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False alarms and flashpoints

Plans are now afoot to put the ECB in overall charge of bank supervision in the euro area. The Bundesbank politely welcomes a more harmonised approach but is anxious about both the speed of the reform (at least as envisaged by the European Commission) and the details of such a big move. And it has deeper concerns. Putting the ECB in charge of banks might compromise its focus on price stability; and bank supervision may lead to euro-wide bank-deposit insurance, which would transfer risks from weak countries to strong ones in an opaque manner.

A fear of hidden transfers of risk explains widespread alarm in Germany caused by the size of the Bundesbank’s “Target2” claims. Target2 accounts are used to settle payments between the national central banks in the Eurosystem. As private capital has left the troubled economies of southern Europe and Ireland, peripheral central banks have, in effect, had to borrow more from those in the core. The Bundesbank’s claims have now reached €750 billion ($970 billion; see chart), easily the biggest item on its balance-sheet, which has soared over €1 trillion for the first time.

The German central bank has sought to allay worries about the Target2 balances, focusing instead on the credit risk of lending so much to troubled banks against weak collateral. As long as the euro area remains intact, Target2 claims are mere book-keeping entries (although if it were to disintegrate, the Bundesbank would take a hit, in principle limited to 27% of all such claims, reflecting its capital share in the ECB). The Bundesbank interprets them as a symptom of the wider crisis, in which the Eurosystem has been taking on more and more credit risk, rather than as a separate source of trouble in themselves, says Andreas Dombret, the board member responsible for financial stability.

The real flashpoint between the two institutions is bond-buying. The ECB does make some small bond purchases of its own, but the vast bulk is still done by the national central banks, with the Bundesbank buying around 25% of whatever the Eurosystem as a whole snaps up. This exposes the Bundesbank directly to the risk of losses, whereas its exposure through the payments-system balances is indirect, points out Joachim Nagel, the board member responsible for markets.

It was the ECB’s first foray into this territory in May 2010, when it decided to buy Greek government bonds through its Securities Markets Programme (SMP), that led Axel Weber, Mr Weidmann’s predecessor, to resign from the Bundesbank in early 2011. Mr Draghi said last month that the SMP was being closed down but announced a new programme called Outright Monetary Transactions (OMT), which envisages potentially unlimited purchases of short-term bonds.

The new strategy will enforce his shoot-from-the-hip pledge in late July to do “whatever it takes” to save the euro and was welcomed by Mrs Merkel. But Mr Weidmann balked. Although any ECB bond-buying would be conditional on a government signing up for an austerity-and-reform programme, he still opposed it, saying that it was close to monetary financing—direct borrowing by governments from their central banks—which is banned by the Maastricht treaty.

Danger: ECB construction

In fact, that treaty does permit the ECB to buy public debt in the secondary market. And the Bundesbank’s visceral disapproval of bond purchases is not shared by other central banks in rich economies, such as America’s Federal Reserve, which has made them on a grand scale as part of its quantitative-easing policy. But Mr Dombret says that the American analogy is misplaced: the Fed has been purchasing high-quality Treasuries rather than state debt, whereas the ECB will be buying low-graded peripheral-government bonds, redistributing risks across Europe.

The Bundesbank has two fundamental worries about the ECB buying government bonds. First, it exposes taxpayers in northern countries to risks that belong to those in southern states, but does so opaquely within the Eurosystem rather than openly. Second, it takes monetary policy too close to the realm of fiscal policy and thus compromises the ECB’s independence. Even the conditionality of the OMTs can be seen as subjugating monetary to fiscal policy. Mr Weidmann is essentially calling on the German and other European governments to come clean about the fiscal consequences of a monetary union rather than disguising them within the Eurosystem. The politicians have to take responsibility for keeping the euro area together; it has to be their job, says Mr Nagel.

When it emerged that Mr Weidmann had been the sole governing-council member to vote against the OMT programme, much was made of his isolation. But if he is in a minority of one at the ECB, he is not in Germany, where a recent poll showed a big majority supporting his stand against bond-buying. Thomas Mayer, an adviser to Deutsche Bank, thinks that Mr Weidmann’s strategy of open opposition is enabling him to exert restraint on the ECB council—for example, in limiting the bonds that will be bought under the OMT programme to ones with a residual maturity of up to three years.