ECB i President Jean-Claude Trichet i told the Economics Committee on Tuesday that greater transparency regarding sophisticated financial instruments and better risk-management by banks and financial institutions were among the ways to restore confidence in the money markets. Similar messages came earlier in the day from the Internal Market and Economic and Monetary Affairs Commissioners, Charlie McCreevy i and Joaquín Almunia.
Setting out the ECB's response to money market turmoil sparked by the crisis in the US sub-prime mortgage market, Mr Trichet explained the series of operations undertaken to inject short term liquidity to the market. Questioned by Alexander Radwan (EPP-ED, DE), he said that the ECB's primary mandate of maintaining price stability and its responsibility for ensuring the money market functions properly were independent of each other and needed to be kept separate. Responding to committee chair Pervenche Berès (PES, FR), he said it was not significant that the scale of the ECB's injection of funds was greater than that of the US Federal Reserve. Routine refinancing requirements were always larger in Europe for technical reasons.
Wolf Klinz (ALDE, DE) and Sahra Wagenknecht (GUE/NGL, DE) both asked whether banks which had behaved recklessly were being let off the hook, whether by being rescued or through the ECB's refinancing operations. Mr Trichet stressed that "Central banks and certainly the ECB will not bail anybody out. We lent at interest, on a 24 hour basis, with collateral. We are not pouring money into bad behaviour. We are permitting the market to function properly so that those who behaved well do not end up being punished by the turbulence. Those who behave improperly will have to pay the price."
Inflation risk still "on the upside"
Commenting on the ECB's decision to leave interest rates unchanged last week, Mr Trichet stressed the ECB's view that monetary policy was still "on the accommodative site" and that "incoming macroeconomic data confirmed that risks to price stability remain on the upside over the medium term", with the same conclusion to be drawn from money supply data. However, the Bank had decided that, given the high level of uncertainty amid the market volatility, it was "appropriate to gather additional information and carefully examine all new data, before drawing further monetary policy conclusions."
Lessons from the market turmoil
Turning to lessons which might be learned from what he characterised as "a market correction with a significant reappraisal of risk", Mr Trichet said the ECB had repeatedly warned that markets were showing an "under-appreciation of risks in general." He said "the degree of complexity of some products designed for the purposes of repackaging and selling debt instruments has become overwhelming." He argued that both those selling such products and those buying them had a responsibility to understand and manage the risks involved, and further improvements were needed in regulators' surveillance activity to ensure they did. The Basel II arrangements would help, but not solve all the problems. "It is true," he added "that the very small number of large global ratings agencies is a real issue for the present functioning of global finance." He called for potential conflicts of interest to be dealt with and for possible benchmarks of good behaviour to be worked out. He also argued for rapidly implement the Financial Stability Forum's recommendations for the hedge fund industry to take similar benchmarking initiatives. Finally, he stressed the need for greater transparency to increase trust between financial operators. "Current sentiment is largely due to the belief that there are obscure facts which are not being communicated," he said.
Almunia and McCreevy: transparency, ratings agencies and hedge funds
Economic and Monetary Affairs Commissioner Joaquín Almunia, speaking to the committee earlier in the afternoon, also highlighted the need for transparency in the markets as a way to re-establish confidence. He gave MEPs the latest forecasts for economic growth, which the Commission had reduced slightly compared with the previous predictions in May (2.8 per cent for 2007 in the EU27 and 2.5 per cent for the euro zone, 0.1 points lower in both cases). He said that downside risks had increased: "Because of the financial turmoil, we can expect a more pronounced slowdown in the US economy, which will have consequences for the EU. Also, if the current tightening of financing conditions beyond normal appreciations of risk is itself a risk to growth. If present tensions continue, this will have negative consequences for our growth figures." The sooner confidence was restored, the less would be the impact on the real economy. Nevertheless, the fundamentals of the EU economy were sound, and, he said, the best way to counter any potential damage from the financial turmoil was to maintain the improvements in both employment and public finances by keeping track with the Lisbon reforms and fiscal consolidation.
On Tuesday morning, Internal Market Commissioner Charlie McCreevy similarly stressed the need for transparency and better risk management, but highlighted the Basel II (banking), MIFID (financial instruments) and Solvency II (insurance) projects were designed to achieve this, but were not yet in operation. He was strongly critical of the ratings agencies: "they were very slow, they had weak methodology, and there is a potential conflict of interest between providing an objective risk assessment and advising institutions on how to structure instruments. We need to know what agencies do and what they don't." A number of MEPs criticised the Commissioner for, as they saw it, being slow to act on ratings agencies, despite a call from Parliament in its previous term of office for a report on this issue.
Responding to further criticism, notably from Poul Nyrup Rasmussen (PES, DK), over his reluctance to propose regulation for hedge funds, Mr McCreevy argued that is was the regulated banks who held most of the responsibility for lax lending and poor assessment of risk. He warned repeatedly against legislating too quickly in the face of a crisis.
Mr Trichet normally comes before the committee four times a year for the regular "Monetary Dialogue", the next session of which is due on 8 October 2007. This was the first time that an ECB President had taken part in a special additional hearing on specific market developments. The hearing was arranged at the initiative of Economics Committee chair Pervence Berès (PES, FR).
Committee on Economic and Monetary Affairs
In the chair : Pervenche Berès (PES, FR)