Three closely written, annotated sheets of A4 appear on the table. The question was simple: Were you worried at all in the summer of 2007? Worried that you would be unable to translate the signals you were picking up into measures which would rescue the financial world? Worried, in short, that things might go seriously wrong?
Jean-Claude Trichet, former president of the European Central Bank from July 2003 to November 2011, leans forward, sighs and peruses his papers. “We were living in a world full of risks,” says the Frenchman. He sums it up thus: “In February 2007 the British bank HSBC signalled an overall loss of around 10 billion dollars on a portfolio of subprime mortgages. On July 31 that year the US investment bank Bear Stearns had to liquidate two hedge funds. In Europe the German bank IKB was also having major problems with its investments in the US mortgage market. So yes, there were enough indications that something could have gone seriously wrong.”
Trichet (Lyon, 1942) is playing host in the heart of Paris. The imposing office of the former president of the French Central Bank is tucked away behind the Palais Royal. Christian Noyer and Michel Camdessus also have offices in the stately building where Louis VI chairs line the waiting room and the bookshelves are stuffed with Banque de France annual reports dating back to 1820. Trichet serves coffee for his guests himself.
It had taken him just one hour to reply ‘with pleasure’ to our email asking him to look back ten years to the days when the worst financial crisis since the 1930s began. By midday on August 9 2007 governments, the financial sector and the general public had been shocked by a drastic intervention on the financial markets that had no precedent: the European Central Bank injected 95 billion euros into the market to help banks that were no longer able to find short term liquidity. Within a few days, the amount the banks were asking for had topped 300 billion euros.
The measure was seen as the official start of the crisis that the world was subsequently saddled with: from the banking crisis caused by the toppling mortgage market in the US, via the collapse of the financial system following the downfall of the American investment bank Lehman Brothers, to the European debt crisis and its aftermath which is still ongoing.
How did you reach the dramatic decision on August 9 2007 about the 95 billion euros?
“A lot of us were on holiday. I was at my house in Saint-Malo, in Brittany. That morning our head of market operations, Francesco Papadia, told me the euro money market was totally dysfunctional. The banks had stopped lending to each other altogether. I contacted the board members of the ECB by phone and our Blackberries. It was very difficult to put together a proper analysis. We took the view that the effects of the accelerating mortgage crisis in the US had created a sense of panic in the global markets. It was so bad that the supply of dollars simply dried up. That meant market players had to go in search of other currencies in markets that were open and still liquid in order to swap them against US dollars. That morning, an awful lot of financial institutions were buying euros on the European markets.
“We considered several options from modest to bold and far-reaching. I was convinced that, in any case, the money market had to be brought back to life.
“We opted for the most far-reaching solution. The ECB gave the banks unlimited access to euros at the fixed interest rate of 4 per cent. The banks asked for 95 billion euros straight away which they were given, on the condition they paid it back the next day. A day later we repeated the measure. That’s how, given the circumstances, we showed we intended to remain the masters of our own financial markets. That was the most important thing for me. When we took the decision, we did not know whether it would work but fortunately it made a major impression.”
Did you realise this might be the start of an unprecedented international crisis?
“At the time there were two interpretations of what was going on. The first was that this was the first sign that the financial system was extremely vulnerable and that we would have to deal with much more dramatic events later on. The second interpretation was: we knew for a long time that the risks in the financial markets were largely underestimated. The events of August 9 were the first of many market corrections that were necessary for all western economies to reassess the volume and the prices of risks that were embedded in their financial markets. If the risks were reassessed in advance, the international community would avoid a financial collapse. To be honest, we leaned towards the second, more benign interpretation of these events, until Lehman fell in September 2008.”
We knew for a long time that the risks in the financial markets were largely underestimated
With hindsight, could you have done more in August 2007 to prevent the events that happened more than a year later?
