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Former ECB Chief Economist Stark: Not So Fast

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Former chief economist of the European Central Bank Jurgen Stark has openly stated reservations about any further bond buying from his former employer. In a radio interview with Deutschlandfunk in his native Germany, Stark vehemently opposed bond buying by the ECB, stating that it was against the bank's charter and would prevent governments from reforming budget malfeasance.

Stark left the ECB in protest at the end of 2011 after the bank bought bonds on the open market. He feels as though the ECB buying bonds is against its charter, in that the ECB cannot fund sovereign budgets. Stark cut short his term as one of the six members of the governing council of the ECB short when he left, a bold stance against policy actions taken by the bank.

Stark is just one of many German economists who oppose bond buying by the bank. Germans have every right to be infuriated; the ECB is attempting to stem the tide in markets for those nations that have not adhered to European treaties that set limits on deficits. By buying bonds, Germans fear that the peripheral nations such as Greece, Italy and Spain will not reform their spending practices enough and will rely on stability mechanisms from the ECB to stay solvent. Stark's comments appear to be more of the norm from German economists than the rarity in terms of their opposition to bond buying.

ECB President Mario Draghi will have to win over the conservative German economists if there is any hope for new crisis-fighting policies from the ECB this week. Over the weekend, Draghi met with Bundesbank (the German central bank) President Jens Weidmann, who is also a staunch conservative. The results of their conversation have not been made public, however it seems as though the two have reached an agreement on policy.

One such policy that could appease conservative German economists would be to utilize the remaining capital of the European Financial Stability Facility to backstop losses at the ECB. The EFSF has approximately 250 billion euros of remaining capital that it can deploy and rather than use that capital to buy bonds, it could be used to insure losses on bonds purchased by the ECB. The bank fears a few things in purchasing bonds: first, it wants to avoid a seniority crisis like the one that occurred during the Greek restructuring, and second, it doesn't want to take losses and have to print money to recapitalize itself.

Such a plan was advocated by German Finance Minister Wolfgang Schauble last week and could come to fruition. However, economists have remained skeptical ahead of the Thursday announcement. With the ECB's reluctance to buy bonds, analysts and economists are taking a wait and see stance and want the ECB to show its hand before deciding that the ECB can fix the crisis. As written nearly one and a half months ago on Benzinga, it is up to the ECB to step up as the crisis fighting mechanism. Only the ECB can act fast enough to quell the crisis.

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The first step in housing a banking regulator within the bank is a large step for European leaders. Even if pan-European deposit insurance existed with the ECB's backstop, banks could still face capital flight. So long as capital flight occurs, banks will remain exposed to exogenous shocks in the financial system, meaning that bond buying is a step in backstopping some bank assets. Until deposits are protected, banks could still suffer. As Americans know full well from 2008, once the banks go, the economy goes.

The real fear is that the recession and banking crisis spills to Germany or France, where banks are much larger as compared to the size of their respective nations' GDP's. In the U.S., bank assets are less than 100 percent of GDP, meaning that should the banks require a bailout, the U.S. government has the ability to do so. However, in France for example, bank assets are more than 300 percent of GDP. Thus, it may be that the French government is unable to effectively bailout its banks should it need to. Thus, the need for a true banking regulator within the ECB, who can print money should it have to, is the only solution to fix the banks and decouple the cyclical link between financial institutions and sovereign finances.

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