With plans for the EFSF floundering, there are increasing
calls for the ECB to buy large quantities of Italian sovereign debt in an
attempt to reduce Italian bond yields and retain Italy’s access to the primary
debt market. For example, Portuguese President Anibal Cavaco Silva called last
week for the ECB to act as a lender of last resort with a “foreseeable,
unlimited intervention.”
While these calls are understandable given the current
circumstances, recent indications suggest these calls are falling on deaf ears. Regardless of the various economics arguments for and against the ECB adopting a role as lender of last resort for Member States, there appear to be compelling legal issues arguing against this, beginning with the statute that enabled the European System of Central Banks.
The Statute of the
European System of Central Banks (ESCB)
The Statute is a protocol attached to the Maastricht Treaty,
agreed in February 1992. Article 18(1) of the Statute permits the ECB and the
national central banks of the eurosystem to purchase securities to achieve the
objectives of the ESCB, while Article 18(2) gives the ECB the ability to
establish principles governing these purchases. These Articles are fairly short
and are worth repeating here.
Article 18
Open market and credit
operations
18.1. In order to
achieve the objectives of the ESCB and to carry out its tasks, the ECB and the
national central banks may:
— operate in the
financial markets by buying and selling outright (spot and forward) or under
repurchase agreement and by lending or borrowing claims and marketable
instruments, whether in Community or in non-Community currencies, as well as precious
metals;
— conduct credit
operations with credit institutions and other market participants, with lending
being based on adequate collateral.
18.2. The ECB shall
establish general principles for open market and credit operations carried out
by itself or the national central banks, including for the announcement of
conditions under which they stand ready to enter into such transactions.
It’s worth noting that while Article 18 gives the ECB fairly
broad powers to buy and sell securities, it places a constraint on the purpose
for which these market transactions can be conducted. In particular, these
powers have been granted “in order to achieve the objectives of the ESCB,” which are specified in various documents, including the Maastricht Treaty.
The Maastricht Treaty
The powers granted the ESCB by Article 18 of the Statute are
further constrained by Article 104 of the
Maastricht Treaty, now article 123 of
the Treaty for the Functioning of the European Union (
TFEU). The first paragraph of Article 104 prohibits monetary financing of EMU Member States and deserves careful consideration.
Overdraft
facilities or any other type of credit facility with the ECB or with the central
banks of the Member States (hereinafter referred to as ‘national central banks’)
in favour of Community institutions or bodies, central governments, regional,
local or other public authorities, other bodies governed by public law, or
public undertakings of Member States shall be prohibited, as shall the purchase
directly from them by the ECB or national central banks of debt instruments.
It's important to note that the prohibition in this paragraph is of purchases that are made “directly” from EU sovereigns. The
lack of an explicit prohibition against secondary market purchases has been
seized upon by those advocating that the ECB act as a lender of last resort for
Member States by purchasing significant quantities of sovereign debt in the secondary
market. However, secondary market purchases for this purpose appear to be
restricted by a regulation issued in 1993 by the Council of the European Union
as part of the implementation process for the Maastricht Treaty.
Council Regulation
(EC) No 3603/93 of 13 December 1993
In
EC No 3603/93, the Council addressed the issue of
secondary bond market purchases by clarifying the definition of the phrase, “other
type of credit facility” in paragraph 1 of Article 104 of the Maastricht Treaty
(Article 123 of the TFEU). The relevant article appears below with the key text
highlighted in bold for easier reading.
Article 1
1. For the purposes of
Article 104 of the Treaty:
(a) 'overdraft facilities' means any provision of funds to
the public sector resulting or likely to result in a debit balance;
(b) 'other type of
credit facility' means:
(i) any claim against the public sector existing at 1 January
1994, except for fixed-maturity claims acquired before that date;
(ii) any financing of
the public sector's obligations vis-à-vis third parties;
(iii) without prejudice to Article 104 (2) of the Treaty,
any transaction with the public sector resulting or likely to result in a claim
against that sector.
In its
Convergence Report of May 2010, the ECB also addressed
this issue. In a section titled,
Prohibition
on Monetary Financing, the ECB commented on Council Regulation (EC) No
3603/93, noting “
the prohibition includes
any financing of the public sector’s obligations vis-à-vis third parties.”
Intent matters
The effect of the Maastricht Treaty, the ESCB Statute, and
the associated Council Regulation is to permit the ECB to purchase sovereign debt
in the secondary market with the intent to “achieve the objectives of the ESCB”
but to prohibit secondary market purchases with the intent to provide monetary
financing of Member State budgets.
This interpretation appears to be shared by the ECB, as
evidenced in various ECB opinions. For example, in a legal opinion dated
25-Mar-10 on independence, confidentiality and the prohibition of monetary
financing (
CON/2010/25), the ECB indicated,
“The
prohibition of monetary financing prohibits the direct purchase of public
sector debt, but such purchases in the secondary market are allowed, in
principle, as long as such secondary market purchases are not used to
circumvent the objective of Article 123 of the Treaty.”
And to underscore the importance of these restrictions and
its commitment to them, the ECB also wrote in that section, “The monetary financing prohibition is of essential
importance to ensuring that the primary objective of monetary policy (namely to
maintain price stability) is not impeded. Furthermore, central bank financing
of the public sector lessens the pressure for fiscal discipline. Therefore the
prohibition must be interpreted extensively in order to ensure its strict
application...”
The Securities Market
Programme
The ECB has repeatedly stressed the limited and specific purpose
of the SMP. For example, in the ECB
Decision to establish the SMP, it cited
“...severe tensions in certain market
segments which are hampering the monetary policy transmission mechanism and
thereby the effective conduct of monetary policy oriented towards price
stability in the medium term.”
With this in mind, the critical issue at the moment is
whether the ECB believes significant purchases of Italian debt would be to
enable the effective conduct of monetary policy or to provide monetary financing
for a Member State. Reasonable people can and do differ on this issue, at times
considerably. For example, Axel Weber, at one point the presumptive successor to President
Trichet, and Jürgen Stark, the ECB Chief Economist, were so strongly opposed to
the SMP in its current form that they resigned earlier in the year.
With President Trichet having just ended his tenure as
ECB President, it’s useful to consider the views of the new President, Mario
Draghi.
The views of
President Draghi
At his inaugural
press conference as ECB President on
November 3, Mario Draghi was asked a pointed question by a journalist. “
Are you prepared now to make a commitment
that you will do whatever is necessary to keep the euro area in one piece,
including – if necessary – becoming the lender of last resort to governments?”
Draghi’s response was instructive. “I
have a question for you: what makes you think that the ECB becoming the lender
of last resort for governments is what is needed to keep the euro area
together? No, I do not think that this is really within the remit of the ECB.
The remit of the ECB is maintaining price stability over the medium term.”
From this response, it appears Draghi is not inclined to
support additional purchases of Italian debt for the purpose of providing
monetary financing for Italy.
The Bottom Line
The clear legal intent at the establishment of the monetary
union was to avoid monetary financing of Member State budgets, and President
Draghi appears committed to upholding this principle.
It appears reasonable
to expect that moderate purchases of Member State debt will continue for the
specific purpose of facilitating the transmission mechanism for monetary
policy. But calls for the ECB to contravene the enabling treaties, statutes, regulations,
and decisions of the monetary union appear to be falling upon deaf ears. Regardless
of any economic arguments to the contrary, the legal issues simply don’t appear
consistent with the ECB assuming a lender of last resort function with respect
to Member States. If the market refuses to provide additional financing for Italy at some point, it appears the Italians will have to look elsewhere for assistance in financing their budget.