“Target 2” and its predecessor “Target” used to be a mundane part of the European System of Central Banks (ESCB). Something technical that people didn’t pay attention to. The ECB would borrow from the central bank of one Eurozone country and lend to the central bank of another Eurozone country, but eventually the transaction would be reversed. In 2008, however, as capital flight from peripheral countries heated up, the credit flows became one-sided and mushroomed with each new outbreak of the debt crisis. It was the first de facto bailout.
Now, the credits extended to the central banks of Greece, Ireland, Portugal, Spain, and Italy exceed €800 billion ($1.05 trillion), of which €635 billion is owed the German Bundesbank—the largest item on its balance sheet, and 23% of Germany’s GDP. If anything happened to the euro, those claims could be, poof, gone.
The risks had been swept under the rug for years and might have stayed there had it not been for Hans-Werner Sinn, President of the Ifo Institute for Economic Research, which publishes the closely-followed Ifo Business Climate index. It was Helmut Schlesinger, former President of the Bundesbank, who’d drawn Sinn’s attention to the Target 2 balances in 2010. The 87-year old retiree had noticed claims by the Bundesbank to the tune of hundreds of billions of euros against the ESCB … and couldn’t figure out what was behind them. “Since this day, the topic has been dogging me,” Sinn said.
As he saw it, if one of the Southern European countries were to leave the eurozone, its debt under Target 2 would be transferred to the remaining Eurozone countries and their taxpayers. Bad enough. But if the euro broke apart entirely, all claims by the Bundesbank against the ECB would evaporate. “Germany could lose €500 billion euros,” Sinn said at the time—which now has grown to €635 billion.
He was accused of exaggerating and making gross mistakes in his analysis. The Bundesbank brushed him off, calling the Target 2 claims, despite their magnitude, “irrelevant balances.” But late February, everything changed: Bundesbank President Jens Weidmann wrote a letter to ECB President Mario Draghi, warning him of the growing risks within the ESCB. He specifically addressed the Target 2 balances and suggested that security policies be implemented to contain their risks. If some countries defaulted on these debts to the ECB, Weidmann wrote, the rest of the European central banks would have to absorb the losses, which they might not be able to do.
The letter instantly deepened the rift between the ECB and the Bundesbank. And it unceremoniously dumped the reeking pile of Target 2 balances on the government’s doorstep. Now even Chancellor Angela Merkel is supposedly keeping an eye on it. That might have been it. Watchful waiting while everyone is holding their nose, hoping the problem would go away.
Alas, yesterday it emerged that Bernd Schünemann, a law professor at the Ludwig-Maximilian University in Munich, has sued the Executive Board of the Bundesbank, accusing it of perfidy (Untreue) with regards to the Target 2 balances. He cited the work of Sinn, Schlesinger, and others.
“The people in charge must no longer look the other way, given the dimension of the risks,” said Brun-Hagen Hennerkes, CEO of the Stiftung Familienunternehmen, a non-profit research and support organization for family-owned enterprises that is backing Schünemann’s efforts. “The Executive committee and the Federal Government shouldn’t have allowed the ECB to do this. They should protect the Federal Republic and its taxpayers from potential damage.”
A dilemma. If Germany knows that it would end up holding the bag if the euro broke apart, would it not sacrifice practically anything to keep it together? It might have to because the next president of France will likely press the ECB to take even greater risks and print more money to fund budget deficits directly. Or it could be the last straw.
But the risk of the Target 2 balances is moot because the euro is sound and safe, with all the bailout funds in place, and with the ECB having cranked up the printing press. Oh, wait…. The IMF said what just now? Holy cow! It said there were “flaws” in the currency, and a “disorderly default and exit by a euro area member” could occur. Indeed, with Spain spiraling downward, heading for a crash or an emergency bailout, the IMF finally came to grips with the Eurozone. “A break-up of the euro area could not be ruled out,” it admitted for the first time. “The financial and real spillovers to other regions, especially emerging Europe, would likely be very large.” Not to speak of the German taxpayer.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
