The ECB earns its stripes?
This WSJ praises the ECB for its recent massive intervention in the markets to ensure adequate liquidity in a time of genuine panic:
The ECB has been at the front of a global liquidity infusion that’s seen central banks around the world inject billions into the financial system since the credit crunch emanating from fears about the subprime-loan market hit euro-zone money markets this month. On Friday, the central banks of Russia and Kazakhstan intervened to prop up domestic money markets hit by a liquidity squeeze. Russia’s central bank injected 42.4 billion rubles ($1.64 billion) into its money market.
The cash injections are nothing new for the world’s monetary policy makers. In the past, the ECB and other central banks have also staged major interventions to help markets when liquidity got tight — most significantly after the Sept. 11, 2001, terrorist attacks. But never before had the ECB told banks ahead of time the sums available were unlimited. The reason for the change: This time, as former Defense Secretary Donald Rumsfeld once put it, they knew what they didn’t know.
In the current crisis, banks have been spooked by the fact they don’t know who is guaranteeing bad debt from the U.S. subprime-mortgage market: These days, banks routinely lay off risk through complex and opaque investment instruments. For the ECB, the best way to figure out how much money it would take to ease euro-zone banks’ nerves was to let them take what they wanted.
The banks wanted a lot. In the Aug. 9 move, the ECB gave nearly €95 billion ($127.45 billion) to 49 bidders, in a loan that needed to be repaid the next day. In the days that followed, the ECB kept injecting short-term funds. But with a clearer idea of just how much cash the market needed to keep functioning the bank was able to decide when to turn off the spigot, showing it was both willing to help the markets and in control of the situation. By early this past week, overnight rates were back to normal, around 4%.
ECB staff recognize that this is a defining moment for a very young bank. The ECB, which manages monetary policy for the 13 countries that share the euro currency, was founded on June 1, 1998. Its unexpected intervention swept aside longstanding accusations of conservatism. It also heralds the new reality of a globalized financial system that has become so complex that locating risk — even for central bankers with reams of market information at their fingertips — has become more art than science.
“It was exemplary central banking,” says Erik Nielsen, senior European economist with Goldman Sachs in London. French President Nicolas Sarkozy, who has long challenged the ECB to focus on jobs and growth rather than just inflation, also commended the bank’s actions in a letter on Thursday urging G-7 leaders to focus on finding ways to locate where risk lies in the financial system.
This space has been somewhat critical of the ECB in the past, though we think their actions over the last two weeks were appropriate to the occasion. It is fair to note, however, that an ineffective response by a “very young bank” would have potentially been highly damaging to its credibility and long-term prospects. It remains to be seen how the bank will deal with the stresses of highly divergent national financial performances in a major European economic downturn. Therein perhaps lies the real test.