Gillian Tett
Fifteen years ago, a little-known tragedy hit the Bank of Japan (BOJ). In the mid-1990s, during the early stages of Japan?s banking crisis, BoJ officials decided to use some of the central bank?s own yen to prop up a failing finance company in a desperate effort to paper over problems and buy time.
But the company went bust, and the money was lost, creating a hole in the BoJ balance sheet for the first time since the second world war. Haunted by shame, the senior official in charge committed suicide, in a move that has left scars on the collective psyche of central banks? leadership that last, even today.
Outside Japan, few know this tale. But the tragedy popped into my mind as the political battles intensify around the eurozone.
In some senses, what occurred at the BoJ fifteen years ago was an entirely idiosyncratic incident; thankfully, few other cultures share Japan?s extreme culture of shame.
But in other senses, this Tokyo tale echoes wider policy themes that are still playing out. For Japan is not the only country where central bankers are averse to recognising losses, nor is it the only place where these fears keep creating incentives to paper over problems. On the contrary, if you look at the eurozone, a similar type of mood music is playing again; and this has produced consequences that are equally debilitating (albeit, thankfully, not so tragic).
In narrow economic terms, there is no reason why central bank bureaucrats should ever be terrified of balance sheet losses. Central banks exist to support the financial system; they are not driven by profit motives. Since an institution such as the European Central Bank, BoJ or Federal Reserve can always create more money, ?losses? are primarily an accounting issue. That point was hammered home by Thomas Jordan, acting head of the Swiss National Bank. He recently gave an interview to the FT in which he insisted that there was no need to panic if the Swiss bank temporarily suffered ?negative equity? as a result of losses incurred by its bold interventions to weaken the franc. If that occurred, he explained, the central bank could simply rebuild its capital buffers through its normal operations; the central bank could not go ?bust?, even amid red ink.
But Jordan?s comments are notable precisely because they are so rare in their honesty; other western central banks have bent over backwards in the last couple of years to avoid discussing the issue in front of voters, even as they engage in novel forms of quantitative easing. And in the case of the ECB, its leadership has made strenuous efforts to avoid writedowns on its own sovereign bonds; witness its latest deal with the Greek government designed to provide protection against forced losses on its portfolio of Greek bonds?estimated to have a face value of about 55bn euros (but which it is thought to have paid about 40 bn euros).
ECB officials blame this stance on their fear that haircuts might spark investor panic. Some officials also argue that accepting haircuts could be technically illegal, since if the bank suffers a big loss, it would be forced to tap eurozone governments for more funds? and that might breach European Union laws that ban ?monetary financing?, or central bank funding of governments. But behind these legal technicalities, there is emotion?or bureaucratic instinct?at work too: to many eurozone central bankers, particularly Teutonic ones, the idea that a central bank might lose money seems almost taboo, if not shameful; it undercuts everything that is supposed to make a central bank credible.
Perhaps this is understandable; trust in central banks, after all, can be fragile. But, the practical consequences of this stance have been profoundly debilitating. For one thing, the ECB?s opposition to voluntary haircuts has made it harder to persuade private sector creditors to accept their own voluntary haircuts in any restructuring of Greek debt.
It has also made it harder to assess any clearing price for Greek bonds and move towards a resolution. Indeed, the ECB?s pattern of behaviour has been oddly similar to the US banks during the Latin American debt crisis, as David Beim, a New York economist points out*: time and again, the central bank has avoided crystallising losses, preferring to play for time, in an effort to paper amortise the pain (or hope it goes away.)
This stance may be changing. In recent weeks officials have indicated they may be willing to take some token loss such as sacrificing future profits on bonds to help an overall deal. But the ECB?s latest move to exchange its Greek bonds for new ones exempt from any legal action by Athens to impose losses, suggests there is still aversion to taking a real hit.
This is a profound pity. Covering up the losses will not make them disappear. Just look again at Japan.
*Can the Euro be Saved?; David Beim, Columbia Business School, October 2011