European Affairs

Before taking a closer look at the new man, it seems useful to speculate briefly on the world in which he seems likely to find himself when he takes his seat at the head of the ECB on November 1. Some things will be predictable: the calendar will show Tuesday, he will be sitting behind the same impressive wooden desk in Frankfurt occupied by his French predecessor.

But much else on the European economic scene may be unrecognizable from the situation last June,  when he was confirmed by EU leaders as the new leader of this crucial institution.

The newspaper headlines on his desk may reflect changes that were almost unthinkable six months earlier. Europe could have established a so-called Wirtschaftsregierung, an economic government, orchestrated by the Germans and the French – whose degree of effectiveness has still to prove strong enough to make eurozone governments demonstrate fiscally responsible behavior. And the ECB could have become a “bond-buyer of last resort,” purchasing treasuries bonds from European governments  worth billions of dollars no one else wanted to buy – including even bonds issued by Italy, his home country. The once-shining high standard of ECB’s firm management of the single currency could now be further tarnished by the continuing euro crisis that still has no end in sight. And Mario Draghi -- or “Super-Mario” as some people nickname him – finds himself presiding over a bank that has turned into an emergency tool for apparently helpless European governments. While making himself comfortable in the black leather chair in the president’s upper-floor office of the Eurotower overlooking vibrant Frankfurt, he suddenly feels the burden of his new responsibilities. And Super Mario sighs.

In reality, Mario Draghi’s first day in office may not look quite so grim. But, some of the legacy that the Italian banker will have to confront is already in place and will challenge his financial talents and political skills. These are well established. He won praise (from among others U.S. Treasury Secretary Timothy Geitner) for his work in the five years after 2006 when alongside his job as Italy’s central banker he also served as head of Financial Stability Board (FSB), the body designed to monitor and shore up the governance of global systemically important financial institutions. In fact, under Mr. Draghi’s oversight, the FSB put some potentially effective financial regulatory rules on the table.

Upon arrival in Frankfurt, he will find an ECB that finds itself at a major crossroad. Its main challenge, especially in the view of Germany, its main “shareholder,” stems from the central bank’s decision to purchase treasury bonds from EU countries whose debt burdens have put them “under water” i.e. not able to find fresh credit elsewhere to pay the interest on their existing euro debt. Germany's divergence from the ECB broke into the open when the chief economist of the bank (and member of its board) resigned on September 10.

The practice of the ECB buying bonds that have become suspect in the market started in spring 2010 when the ECB bought bonds issued by Greece, Portugal and Ireland worth roughly $74 billion. That was the public figure, but it is widely believed that the ECB actually bought even more in a bid at least to “buy time” for eurozone governments to redress their situations. That phase was followed by a months-long lull during which the bank refrained from providing this open window to other EU member states, leading some to hope that the ECB-financed bailout was a one-time exception and not a fundamental policy deviation. But then in August 2011, the ECB  acknowledged that it had resumed the practice. This caused consternation and shock, especially in Germany. Christian Wulff, the normally discreet German President, reacted publicly with his view that it was “legally questionable” for the ECB to pursue this policy.

Why? Because the ECB, as created by EU leaders at Maastricht as part of the new single currency system, was not set up to buy degraded bonds that enable debt-laden member states in effect to “print money” (which they were supposed to be barred from doing by the creation of the euro). In its founders’ eyes and its charter, the ECB was built as a bulwark of stability to make the euro at least as hard as the currency – the Deutschmark – that Germany abandoned for the euro. If this goal is fading, it is doing so under the pressure of events, not because of any desire to diminish the rigor of the ECB. (President Trichet has a long record both in France and subsequently in Frankfurt, as a man who shares the German view about the need for monetary stability and discipline.)

Will President Draghi want to restore the original cornerstone of the bank’s foundation? And if he wants to, can he? In the search for Trichet’s successor, Draghi was labeled “the most German among all the non-German candidates”  by the German media. Coming from them, it was an unusually broad endorsement for an Italian. But it also reflected hopes that Draghi, 63, who has also worked for Goldman Sachs, shares the increasing insistence of his new peers – not only Ben Bernanke at the U.S. Federal Reserve but also Trichet himself at the ECB – that governments are going too far in shifting the burdens of handling the financial crisis to the central banks (using loans and low interest rates) and doing too little to meet their own political responsibilities by demanding more financial discipline, budgetary control and austerity from their electorates.

