Collusion_How Central Bankers Rigged the World Read online

  THE WARM-UP FED AND ECB DANCE

  In early 2008, as the United States buckled under a budding housing and banking crisis, Europe faced the milder problem of rising inflation. During the first half of the year, the euro appreciated to record levels against the dollar as investors feared dollar-denominated assets would exacerbate the issue. On February 27, 2008, the euro hit a record high ($1.50) against the dollar since its creation.10

  Containing inflation as a policy prescriptive, common beforehand, in the post-crisis years would be superseded by global requirements for bank liquidity. These were not normal times. They were times of panic, reminiscent of others in the United States a century earlier. In fact, the Fed was spawned in 1913 largely because the early 1900s mega-banker J. P. Morgan needed a central bank to back him in case another panic like the one of 1907 occurred.

  Now, about a century later, the Fed’s chief worry was keeping the US banking system functional. Low inflation provided license to fabricate or “print” money. But inflation was low because organic growth was slow—conjured money couldn’t fix growth in the real economy because it wasn’t specifically directed into the real economy.

  On March 11, 2008, increasingly concerned about the squeeze in the credit market, the Fed announced a $200 billion funding package. It would lend Treasury bonds to primary dealers against their federal agency debt and residential mortgage-backed securities (MBSs). The action underscored two truths: first, the Fed’s power over other central banks, and, second, their fear of what could happen if they didn’t play ball with the Fed’s mandates.

  As Bear Stearns swooned toward bankruptcy, the international press speculated that the United States might temporarily lose its place as the “world’s biggest economy” to the Eurozone. In February 2008, a Gallup poll revealed that “Americans see China crowding out US as economic leader.”11 There was fear of losing the top slot in the economic hierarchy—not just from within the Washington elite but among the American middle class.

  On March 17, the Fed effectively became an investment bank, acting as merger adviser, creditor, and backer of risk for JPMorgan Chase’s $240 million purchase of Bear Stearns. The next day, the Dollar Index plunged to its lowest level ever, at 69.2802 in a vote of no confidence.12 Big US banks were in big trouble.

  In solidarity with the Fed, Trichet announced a $15 billion auction on March 25, 2008.13 It was a small trickle of what would become a massive flow of money infusion into private banks. Because private international banks had comingled risk, like playing dominoes, central banks had to consider those codependencies and provide aid and liquidity to cover them.

  Monetary policy collusion began quietly—and several months earlier. In mid-2007, banks noticed faulty assets based on defaulting subprime mortgage loans—a much bigger problem than the loans themselves by virtue of their size and complexity. Banks began to lose confidence in each other, and that meant a credit crunch was not far behind. Central banks had to jump to the rescue and ensure there was enough credit or liquidity flowing within the banking system. This is how swap lines between the Fed and ECB first came into being, on December 12, 2007. It was an early sign the Fed knew more than it was telling the public.

  The Fed increased existing temporary currency arrangements (swap lines) with its European partners by 50 percent on March 11, 2008. It provided up to $30 billion to the ECB and $6 billion to the Swiss National Bank.

  There was no mistaking the importance of this financial aid package in the private international banking community, which was its first beneficiary and needed the money soonest. “The G-10 central banks have continued to work together closely and to consult regularly.”14 This collusion wasn’t to create jobs. It was to provide welfare to banks.

  The world became a financial battlefield where central bankers fought to preserve their independence while being coerced through circumstance and external demands to fall into line behind the commander-in-monetary-policy, the Federal Reserve.

  The G7 central banks united to provide global banks and markets the constant infusion of capital required. Restricting one bank or market in one country could restrict them all. But, equally, each central bank had to consider its own area of official focus because the standard monetary policy didn’t always fit their nation. In practice, the central banks of more developed countries colluded, and as the crisis escalated, the Fed had to save its private bank members, its own influence base, and the dollar as the most prevalent and powerful reserve currency.