No, I don’t think the central banks could have done so. The central banks had been warning about the risks in the markets for years. Remember that the ECB was considered the most cautious and orthodox of major central banks, both with regard to our monetary policy and our call for financial prudence. We wanted much more prudence, but looking back I don’t think central banks alone were ever in a position to actually redress the major systemic risks. If I ask myself: could we have implemented the changes that we implemented after Lehman before the collapse; would we have had the political capacity to mobilise the G20 leaders to take the necessary steps to bring the whole of the system and the financial institutions into safe waters and could have we convinced the political leaders of America, Europe and Japan that they had to dramatically reform their financial markets, bring in more drastic regulatory measures and be more cautious in their budgets before public opinion was convinced of the need? then I would have to say no, it was absolutely unthinkable.”
Was it difficult to accept that it was politically impossible?
“It was a fact of life. Central bankers were aware of the risk of a worldwide catastrophe. We shared that sentiment as clearly as we could with our governments. I was in permanent contact with my American partners and friends Ben Bernanke and Tim Geithner [the bos of the American and the boss of the New York central banks respectively], but they simply couldn’t sway American politicians. The evidence is simple: even after the collapse of Lehman Brothers and the obvious grave and immediate threat to the financial sector, the US Congress couldn’t be persuaded to vote for the TARP rescue package because public opinion was not yet convinced of the extreme gravity of the situation.
“I actively told our European governments that they couldn’t allow a bank to go bankrupt like Lehman. I was in close contact with central bank governors and finance ministers in practically every country. I even participated in a cabinet meeting in Belgium to explain how critical the situation was. I am very happy that we didn’t have a single Lehman in Europe. The probability of such a catastrophe was extremely high, with 15 countries, 15 governments and 15 parliaments. That could have turned the Great Recession into a Great Depression. In the 1930s it might have taken three months for the crisis to spread; in 2007 it was half a day at most.
“For me, one of the issues we face now is that the extraordinary and necessary measures the central banks have taken in recent years are being viewed by many politicians and observers as permanent forms of support. That view might deter governments and market players from coming up with the necessary structural reforms for the medium and long term. Central bankers are continually taking this message to governments. The question is whether they understand it.”
Does the fact that governments mainly focus on the short term make it harder for central banks to come up with an exit strategy?
“There is no exit in Japan. In Europe, the ECB is closer to the point where it will start winding down its crisis measures. So I think everybody anticipates and expects it. In the US, the Fed has already stopped buying up securities and started increasing interest rates. But the government is doing little, despite still having a large current account deficit. There are no structural reforms in the US in the areas where they are most needed, in secondary education for example. Worse still, in Washington they don’t seem to be aware of anything. They are talking about increasing public spending and reducing taxes. The need for structural reforms is still larger in many countries in Europe, including Italy and my own country.
“One thing is certain, the central banks of the advanced economies need to be even more assertive and tell governments even more forcefully that it’s their turn now to step in. That’s obviously more complicated in Europe than in the US, because in Europe some countries have to increase wages while others have to practice wage moderation in order to help their economies get back to an appropriate level of cost competitiveness. You can’t send out a single message across the whole eurozone.”
So monetary policy by central banks is the only option?
“Yes, but it shouldn’t be. A lot of governments will need to change their economic policies. But there isn’t one standard method that applies to all countries. There is an issue in the Netherlands too. The present trade balance is large, very large. I understand that the Netherlands wants to remain competitive with Germany and there are very good reasons for that. But in a normal, well-functioning market economy, the level of competition within the Eurozone should be in balance. So if wage moderation is necessary in Italy and France, in Germany and in the Netherlands wages should rise.”
You raised the problem of many democracies having a far too short-term vision. Isn’t that an inevitable problem when there are elections every four years?
“In theory it can be solved easily! Public opinion needs to be as realistic as possible and the general public should be aware that there are not only present day interests to defend but also the interests of their children and grandchildren. That’s the attitude you’d expect in an enlightened society. It’s in your own interests to create jobs and long-term prosperity through lower government spending and lower deficits and by boosting competition through structural reforms. You are building for the future. Politicians and all opinion leaders need to have the courage to say this. Otherwise the demagogues will win every four years.”