In many German financial circles, there is skepticism about the outlook for the ECB – skepticism rooted in the fact that Draghi is an unknown quantity when it comes to monetary policy. He was obviously comfortable as a banking regulator heading the FSB in Basel, where he could delve into questions of law and oversight. As an individual, he has earned himself a notable reputation of integrity and diplomacy. But no one can say with certainty what direction he will choose in steering the ECB.

For many Germans who feel alarmed about the recent trends, they try to find clues in taking a closer look at President Trichet. The Frenchman was often quoted in the past saying of himself that he is “a clone of Hans Tietmeyer,” the former head of the German Bundesbank. That was meant as an assurance in particular to the Germans that Tietmeyer’s reputation as a tough-minded, stability-oriented banker would be the template for Trichet’s governance. That was initially true.

Then last year as the euro crisis finally hit with full speed, signs emerged that Trichet’s convictions were negotiable – at least under the pressure of mounting sovereign debt on some eurozone countries that had been profligate during the boom years. When Trichet sought to revive his emergency agenda of bond-buying this year, he faced strong German opposition in the ECB governing council.  But by August 7, he had collected enough council votes to restart the purchase of treasury bonds, this time from Spain and Italy – effectively providing them time that they could only have obtained otherwise by more radical political restrictions on government spending than their governments felt willing (or perhaps able) to take.  Today, would Trichet still boast that he is a “Tietmeyer clone”? Probably not. He would, however, argue that the bank faces exceptional circumstances and needed to take the audacious and controversial step of reintroducing anti-crisis measures such as the unconditional bond-buying. Indeed. But these same circumstances were also a chance for him to invoke the full credibility of his experience and reputation.

As the Trichet example shows, the ECB is under pressure to stray from its original charter and founding principles and instead assume the role of savior for suffering eurozone countries. It is an agonizing debate for a man like Trichet, according to Mohammed A. El-Erian, head of Pimco, a major global bond trader. He wrote recently in that the disturbing realities of central banking in the era of debt overhangs and sovereign-debt concerns, a decision-maker such as Trichet feels forced to move away from his conservative mandate as a temporary measure while hoping for a return to economic growth, notably in the U.S.

But for many analysts, in Germany and elsewhere, it is a false debate because the problem is being forced on the ECB by political failures on the part of European leaders (and a deadlocked U.S. Congress) in failing to act more audaciously. That leaves the ECB (and Fed) alone to bail out the sinking ship, El-Erian says – while they hope and wait for help. The real onus, according to both analysts, market players and central bankers, should be on the government leaders to assume their political responisbilities and legislate effective European actions to resolve the debt crisis.

Even this rationale – of emergency defensive action by the ECB – is a short-sighted option, according to the prevailing view in German financial circles. “Short-sighted” and limited, they say, because it hurts the balance sheet of the ECB. In buying junk bonds, the bank’s equity is strongly diminshed. Beyond that, critics say the practice is outright wrong for larger reasons. It has the effect of spoiling standards and spreading disastrous acceptance of “moral hazard,”  enabling recipient governments to borrow and spend money without any risk because they can expect to borrow more from the ECB. In an interview with German business paper Handelsblatt, Jörg Krämer, Chief Economist of the Commerzbank, said: “By purchasing treasuries of countries like Italy the ECB is taking the pressure off the governments – and the politicians in charge don’t feel the need any more to quickly go to the roots of their malaise and fix it.”  President Trichet has said as much himself in private. The question is: Will has successor be willing and able to do anything to rectify the situation?

While incoming President Draghi has yet to earn the broad international credibility of his predecessor, he has the experience of having gone through many similar crises at home before – and always kept his cool. (Similarly, Trichet went through domestic crises in French finances and kept his cool. But the Italian situations appear to have been more dire.) In these turbulent times, experience of this sort may prove to be a more valuable qualification for the ECB than it would have been in the past. The very fact that he is  Italian and representing a troubled country may push President Draghi to prove the skeptics wrong – with a degree of motivation that might not be felt as strongly by his Dutch and French predecessors (or by a German).

For the ECB, that could be a welcome and unexpected blessing.

Markus Ziener is Washington Correspondent for Handelsblatt, German Business Daily.