Europe to Begin Unprecedented Market Intervention in Face of Crisis

The European Central Bank steps in to save Italy and Spain

On late Sunday night, the European Central Bank (ECB) signaled it would begin an unprecedented intervention in European markets in response to the escalating debt crisis, and particularly to protect Spain and Italy, the New York Times reports. The ECB indicated it was ready to start buying Italian and Spanish securities.

Why now? The global economic situation is becoming increasingly drastic. After the S&P downgraded the U.S. credit rating, the ECB was "under extreme pressure to try to do something to restore confidence," according to the Times, and prevent an "extension of the stock market rout that began last week." The U.S. saw the worst stock market week in three years last week. Stock markets in the Middle East fell in Sunday trading, and, the Times reports, "the Tel Aviv exchange delayed opening for the first time since the collapse of Lehman Brothers in 2008." In Europe, the situation is particularly acute for Italy and Spain. Analysts said to the Times that Italy "posed a threat to the financial system too great for any one economic superpower to cope with alone, and that a coordinated effort was needed." Uri Dadush of the Carnegie Endowment for International Peace said Sunday that without intervention, Italy ‘‘would be a Lehman-type situation."

What are the other options? Few, it seems, if any. This policy was called a "reluctant decision" by the Washington Post. Bloomberg points out that "buying Italian and Spanish debt may open the ECB to accusations it is bailing out profligate nations, breaching a key principle in the euro zone’s founding treaty and eroding its credibility." Nonetheless, Joe Weisenthal at Business Insider explains that the general thinking is that "existing bailout mechanisms (like the European Financial Stability Fund) are clearly too small to save countries the size of Spain and Italy. What's more, to expand them would be to significantly imperil the German balance sheet...Only the ECB has the firepower and the balance sheet (unlimited, really) to address countries the size of Spain and Italy..."

What do they plan to do?  In its statement, the ECB would “actively implement” its bond buying program to address “dysfunctional market segments.” The Times writes that this is "likely to be interpreted as a sign that it will begin intervening to prevent borrowing costs for the two countries from becoming unsustainable." But the ECB will buy Italian and Spanish debt only following reform commitments in both countries. In fact, ECB members were split down the middle on the Italian debt question, the Independent reports. German officials in particular wanted to see tough reforms before taking on debt commitments. Nonetheless, the ECB was "anxious to reach a solution before markets opened today."

Will it help? Investors had warned that markets could plunge if the bank failed to intervene. Nonetheless, the ECB's decision has not been showered with confidence. The head of fixed income at Evolution Securities told the Financial Times that this decision "is a positive in the short term. But in the mid-term it doesn’t really help solve the problem. Something else will be needed.” An analyst at Barclays Capital was also skeptical, telling the Times that “this type of bond market intervention is unlikely to achieve much” and it "begs the question of how far the ECB. is ready to go."  Finally, at Business Insider, Weisenthal surmises that this move "is not a bazooka. It's not a promise to buy unlimited amounts of sovereign debt no matter what. It's not clear that this will be enough."