- Associated Press - Sunday, October 9, 2011

FRANKFURT, GermanyJean-Claude Trichet, the euro’s chief guardian, this month will leave the European Central Bank (ECB) in a very different place from when he took the helm in 2003, with a dramatically expanded role to fight the government debt crisis.

The bank has gone from arbiter of interest rates to chief firefighter in the crisis, government creditor and even political enforcer of budget cuts on elected governments.

It’s a role that Mr. Trichet, who last Thursday chaired his last monthly ECB news conference, took on with reluctance and, many say, with little choice.

The bank’s bold steps against the debt crisis have so far kept the eurozone from a widespread collapse of government and bank finances.

But those emergency measures, particularly the purchases of troubled governments’ bonds, mean long-term risks for the bank’s credibility as the key institution behind Europe’s 12-year-old shared currency.

It is even still possible that Mr. Trichet’s legacy could be marked by unforeseen events in the final three weeks of his eight-year term, which ends Oct. 31. The crisis is still alive with worries that Greece might default, which would rock Europe’s banking sector.

Many expect it will be years before it is clear if the path Mr. Trichet has led the ECB down was the right one.

“The book is very much still open, and the assessment of the ECB policies during this crisis will only be possible in quite some time,” said Marie Diron, senior economic adviser to Ernst & Young. “But on the whole, he probably leaves the ECB in a stronger position.”

“The ECB has played probably a much bigger role during this financial crisis than it would have envisaged at the beginning,” she said, “by the broad nature of the interventions that it had to take, the size of the interventions that it had to take, and the political roles that it had to play in negotiations on debt restructuring and fiscal policies.”

The 68-year-old Mr. Trichet started saying his public goodbyes on Thursday at his final post-meeting news conference after a meeting of the bank’s 23-member governing council in Berlin.

Mario Draghi, currently head of the Bank of Italy, was chosen by eurozone leaders as his successor and takes over Nov. 1.

One token of the bank’s burgeoning role can be seen in the detailed letter Mr. Trichet and Mr. Draghi wrote in early August to Italian Prime Minister Silvio Berlusconi.

The two unelected central bankers pushed Mr. Berlusconi hard to move quickly on cutting Italy’s deficit, and urged specific changes, such as cuts in public employees wages, according to a leaked text published in Italy’s Corriere della Sera newspaper.

Mr. Trichet says there was no “negotiation” with governments over the terms of the bank’s help.

But the fact remains that the ECB and the bond purchases, which drove down interest rates on government debt after they were launched Aug. 8, were, and still are, the only thing between Italy and a possible death spiral of higher borrowing costs.

Similar spirals based on bond market fear of default earlier pushed Greece, Ireland and Portugal to seek bailouts. But Italy and Spain are considered too big to bail out.

In effect, by pushing for government policies in exchange for help, the ECB was taking on an enforcer’s role more typically played by the International Monetary Fund.

The bond purchases led to strife on the ECB board: Chief economist Juergen Stark is retiring in apparent disagreement, and Axel Weber, head of Germany’s Bundesbank, earlier this year abandoned a bid to succeed Mr. Trichet over disagreement with the board’s decision on bond purchases.

Mr. Trichet, whose position has less direct authority than that of the U.S. Federal Reserve chairman, has had to build consensus.

He steered a course between strict bailout opponents such as Mr. Stark and Mr. Weber, and outside economists who have urged him to buy the bonds by creating new money, a potentially unlimited source of financial firepower, but also potentially inflationary.

The ECB has refused, although the Fed and the Bank of England have done so.

Mr. Trichet’s own summing up in recent speeches focuses more on the bank upholding its mandate to keep inflation under control, as spelled out in the 1993 Maastricht Treaty that created the euro.

With the debt crisis, he said Tuesday before a European Parliament committee, “it is sometimes forgotten that our primary objective is to maintain price stability.”

“This is what the treaty demands from us. This is what the citizens of the euro area expect from us. And this is what we have delivered.”

He stressed one number: 2.01 percent, the annual inflation rate over the life of the euro despite sharply higher oil prices over the period. That is better, he says, than member states were able to achieve under their separate currencies over the previous 50 years.

Yet with the crisis now threatening the existence of the euro itself, the most intense discussion is now about the bank’s efforts to douse the crisis. Risks include potential losses on the $211 billion in government bonds it has bought, between $53 billion and $66 billion from Greece.

Analyst say the bank has the capital cushion to handle losses, but the more serious damage would be a dent in its reputation for well-thought out policies.

Commerzbank economist Michael Schubert said that if the bond program ends with losses from a default “then I think it will have an effect on their credibility.”

“It depends very much on what will happen. People will not think too badly about what the ECB has done regarding the bond purchases if, in the end, states will consolidate. Then they will say, ‘Oh, that was the right measure.’ ” Mr. Schubert said.

A bigger risk could be so-called moral hazard: the chance that governments will move more slowly to fix their finances, or that EU leaders will be more reluctant to take over the bailout burden, because they think the central bank will step in and rescue the situation.

Guntram Wolff, deputy director of Brussels think tank Bruegel, says the bank’s actions are “a big example of moral hazard.”

But he adds it had little choice.

“The ECB had to step in and be a market maker for Italy and Spain, or they would have risked a financial meltdown,” said Mr. Wolff, who formerly coordinated the research group on fiscal policy at Germany’s famously anti-inflation Bundesbank.

“I don’t see how the ECB could not have done it. And it was difficult for me to come to that conclusion, with my background at the Bundesbank.”

Mr. Wolff said the challenge now for Mr. Draghi was to shift the balance and force governments to be the ones to do the bailing out and enforce the terms of good behavior.

“It should come from the capitals,” Mr. Wolff said. “It shouldn’t come from Frankfurt.”

Mr. Trichet appeared to concede Tuesday the bank’s hand was essentially forced, and to say ‘no’ would have meant even more worse trouble.

“To be in denial that we have the worst crisis since World War II would be the biggest mistake we could make,” he said.

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