  On April 28, 2008, a group of European journalists interviewed Trichet on the matter. He had been the “it” central banker of 2007—named Central Banker of the Year by The Banker and Person of the Year by the Financial Times for steering “a confident path through the choppy waters of 2007’s credit crisis.”15 Waters were about to get a lot choppier.

  Trichet noted that people increasingly believed that gains were being privatized and losses socialized. But he wanted to correct this assumption and uphold the mantle of central banker as general savior. “It is all about protecting those who behaved properly against the harm that has been done to the market as a whole by those who have taken bad decisions.”16

  Asked if he listened to politicians like Italian prime minister Silvio Berlusconi or French president Nicolas Sarkozy when they criticized the ECB and its unilateral actions, on April 30, Trichet retorted, “The Maastricht Treaty has given us full independence.”17

  Yet, as in Latin America, the crisis shed light on the struggle between governments and central banks as they wrestled over the course of action to best benefit national economies versus multinational banks. Central banks were compelled to follow the Fed and its remedy for the US banking and financial systems—conjured money—in contrast to the best interests of their own countries.

  From his post atop the ECB, headquartered in Eurotower, a sleek twenty-five-story glass skyscraper located in the heart of Frankfurt’s financial district, Trichet watched inflation—like the hawk he was. Briefly, he struck an independent path from his Fed brethren. On July 3, in contrast to the Fed’s money-loosening strategy, the ECB raised rates by 0.25 percent to 4.25 percent. Trichet cited the reason as the rise in energy and food prices, the weakening of European GDP in Q2 2008, and high credit and monetary expansion in Europe.

  But he was wary. He said, “Starting from here, I have no bias.” He claimed that the ECB was “called upon” to do everything it did on behalf of the European people: “We are doing what the Treaty calls upon us to do. It is also what the people of Europe are asking us to do today.”18 Trichet took care to assert the political independence of the ECB by depicting it as a vehicle of the people, not of the banks that it directly supported through making liquidity available to them.

  A week and a half later, on July 15, Spain’s leading real estate agency, Martinsa-Fadesa, with an estimated debt of €7 billion, filed for bankruptcy. It was the biggest bankruptcy in the history of Spain. This bursting of Spain’s speculative, foreign-induced property bubble left the country in a weaker economic position to face the effects of the US subprime crisis and the eventual outbreak of the European sovereign debt crisis. Spain’s plight might not have been the catalyst for the crisis in Europe, but it signaled that the entire system was in trouble.

  On September 29, the US House of Representatives rejected a $700 billion rescue plan for banks, causing mass panic across international financial markets. If the big US banks weren’t given emergency capital to cover their risk-driven bets, the United States could crash the entire global system. The S&P 500 stock index fell almost 9 percent and the DJIA by 778 points (almost 7 percent), its worst decline since the crash of 1987.

  Swap lines with Fed allies grew to accommodate the banking system’s thirst for liquidity and inability to fashion its own. The largest lines were provided to central banks on September 29 and extended to April 30, 2009. The ECB’s line grew to $240 billion, the SNB’s to $60 billion, Bank of Canada’s to $30 billion, BOE’s to $80 billion, BOJ’s
to $120 billion, the Danmarks Nationalbank’s to $15 billion, the Norges Bank’s to $15 billion, the Reserve Bank of Australia’s to $30 billion, and the Sveriges Riksbank’s to $30 billion.19 It was a dollar party thrown by the Fed.

  A frazzled US Treasury secretary Hank Paulson spoke in front of the White House that day. He admitted to reporters, “We’ve experienced significant turmoil in our financial markets in the last few days including the collapse of Washington Mutual and Wachovia here and the failure of two major financial institutions in Europe… markets around the world are under stress and that reduces the availability of credit.” When pressed on whether enough was being done to alleviate the problem, he replied, “We have significant tools in our toolkit but they are not sufficient… so we are going to continue to work… until we get what we need.”20

  At the October 2, 2008, meeting of the ECB in Frankfurt, Trichet expressed fear that the US crisis, having struck Europe, would not be contained by central bank measures. Reinforcements were needed. He said, “And all governments—but not only governments—have to be up to their responsibilities. Of course we are not the United States of America as far as the institutional framework is concerned.”

