Geithner Lets the Cat Out of the Bag

By Marshall Auerback

Michael Kinsley once defined a gaffe as “when a politician tells the truth – some obvious truth he isn’t supposed to say.”  On that basis, the recent headline that just popped up might well represent a major gaffe of the Kinsley variety by Treasury Secretary Tim Geithner:


Speaking on CNBC’s “Delivering Alpha” conference, the Treasury Secretary argued:

What is very important is that [Eurozone officials] not leave the Continent hanging on the edge of the abyss as a device for getting more leverage for reform, because that leaves the rest of the world much more exposed to financial pressure and slower growth from Europe.

In essence, Geithner is letting the cat out of the bag. He is implying that Europe is hanging on the edge of the abyss. Only Germany can prevent it from falling in, and at the same time it appears that Berlin has now moved into a position where they cannot or will not prevent that disasterous scenario, either for economic or legal reasons.  The decision by Germany’s constitutional court to delay its approval of the German Parliament’s ratification of the ESM and fiscal compact may be a warning. The court could have moved to approve quickly. Instead, it will not rule on emergency appeals for an interim injunction against the parliamentary approvals until the end of this month. If the court rules in favor of an interim injunction, the final decision on the ESM and fiscal compact may not be made for several months.

This decision to delay by the constitutional court suggests that it cannot be counted on to approve bailout measures for other European nations even if a failure of Germany to participate in such bailouts may lead to a quick and perhaps decisive European financial crisis. Also its decision to delay may also reflect a growing opposition to such bailouts in Germany that will lead to more and more constitutional challenges. If so, the odds of an adequate ECB and EU policy response is surely dimmer.

In short, there is virtually no appetite for the kind of FDIC style eurozone-wide deposit insurance needed to halt the bank run which is still afflicting the EMU.  Geithner’s Kinsleyian gaffe might therefore represent a very,very revealing slip on his part.

So why is there so little reaction in the markets?  Is it simply a case of the summer doldrums?  Are people just plain and simple sick of the whole crisis and just want to enjoy a few weeks’ respite on the beaches?  That might be part of it, but an equally salient factor is that the ECB now appears to be engaged in a massive cover-up to disguise the extent of the bank run and the corresponding problems afflicting Europe.

Consider this:  about 18 months ago, Wilhem Buiter wrote a very interesting paper for Citibank on the legality of the ELA’s use in Ireland.  He suggested the following:

Above we noted that, at least in the interpretation of the ECB, the monetary financing prohibition in the Treaty would be violated if ELA were granted to an institution that was not just illiquid, but insolvent. Of course, the distinction between the two concepts is notoriously difficult, and especially so during periods of high market stress and very volatile asset prices. Nevertheless, in the Irish case, it appears that the main beneficiaries of ELA were institutions whose solvency must at the very least have been in question even at the time ELA was provided …

The implication was that the use of the ELA for Ireland was probably illegal as Ireland’s banks were probably insolvent. If Ireland’s banks were insolvent, then those of Greece today can only be described as “insolvency squared.”

How are they surviving? They are almost certainly being kept alive solely by the ELA. But nobody talks about it.  The odds are that, once the deposit run unexpectedly got out of hand, the ECB and the EU authorities have been afraid to make any mention of it because, in drawing attention to it, they would probably exacerbate the run.

In fact, you can’t even find the ELA on the ECB’s balance sheet as a specific line item. Two months ago the prevailing estimate for ELA financing from the central bank of Greece was 50 billion euros as of the end of 2011. As of February of this year, according to the central bank of Greece, its ELA rose to 109 billion euros. However, those same central bank of Greece reports now show that their ELA exposures are almost nonexistent. Has such emergency lender of last resort financing suddenly been repaid? Of course not. It has been reclassified.

And as Buiter’s report indicated, the manner in which the ELA has been used might well be illegal.

The cover-up will be hard to sustain going forward, given that there has been a precipitous plunge in Eurozone interbank lending in the nine months through April and a very sharp decline in the net foreign assets of the ECB since the beginning of May.

And, in the final twist to this saga, Buiter’s report on Ireland, entitled   ‘Ireland Emergency Liquidity Assistance (ELA) 21/01/11’  (excerpts of which were available courtesy of FT Alphaville) have now been deleted (see here).

ADDENDUM* The full report is available here (h/t Ramanan).

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