Trichet to Leave a Difficult Legacy at Central Bank

Since Europe’s debt crisis became acute last year, the European Central Bank has gone beyond its role as arbiter of monetary policy to become in effect the adult supervision for quarreling heads of government.

Jean-Claude Trichet
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Jean-Claude Trichet

Time and again the bank and its president, Jean-Claude Trichet, have applied pressure when they thought heads of state were not acting responsibly. As a result, when Mr. Trichet’s eight-year term expires at the end of October, he will leave behind an institution that has grown substantially in stature and influence.

He also leaves behind a difficult legacy for his most likely successor, Mario Draghi, the governor of the Bank of Italy. Mr. Draghi appears to share Mr. Trichet’s ability to negotiate cordially with European leaders — and to browbeat them when necessary. But Mr. Draghi, already an influential member of the central bank’s governing council, will also inherit an institution that has become deeply entangled with the banking system, financial markets and the political process.

“The ECB so far has done an admirable job, all things considered,” said Dennis J. Snower, president of the Kiel Institute for the World Economy in Kiel, Germany. “But it has found itself in a very uncomfortable place not of its own choosing. This place may become more uncomfortable as time goes on.”

In May 2010, Mr. Trichet and others pushed leaders to recognize that there was a crisis in the first place, and then to fashion a rescue package for Greece. The bank did its part by buying Greek government bonds.

This year, the bank has used its influence in the banking system to insist that Portugal and Ireland accept bailout loans. Mr. Trichet has also pushed governments, with limited success, to adopt tougher sanctions against euro countries that run up too much debt, with the goal of averting future crises.

In recent days, as the idea of allowing Greece stretch out its debt payments gained traction, the bank set itself up as the main opposition. It is not clear whether the bank will succeed in blocking a restructuring that many economists see as inevitable.

Mr. Trichet and others argue that a Greek default could disrupt financial markets in ways that would be unpredictable and impossible to control. But in recent weeks the bank has faced criticism that it has a conflict of interest.

In May 2010, the bank began buying Greek, Portuguese and Irish debt in an effort to stabilize markets for those bonds. The bank acted with the national governments, which at the same time set up a 500 billion euro, or $715 billion, bailout fund for the distressed countries.

As a result, though, the bank now holds 75 billion euros in bonds from those countries and would lose money if any of them defaulted.

In May, Mr. Trichet walked out of a meeting with leaders of euro zone countries in Luxembourg. He was upset that the politicians were toying with the idea of a Greek debt restructuring.

Yet the bank’s venture into politics also created strains in its own governing council. Axel A. Weber, the president of the German Bundesbank and a member of the council, argued that the bank was making a mistakeby intervening in government bond markets.

Based on public statements Mr. Weber made later, it appeared that he thought the bank was moving too far into fiscal policy and letting governments off the hook.

“Primary decision-making over wide areas of economic and finance policy remains with member states,” he and two Bundesbank economists wrote in a March commentary published in The Frankfurter Allgemeine newspaper.

The ideological split had lasting consequences for the bank. Mr. Weber, who had long been seen as the front-runner to succeed Mr. Trichet, resigned as Bundesbank’s president at the end of April to avoid defending polices he disagreed with.

Even though European politicians seem to resent meddling, they have been glad to allow the central bank to deploy its financial resources at crucial moments, propping up commercial banks with cheap credit and intervening in bond markets.

In many respects, the bank is better equipped to deal with the crisis than national governments. It is a pan-European institution able to act quickly — and independently.

Mr. Trichet and the other members of the governing council, which is made up of the six members of the bank’s executive board and 17 heads of national central banks, do not need to worry about re-election and are therefore often better positioned to take unpopular stands.

The bank has platoons of economists as well as lines of communication to banks that provide it with constant information about markets and the euro zone’s economy. Most national finance ministries have nowhere near the same expertise.

And the central bank has leverage over the banking system. Some Greek and Irish institutions might collapse without the cheap loans that the bank provides, accepting the banks’ devalued government bonds as collateral.

The financial lifeline also gives the bank huge influence over those countries’ banking systems, a situation that some leaders resent. Brian Lenihan, the Irish finance minister until his party was voted out of power in February, complained publicly that he had been rushed into accepting an aid package.

Members of the bank’s governing council bristle at any suggestion that they have bullied anyone and instead see themselves as rescuers.

“The level of commitment of the euro system to Ireland has absolutely no historical precedent,” Mr. Trichet said in early May, referring to the monetary infrastructure overseen by the bank. “We are siding with Ireland in the difficult circumstances.”

European leaders may chafe at scoldings from the bank, but they seem to recognize the need for a strong president at the bank.

Mr. Trichet’s departure presented an opportunity to choose someone more pliant to replace him. Instead they have nominated Mr. Draghi, who brings many of the same qualities as Mr. Trichet.

Mr. Draghi is well known among leaders of the Group of 20 nations and for years has played the same role in Italy that he has been asked to play as head of the bank — the rational technocrat restraining the spendthrift impulses of politicians.

Last October, for example, the French president, Nicolas Sarkozy, lost his composure with Mr. Trichet during a meeting in Brussels. Mr. Trichet wanted tougher automatic sanctions for countries exceeding treaty limits on debt and deficit spending, and he was upset about suggestions that private investors should contribute to a bailout of Greece.

According to people who attended the meeting, Mr. Sarkozy shouted that he was not going to let some bureaucrat tell him what to do.

Mr. Trichet also replied sharply, startling others in the room, according to one high-ranking participant, who would speak only anonymously in order to prevent jeopardizing his relationships with other officials.

“But it was short-lived,” the person said. “Just after that they exchanged kind words and the incident blew over.”

After years of working with Silvio Berlusconi, the Italian prime minister, Mr. Draghi appears to have the demeanor to deal with similar outbursts.

“You don’t just need a background in technical monetary policy to run the ECB,” said Stefan Gerlach, managing director of the Institute for Monetary and Financial Stability at Goethe University in Frankfurt. “You need somebody who has as good political savvy as President Trichet.”