Greek Dilemma A State of Emergency or Illegal Blackmail?

Granting Greece emergency credit through the ECB is both legal and necessary, according to our guest author, who wants to see a clear distinction between justified emergency measures and unlawful blackmail.
Mario Draghi's dilemma.


Is the European Central Bank acting illegally? Many Germans would answer in the affirmative. They see the ECB as the handmaid of foreign interests and are outraged about it. Others see things similarly, but the other way around.

In the fall of 2010, the ECB ensured that the Irish taxpayers were responsible for the claims German banks had on Irish banks. The central bank “convinced” the Irish government at the time with the threat of stopping the emergency credit (Emergency Liquidity Assistance, or ELA) to Irish banks. That would have let the Irish banks collapse and the rest of the economy with them. For the Irish, it was illegal blackmail in the interest of the Germans.

Now the ECB has frozen emergency credit for Greek banks. The cause was the collapse of negotiations between the Greek government and the Eurogroup over austerity measures and debts. Banks in Greece have been closed and the monetary transactions and access to cash drastically limited.

According to the E.U. Treaty, the Frankfurt-based central bank is responsible for money supply and the functionality of payment systems, including that in Greece. Therefore, the freezing of emergency credit is not reconcilable, and the threat against the Irish government was not either.

If Jens Weidmann, president of the German Bundesbank, had had his way, the emergency credit to Greece would have been stopped even sooner. At the end of May he told Handelsblatt: “I do not think it is right, in light of the ban on monetary state financing, that banks without market access are granting credits, which then finance the bonds of the country’s own government, which itself is without market access.” This sentence is misleading in three ways.

First, he suggests that banks without market access should not receive any central bank credits. Aside from the fact that the Greek Banks did not have financing problems until the end of 2014, the task of the ECB as the creditor of last resort exists exactly in preventing a collapse of the monetary system by issuing emergency credits when there is an erosion of the markets.

Mr. Weidmann also suggests that the Greek banks use the ELA loans for state financing. That does not correspond to the facts. The Greek banks have held back with state financing since 2012. The ELA loans this year have only compensated for the withdrawal of customer deposits. Apart from that, the ECB, as a supervisory authority, has prohibited the Greek banks from expanding the loans to their own government.

Finally, Mr. Weidmann makes the suggestion that it violates the E.U. Treaty when commercial banks lend the funds they receive from the ECB to their government. That is also false. The treaty does not contain any stipulation for how the commercial banks should use the funds that they are lent from the ECB. Banks are free to make business decisions within the limits set by legislators and supervisory authorities.

If national central banks lend to commercial banks, there are no liabilities to other central banks.

The treaty does not allow the European Central Bank to use its power over the monetary system of a member nation to extort the governments into good behavior with their creditors or the creditors of the banks. In a proceeding at the European Court of Justice, the Advocate General specifically issued the reminder that the ECB should keep more of a distance from the negotiations over debts and austerity measures of debtor nations.

But don’t the ELA loans hold intolerable risks for the German taxpayers? Hans-Werner Sinn, the president of the Ifo Institute, reported that the Greek Central Bank could only bear losses on these loans up to a limit of €41 billion, which is less than half of those that have already been covered. Higher losses, he said, would burden the other central banks, and as such the German taxpayers. Clemens Fuest, Mr. Sinn’s designated successor, has made similar statements.

One wonders if Mr. Sinn and Mr. Fuest have read the E.U. Treaty. There is namely nothing in it that says the Greek Central Bank is responsible to other central banks for losses on ELA loans. 

If national central banks lend to commercial banks, there are no liabilities to other central banks.

However, each year the surpluses or losses from loans falling under the scope of monetary policy are put together in one joint pot, and then divided. The ELA loans are the exception to this rule. The seigniorage tied to these loans remains with the national central bank, as do any losses. The losses, however, are never higher than the seigniorage. Liabilities to other central banks only exist if the commercial banks transfer funds abroad or withdraw cash. There is no difference here from the loans in the framework of normal monetary policy.

Mr. Sinn criticizes the size of these assets in Greece, but in 2011 they were higher than they are today, and since then they have dropped by more than half before Syriza’s electoral victory let them rise again. Fluctuations in these assets are a normal part of the currency union. There are only risks for taxpayers if a country leaves the currency union. The ECB Governing Council can prohibit the emergency credits if it is of the opinion that they are “not compatible with the goals and responsibilities of the euro system.” That is meant to prevent uninhibited printing of money by a national central bank.

The ECB is currently massively expanding the central bank money supply because it is afraid of deflation. As such, no conflict between the ELA loans and the monetary policy of the ECB is evident. Bringing the member states to heel is not one of the goals and responsibilities of the euro system.

“But the Greek banks are insolvent!” When Hans-Werner Sinn made this statement in February of this year, he was wrong. Since 2012, the Greek banks raised quite a lot of equity capital and smoothly sailed through the audit and stress test last year. Their problem was much more that the depositors do not have any trust in the Greek government and would rather hold cash than bank deposits, which can be changed by a law into drachma — it was a liquidity problem, not a problem of solvency.

In the meantime, the solvency of the banks has become dubious. The recent economic crisis allowed a portion of the loans given by them to become non-performing. Is that a reason for stopping the support through the ECB and letting the banks and the system of payments collapse?

Wouldn’t it have been better for Germany if the Reichsbank had been able to continue supporting the banks in 1931, including the Danatbank, which was apparently insolvent?

But what if the Grexit happens? Then the debts of the Greek Central Bank will be largely be lost to target balances and cash distributions. The freezing of ELA loans can be seen as protection against this possibility, a form of emergency measure in a situation that was not anticipated in the treaty. So far, however, the Greek government has explained that it does not want a Grexit at all, and is only defending itself against the austerity orders from Brussels. But a Grexit could be unavoidable if the supply of money to Greece continues to be stopped. Without a functioning monetary system the economy will also not function, and life will quickly become unbearable.

In this vicious circle the distinction between a justified emergency measure and unlawful blackmail is difficult to make. For many people in other countries, not just in Greece, the answer is obvious, however. It is made worse by the fact that the German protagonists make the blackmail interpretation so believable.

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