So if politicians don’t take steps will we end up with a crisis that’s worse than 2007-2008?
“It would be exaggerating to say that the more advanced economies have done nothing to make the system more resilient. Just look at the way banks protest about stricter regulatory regimes. Then you know you have done something right.
“It is also clear government debt is continuing to grow in the developed economies, even if the growth of private debt has more or less stopped. It varies from country to country. But on the whole, I wouldn’t say that the advanced economies are more vulnerable than they were ten years ago.
“Unfortunately I cannot say the same for the global economy as a whole. The overall level of global debt, public and private, as a percentage of global GDP has continued to increase at the same pace as before the crisis. Not so much this time because of the developed economies, but because of the emerging ones. The epicentre of a possible new crisis is more likely to be in the emerging economies.” That means that all economies, developed and emerging, need to build up their resilience and not be tempted to leave things as they are. There is no room whatsoever for complacency.”
Are the commercial banks strong enough to withstand a new crisis?
“In general, they are in a much better situation than before the 2008 crisis. But that doesn’t necessarily mean that new events such as Lehman could not trigger new tsunamis. Every tree in the forest might have deep enough roots but that does not mean the forest will survive if the wind is strong enough.
“I am circumspect about whether this will really happen. But I do think we need to take proper precautions.”
Are central banks capable of handling another crisis in the next few years?
“There are two issues here. First, you will inevitably have a cyclical downturn. On top of that, there is the issue of a possible global systemic crisis. As regards the downturn, it will come along in the US, not necessarily within a year or two, but sometime in the next five years. What firepower will the US have to combat it? There is very little room for manoeuvre when it comes to fiscal policy, and in terms of monetary policy there is not much they can do when you look at the present interest rates and the size of the Fed’s balance sheet. It’s probably the first time since the Second World War that we are approaching the bottom of the economic cycle with so little ammunition to offset a recession.
“In Europe we don’t have the firepower to mitigate a recession either. In many countries they have even fewer options than the US. There are major risks, even before the downturn starts. A new global crisis would considerably aggravate our problems, even if the epicentre is not in the west.
How confident are you about the next few years?
“The US doesn’t have necessarily much time left. My theory is that the downturn will come later in Europe, mainly because we’ve had to deal with the debt crisis surrounding Greece, Ireland and Portugal in 2010, and then had Spain and Italy added on in 2011. That is why the recovery started later.
On the other hand, Europe has an overall current account surplus, thanks not only in part to Germany and the Netherlands. That means in the eurozone we have some macroeconomic room for manoeuvre and can start structural reforms which will strengthen growth and confidence.”
Were you never concerned about the future of the European project?
“Speaking frankly, in the past I was concerned about the systemic risk in the eurozone at a time when many people weren’t thinking about it at all. But I was always convinced that the resilience of the European project would see us through the crisis. I’m also reasonably sure that no other EU country would follow the UK. I can’t imagine a Frexit or a Nexit. I’ve not worried about that happening, not for one second. After all the wars we have had on our soil I couldn’t imagine that the close cooperation, deep unity and friendship within Europe would be seen as useless and futile. Britain has not had a war on its own soil since William the Conqueror and that makes a tremendous difference.
We have never tried to disguise the fact that we had a very difficult crisis in the eurozone. But we had 15 countries in the eurozone when Lehman Brothers went bust and those 15 countries are still there. We have added four more countries since Lehman and now have a eurozone of 19. So an entity that people said would fall apart has survived and expanded during the worst crisis since the Second World War. That is not how the world’s press write about it, because it goes against the dominant anti-European mantra. Unfortunately the media has a great deal of influence.”
As we part company the name comes up of Jean Pisani-Ferry, the economist who wrote French president Macron’s election manifesto and was formerly director of the Brussels think-tank Bruegel. Trichet is currently chairman of Bruegel. Does he have a role in Macron’s circles? The eyes in the old face begin to twinkle. “Right now in Paris a lot of conversations are going on between interesting people,” he says.