Saviors

The European Central Bank lost its innocence on May 10, 2010. The day after the European Union and the International Monetary Fund put together a rescue package for Greece, former ECB head Jean-Claude Trichet announced the central bank would purchase public and private bonds.

This so-called "securities markets program" collided with the ECB statute and EU treaty on two counts: first, the ECB is prohibited from financing member states; and second, it is not allowed to accept instructions from national governments.

Trichet argued that the ECB does not subscribe to bonds directly but rather acquires them on secondary markets through private investors and thus provides no direct government funding. Nor, he added, did the central bank face any pressure from national governments to intervene.

But you didn't have to be there on this fateful May weekend to imagine how the ECB head was worked over alternatively by eurozone finance minister and the "Merkozy" leadership duo.

Even if the ECB move was not totally in line with its rules and statute, the bank had no other option, according to Henning Vöpel from the Hamburg Institute of International Economics. "It was very clear that politicians would not be able to act in such a short time," he said. "So the ECB had to intervene by means of monetary policy."

Stopgap solution

But in the long term, the ECB will remain a stopgap for politicians because "the heads of state and government had no reasonable crisis management at their euro summits," Paul Welfens from the University of Wuppertal told DW.

As such, the ECB has become a substitute bank of sorts for the eurozone. In fact, cynics refer to it as Europe's "bad bank." From May 2010 to July 2011, it amassed Greek, Portuguese and Irish debt instruments of more than 70 billion euros.

And there was more to come. Since the yields for Italian and Spanish bonds soared, the ECB felt forced to acquire the bonds of the third and fourth largest eurozone economies.

The ECB also harvested plenty of criticism for its bond purchases. Former German Central Bank head Axel Weber and former ECB chief economist Jürgen Stark resigned in protest. But for others, the ECB didn't go far enough. More and more politicians and economists called upon the ECB to fire its "bazooka" and declare its intention to purchase as many bonds as necessary.

Lender of last resort

On December 21, 2011, ECB head Mario Draghi pulled out the bazooka as the sovereign debt crisis on the edge of the eurozone threatened to penetrate its core and lead to a possible bank crisis. But instead of buying government bonds and playing the "lender of last resort" for the troubled eurozone member states, Draghi took over the role of being the lender of last resort for banks. With an interest rate of one percent for a three-year period, European banks could borrow as much money from the ECB as they needed to cover their exposure. More than 500 banks borrowed a half a trillion euros.

With this expansive fiscal policy, the ECB was able to kill four birds with one stone. A credit squeeze was avoided since the banks were able to lend money to companies again. The balance sheets of banks received a shot in the arm since they only had to pay the ECB one percent interest on money that they could use to achieve five to six percent yields on bonds from the debt-straddled eurozone members. And since the banks could use these bonds as security for receiving further ECB money, interest costs dropped, especially for Italy and Spain. And the central bank was able to put the controversial bond purchases to rest.

For Vöpel, the entire situation has a blemish. "One can view this move as a backdoor for financing or purchasing government bonds," he said, pointing out that banks can continue to use bonds that are risk of default as a security for central bank credit.

Despite all the concerns, the ECB plans to repeat the action on Wednesday. Banks are expected to seek as much money as in December. Welfens expects the move to cause some market activity, resulting in lower interest rates.

After that, the central bank plans to abandon its role as the rescuer of the common currency and leave the political arena. Vöpel sees the bank's mission as a monetary watchdog as fulfilled. "The ECB did its part to solve the trust and liquidity crises in the short term," he said. "Now it is the responsibility of the countries to get a handle on their sovereign debt problems through fiscal instruments."

Author: Danhong Zhang / jrb
Editor: Joanna Impey