Monday, November 15, 2010

Eire vs the ECB

The ECB reports that it has lent EUR 130B to the Irish financial sector, which is roughly 25% of its total claims on banks. This exposure continues to grow as Irish banks’ market liabilities mature and are unable to be refinanced in the interbank or bond markets.

The ECB is now not only Ireland’s lender of last resort, it is Ireland’s only lender. The Irish banking system is a colony of the ECB and lives or dies by the decisions of the ECB’s board. Already, Axel Weber, a member of the board and the head of the once-and-future German central bank, has called for the orderly default of eurozone banks. Presumably, he is referring to Ireland's three major banks. (Which is interesting coming from Germany, which has half of its banking system on life-support. I guess he means that only non-German banks should be allowed to default.)

ECB president Trichet is the man in the middle. He wants the EU to bail out Ireland so that he can continue to lend to its banks. The Germans, by contrast, seem to have concluded that Ireland is not too big to fail, or at least Irish banks aren't too big to fail. Is Germany conditioning an Irish bailout on allowing Irish banks to default on their bonds? Could they really be that stupid?

The board meetings at the ECB in Frankfurt must be quite lively as the life and death of European countries is debated.

But what if Ireland plays chicken with the ECB? What if the Irish government refuses to apply for a bailout but continues to borrow from the ECB, this making the ECB’s exposure to Ireland a solvency and credibility problem? This why everyone in continental Europe is leaning on Ireland to apply.

But the only European organ that can make Ireland apply is the ECB, and it may well be that its threats to pull the plug will not be taken seriously by the Irish government. It certainly looks as if this is the case. The EU, which meets on Wednesday, cannot force the Irish to apply for a bailout. Their only leverage is the ECB.

This is truly global brinksmanship. Who will prevail? My money is on the ECB. I’d expect Ireland to submit by the end of the week.

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