–Updating To Include Merkel’s Softening Of The German Position

FRANKFURT (MNI) – European Central Bank Executive Board member
Lorenzo Bini Smaghi, in a veiled reference to Germany and other nations
calling for an extension of maturities on Greek debt, noted the
contradiction with previously stated views that the ECB had taken too
many risks during the crisis.

“This same group even suggests that the ECB should stand ready to
accept, after a debt restructuring, the signature of a default-rated
government as collateral,” Bini Smaghi said in the text of a speech
given in Stockholm. “How are such contradictions possible?”

Bini Smaghi’s comments came before German Chancellor Angela Merkel
made comments backing off Germany’s position and suggesting that she
would embrace the ECB view that a more voluntary rollover of debt, only
upon maturity, was the way forward.

In a clear but only implicit reference to Greece, the central
banker reiterated that the ECB could only lend to “sound institutions”
who provide “appropriate collateral.”

“The appropriateness of the collateral depends in particular on
whether the country under stress follows rigorously the IMF/EU
adjustment programme and is on track to regain market access,” Bini
Smaghi said.

“These rules and principles apply to the central bank but are
ultimately there to protect taxpayers and to prevent monetary policy
from being misused to bail out insolvent governments,” he added. “They
constrain the actions of the central bank, but also give it sufficient
flexibility to react in the event of a crisis.”

Bini Smaghi strongly asserted that, despite pressure to the
contrary, monetary policy must remain completely separate from fiscal
policy, particularly during a crisis like the present one.

“The reason is that it is precisely during a crisis that the fiscal
authorities try to push the central bank towards solving the fiscal
problem through the inflation tax,” he said. “However, the central bank
is protected from this pressure by its statutes and the rules it adopts
for the conduct of monetary policy.”

Bini Smaghi also argued against the view that debt restructuring
would improve market functioning and eliminate moral hazard, saying it
was based on flawed reasoning.

“The problem with this view is that it totally omits the broader
impact on the markets,” Bini Smaghi said.

“Trying to eliminate moral hazard in the middle of a systemic
crisis is like shooting yourself in the foot. Think about it: did the
failure of Lehman Brothers make markets work better, or worse?,” he
asked rhetorically. “Did it reduce moral hazard?”

The central banker also argued against the idea that private sector
involvement [PSI] in a bailout would necessarily minimize the burden on
the taxpayer, stressing that the opposite could end up being true.

“Lehman Brothers’ failure proved that if [private sector
involvement] is applied in the wrong way, the taxpayer will in the end
pay more,” he noted. “Short-term speculative investors benefit from
perverse forms of PSI, while long term investors are punished.”

“That doesn’t sound very clever to me.”

He reiterated the ECB view that more automaticity is needed in
applying sanctions for states that violate the fiscal rules of the EU.
Ensuring greater fiscal discipline by member states “will also better
protect the euro,” he said. “I hope that the Council will show courage
and leadership in this important endeavour.”

— Frankfurt bureau: +49 69 720 142; email: frankfurt@marketnews.com —

[TOPICS: M$$EC$,M$X$$$,M$$CR$,MT$$$$]