  Though he spoke of central banks not being a part of government but still having responsibility, Trichet implied that the United States was less prepared to deal with the problem. He saw economic slowdown in the euro area due to domestic demand contraction and credit restriction.21 Because of that, the ECB kept rates unchanged. The unanimous decision was the pivot toward expansionary monetary policy.

  The next day, the ECB went a step further, though. It allowed more private banks to participate in unscheduled cash auctions through their governments.22 While Trichet was in the United States, he told Europe 1 Radio that US Treasury “Secretary Paulson’s plan [the bailout] obviously must be passed. It must be. It is necessary.”23 President Bush signed the $700 billion bank rescue package that day, October 3, 2008.24

  That wouldn’t be all. According to an October 8 Fed statement released at seven in the morning, several central banks (Bank of England, Fed, European Central Bank, Sveriges Riksbank, Swiss National Bank, Bank of Canada, and Bank of Japan) announced they had “cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.”25 They would collude to cut rates together. It was planned and executed that way. The Fed opened the moves and cut rates by 50 basis points to 1.5 percent.26

  Trichet realized that he would have to succumb to collusive forces. The ECB cut rates the same day, by half a percentage point to 3.75 percent. The minimum rate on main refinancing operations of the euro system fell to 3.75 percent, on the marginal lending facility to 4.75 percent, and on its deposit facility to 2.75 percent.27 Drastic times called for drastic measures. The euro depreciated in tandem. G7 central bank collusion was the new black.

  The delay in the ECB’s decision to follow the Fed was a result of Trichet’s consideration of regional economic conditions in contrast to the possibility of crisis contagion slamming Europe. He believed that inflation was too high to warrant a rate cut. That was old school central banking thinking.

  Trichet’s ECB opted for another 50-basis-point benchmark rate cut to 3.25 percent on November 6.28 The same day, the BOE slashed its rate in one fell swoop by 1.5 percentage points, or 150 basis points, to reach 3 percent, the lowest level since 1954. On November 14, the Economist reported, “The European economy officially fell into its first recession in the ten years since the euro was introduced.”29 Consider the ramifications: it had taken only a few months of global awareness of the extent of the US financial system’s rot to take down a major collection of economies that had been collectively chugging along for a decade.

  At the fifth ECB Central Banking Conference on November 13, 2008, Trichet touted the joint efforts of the world’s dominant central banks like they were war allies: “I would like to mention the fact that the ECB has been providing with euro-denominated collateral US dollar liquidity to the European counterparties through swap arrangements with the Federal Reserve that have no precedent. This action reflects, as much as all the other common actions, the intimate level of trust and cooperation within the community of central banks and, in particular with the Federal Reserve, whose value has been priceless.”30

  On December 4, Trichet told a press conference gathering at the ECB that the central bank had cut rates for the third time in two months, by 75 basis points to 2 percent. It was the biggest reduction since the euro became a supranational currency in 1999.31 He was petrified that intensification of international financial turmoil would harm euro area demand. According to Trichet, “The level of uncertainty remains exceptionally high.”32 That day, the BOE also cut rates again—to 2 percent, the lowest level in fifty-seven years.

