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ECB open-sesame

21 November 2011 By Neil Unmack

The battle for the euro zone’s survival hinges on finding a way to unlock the European Central Bank’s firepower. Even if countries such as Italy and Spain implement necessary reforms, they may not be able to borrow at reasonable rates. The ECB can prop up markets by buying bonds in the secondary market, but is forbidden by European Union treaties and its own statutes from financing countries directly. One idea doing the rounds is to use the International Monetary Fund to circumvent the rules.

There’s some legal basis to such a scheme. European council regulation 3603/93 exempts ECB loans to the IMF from the prohibitions on government funding. Article 23 in the ECB’s own statutes allows it to transact with international organisations.

Such loopholes aren’t legally watertight; neither clause was ever intended to fast-track massive bailouts. However, using the IMF would bring other advantages that could make the case for ECB intervention more robust. Firstly, the IMF lends under strict conditionality. That would remove the decision to lend from the ECB’s governing council, potentially assuaging critics who view interventions – including the current policy of buying bonds in the secondary market – as compromising the central bank’s independence. It would also keep the pressure on bailed-out countries, easing fears of moral hazard.

Also, the IMF lends under a gentleman’s agreement that it will get its money back before other creditors. Unlike its secondary market purchases, that would reduce the ECB’s financial risks.
Putting the IMF and ECB at the front of the queue could spook bond markets by subordinating existing investors. However, that would be offset by the benefits of cheap funding.

The biggest obstacles to an ECB/IMF programme are probably political, not legal. The euro zone will not like the idea of transferring control of its destiny, while IMF member states won’t be keen on the fund underwriting massive euro zone risks. One possible way to reduce this would be to set up a specific facility where any potential losses are passed through to the ECB.

Funding the IMF through the ECB may sound unorthodox, but no less so than the current policy of secondary market purchases. It is worth a closer look.


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