender of last resort to Member States. The bank cannot buy bonds directly from Member State treasuries – although the bank seeks to ‘get around’ this by buying government bonds from private bondholders on the open market. 

5. The ECB charter prohibits it from printing money so ‘quantitative easing’ used in the US & the UK is out for the Eurozone.

6. Over focused the ECB remit on inflation. While the ECB has made major departures in the face of the various crises – they have had to very creatively interpret the charter.

7. Created a ‘central bank’ with no authority standing beside it with taxation powers, and

8. Created a regulatory system in the Euro-zone that is not fit for purpose.  The fundamental question who was at the tiller- who guards the guardians remains unanswered. Often it appears that ‘the markets’ are running the show.   Markets are driven by private greed, they do not do altruism and they have no democratic role or mandate.  

While the Bank has been seen to interpret its remit narrowly, it faces some very real constraints. Under the existing treaty arrangements the ECB cannot provide credit directly to governments. When the system was being set up the concern was that allowing the bank to become the lender of last resort would become a temptation for Governments to take their foot off the spending brake. This prohibition means that euro-zone governments forced to depend on the markets.

The ECB has also been unwilling to contemplate allowing the senior bond speculators to be forced to take pain. In the case of Anglo would have been morally justifiable yet the ECB would not allow it even though the IMF would have agreed.

The Eurozone response to events over the last number of years should give us all pause for thought. 

The system has survived, just- but has not covered itself in glory. 

Increasingly the German Chancellor and the French President seem to set the agenda. That is not as it should be. It sidelines the Commission, ignores the President of the Council, dismisses the role of the Parliament and means that the ‘Community Method’ a core EU principle has gone out the door. 

Technocrats have abrogated to themselves powers that should only be exercised by those who are democratically answerable.  An example being the briefing against Ireland in late 2010. ECB officials were suspicious. They were nervous. They believed the rot could be halted if Ireland was thrown to the wolves– they were wrong. Their action simply whetted the appetite of the pack. Their aim was to send out a sharp lesson to others, instead they undermined Ireland & failed to meet that objective.

Worse it showed that markets could dictate political events. The unelected & unanswerable markets were not satiated,  the head-hunt is not finished.

The Solidarity Principle has also taken a knock. A rather shabby attempt by the French Finance Minister to put Ireland’s tax rate on the table demonstrated at the peak of the crisis demonstrated very little solidarity. 

Convention on the Future of the Euro 

This is the most potentially devastating crisis faced by the EU.

Public confidence in the whole European project has been seriously undermined. 

Europe seems incapable of coming up with a solution. The panic that exists is palpable and destabilizing.  All too often the Union seems to be propelled along by events. 

When Ireland was pressured to submit a request for an IMF/ ECB intervention Ministers commented it wouldn’t stop here – it didn’t. The fact that technocrats are replacing democratically elected leaders may not be seen as a problem now – but ultimately it will feed Eurosceptic claims about the ‘undemocratic nature’ of the Union. 

Chatter of two-tier Europe further undermines both the Euro  & the EU project as a whole.  [Thankfully Junker has spoken out on this.]

We had an open democratic Convention on the Future of Europe – now we need a short sharp Convention on the Future of the Euro and a new and comprehensive Charter for the ECB – giving it a full Central Bank role – controlling money supply, ‘federal’ powers to regulate banks, power to operate as lender of last resort and, working in tandem with the fiscal authorities in the member states, all the resources it needs to get the Eurozone and ultimately the Union itself through the crisis in one piece.

© DICK ROCHE, 16112011

Vice-president of ELDR

Fianna Fáil, Ireland