  The Eurozone was about to hit an even harder wall. Central banks would not slam on the brakes but stamp the accelerator. Years later, regarding the events of that fall, Nobel Prize–winning economist Joseph Stiglitz remarked, “The structure of the Eurozone built in certain ideas about what was required for economic success—for instance, that the central bank should focus on inflation, as opposed to the mandate of the Federal Reserve in the US, which incorporates unemployment, growth and stability.”33

  On December 15, speaking in Frankfurt, Trichet made his next move. Addressing an exclusive crowd of journalist members of the Internationaler Club Frankfurter Wirtschaftsjournalisten, he defended not his policies, per se, but his ego, in the form of asserting central bank independence: “Today an overwhelming majority of central banks across the globe is independent. The political and functional independence of central banks has been an important milestone in the way towards separating the authority to tax and spend from the power to control credit conditions.”34

  DON’T CALL IT QE, SAYS THE ECB

  If the end of 2008 was an entanglement of central banks flexing their muscles to curtail a financial emergency while expressing their independence, 2009 brought even more radical moves. The G7 central banks delved deeper into accommodative territory. But with rates hitting historic lows and the Fed having already adopted zero percent rates, there remained only one way to keep functionally easing. Terrified bankers conjured new money-creation mechanisms.

  The world saw no real recovery. But there was a prevailing concern—whether elite central bankers had the power to do anything about it, and if so, how much, and for how long. That anxiety provoked skepticism of the entire international monetary system. In Europe, it began to pit old monetary powers against the young, decade-old ECB.

  The ECB didn’t just cut rates, it increased bond purchases to provide liquidity under the auspices of promoting growth. German chancellor Angela Merkel opposed this dovish monetary policy as too expansionary for her inflation-obsessed country.35 On January 13, 2009, Germany passed a €50 billion stimulus plan—the biggest since World War II.36

  The ideological chasm between the ECB policymakers and Germany splintered the EU and brought up questions about the entire EU paradigm. The Fed remained in denial about US banks’ role catalyzing the global crisis, and by extension its own failure as a bank regulator, and about US banking regulatory policy in general.

  On January 13, at the London School of Economics, Fed chairman Ben Bernanke gave a lecture titled “The Crisis and the Policy Response.”37 According to him, though rates were already at such low levels, the Fed could still employ many policy tools during the financial crisis. He cited three major tools, like lines of a financial sonnet:

  lending to financial institutions,

  providing liquidity directly to key credit markets,

  and buying longer-term securities—

  It was important to Bernanke that his strategies weren’t mistaken for Japan’s “quantitative easing” policies pursued from 2001 to 2006. He referred to the Fed’s moves as “credit easing,” which resembled quantitative easing as “an expansion of the central bank’s balance sheet.” But he contras
ted the BOJ’s policy, which targeted holding a certain amount of bank reserves, with the Fed’s approach, which sought to hold a “mix of loans and securities.”

  He attributed this difference to wider credit spreads and “more dysfunctional” credit markets in the United States than existed during the “Japanese experiment with quantitative easing.”38 Debt and credit flows were conveniently moving targets.

  Not only Bernanke emphasized his policies weren’t the same as Japan’s. Trichet similarly deflected when the ECB began its quantitative easing programs in May 2009. As the London-based Telegraph reported, “The European Central Bank has cut interest rates a quarter point to a record low of 1pc and embraced quantitative easing (QE) for the first time, catching markets off guard with plans to buy €60bn (£53.5bn) of covered bonds.”39

  Both men wanted to affirm their individual ingenuity in the money-creation process. They were both men of power. Both were featured in Newsweek’s 2008 fifty most powerful global elite list (Bernanke beat Trichet by one place, coming in fifth).40

  In practice, the distinction was irrelevant. Whatever they called it, both central banks fabricated money to inject into the markets or private banks in return for some sort of debt, bonds, or loans. The effects of their strategies, regardless of language, were equivalent: benefits accrued to banks and capital markets, not economies. By alluding to their monetary prowess, the central bankers were not only waging monetary warfare but also staging PR stunts. If they could sell the idea of their support to the general public while helping the bankers, the game was on.

  On January 15, 2009, the ECB cut rates again, bringing total cuts since October 8 to 225 basis points, including a record-breaking 75 basis points in December. Two weeks later, in an interview with the German weekly Die Zeit, IMF head Dominique Strauss-Kahn called for more coordination among European governments to follow the Fed’s lead.