Reuters has a fascinating special report that takes a look inside the internal negotiations on the ECB Governing Council that led to the birth of Mario Draghi’s OMT bond-buying plan to save the euro, announced on September 6.The piece details the negotiations between the Italian ECB chief Mario Draghi and his opponent on the council, Jens Weidmann – the hawkish head of the German Bundesbank.
Weidmann has been staunchly opposed to bond-buying, given Germany’s tumultuous monetary history, so Draghi needed to isolate him on the council following the ECB chief’s pronouncement in late July that the ECB would do “whatever it takes” to save the euro.
And Draghi almost pulled off his plan perfectly. After all, he ended up getting his bond-buying program.
However, as Reuters correspondents Paul Carrel, Noah Barkin, and Annika Breidthardt point out in their report, Draghi made one crucial mistake:
On August 2, as the council put the finishing touches on the statement Draghi would deliver at an afternoon news conference, Weidmann made a special request. He wanted the ECB president to make clear to reporters that support for bond-buying had not been unanimous. Draghi agreed.
A few hours later, Draghi told reporters in Frankfurt and investors watching screens around the globe that the ECB could soon begin buying bonds to reduce borrowing costs in countries like Spain and Italy. But his lack of specifics disappointed markets. And he made one crucial mistake. Instead of sticking to past practice and remaining vague about who had dissented, he named Weidmann as the lone rebel, infuriating officials at the Bundesbank and on the ECB council who sympathised with the German, according to several sources.
“It wasn’t right for him to single out Weidmann,” the senior ECB official said.
In the following weeks, a stung Bundesbank would work overtime to undermine Draghi and his plans through a combination of public statements and aggressive leaks.
But Draghi was able to pull it off on September 6, and the OMT has been unveiled and has served to calm markets, so what’s the big deal?
Carrel, Barkin, and Breidthardt explain the ultimate consequences of Draghi’s crucial mistake: the strong conditionality attached to the OMT program that has caused many on Wall Street to trash the plan.
More from the report:
At the September 6 policy meeting, all members of the Governing Council bar Weidmann backed the plan to buy sovereign bonds on secondary markets.
But Weidmann’s stance and the manoeuvring of others sympathetic to his cause ensured any ECB intervention would come with a strong dose of “conditionality”.
Countries who wanted the ECB to intervene must first sign up to a formal aid programme. IMF involvement would be sought and bond purchases restricted to maturities of up to 3 years. The ECB could choose to sell as well as buy bonds – a veiled warning to countries that it might pull the plug if they failed to deliver on their promises.
The conditionality is a big problem because, for example, it could deter countries like Spain where leaders already face voter angst over unpopular austerity measures to sign up for the ECB’s rescue plan, rendering it useless.
Morgan Stanley rates strategist Laurence Mutkin said the plan was “quite likely” to deepen Europe’s recession because it was like asking countries like Spain and Italy “to sign up for a plan that mandates a ‘fiscal cliff’.”
Nomura economist Jacques Cailloux said that “tough negotiations around the conditionality are likely to destabilise markets further.”
And, pointing to the biggest negative of the plan, BofA economist Laurence Boone wrote that “emphasis on conditionality [is] even stronger than we had expected (as a minimum, ECCL only way to access ECB buying, IMF involvement desired, both significantly lowering the probability that a country will apply for EFSF/ESM support).”
No country in Europe has asked for a bailout yet, but Spain may be getting close. Then, markets may see just how crucial Draghi’s mistake back in August proves to be.
Read Willem Buiter’s take: The Eurozone Will Be In ‘Cardiac Arrest’ For At Least 2-3 More Years >
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