by Adam LeBor
The BIS had to find a new purpose. To Crockett it was clear, White recalled. “Crockett said, we are going to go global.” But for that to happen, the United States needed to be on board. More than sixty years after the BIS was founded, the Federal Reserve still kept its distance and had not taken up its tranche of shares, despite the BIS’s deep American roots. The United States had always followed what was happening at the bank and the discussions taking place there. But the American Federal Reserve officials who traveled to Basel were there as observers, not as representatives of a member bank. Crockett wanted to end this anomaly. All the countries that took part in the G10 Sunday evening governors’ meeting at the BIS should be members of the bank and be represented on the board of the bank, he believed. The Federal Reserve needed first to join the bank, then the board.20
During the 1970s and ’80s, Washington had not been especially interested in the BIS. The focus then had been primarily on trade, rather than finance, said Karen Johnson, a former Federal Reserve director for International Finance. “Trade behaves in a rather predictable way. It’s hard to change, but it’s also hard to surprise you. That began to alter in the 1980s and changed hugely in the 1990s.” Rapidly increasing globalization, the growing power of international markets and money’s ability to flow ever faster around the world highlighted how the United States economy was inextricably linked to the global financial system. “Financial linkages had become vastly more important. The actions occurring in the financial markets were much faster. Crises or unanticipated events were far more likely to occur on the financial side,” said Johnson.
Crockett’s lobbying worked. In 1994 the Federal Reserve finally took up its shares in the BIS, joined the bank and appointed two directors to the board: the chairman of the Federal Reserve and the president of the New York Federal Reserve. The decision to join the board was made, noted Charles J. Siegman, a senior official in the Federal Reserve’s International Finance Division, “in recognition of the increasingly important role of the BIS as the principal forum for consultation, cooperation and information exchange among central bankers and in anticipation of a broadening of that role.”21 The American decision sent a powerful signal to the world suggesting that the BIS was still relevant, necessary and could contribute to international financial stability. Two years later, in 1996, the central banks or monetary authorities of China, India, Russia, Brazil, Hong Kong, Singapore, and Saudi Arabia joined. The BIS’s future was assured.
As director of the Division of International Finance, Karen Johnson attended the governors’ meetings for nine years, from 1998 until her retirement in 2007, accompanying either Alan Greenspan, the chairman of the Federal Reserve or his successor, Ben Bernanke, or their deputies. Johnson successfully pushed for the Federal Reserve to pay attention to the BIS. “The American attitude to the BIS changed because the world changed. The BIS was expanding its membership because countries in the rest of the world now mattered in ways they hadn’t mattered before. The BIS went from being a Eurocentric thing to which the United States paid little attention, to something global and international. Once we took up our shares the degree to which senior members of the Fed became involved changed completely.”22
The Federal Reserve and the New York Federal Reserve, like all visiting central banks, opened up a micro-branch in the BIS headquarters during the Basel weekends. Both had their own offices, as well as a shared extra room for staffers or other governors who might also be attending. Johnson enjoyed her trips to Basel. From Stanford University, she had joined the Federal Reserve in 1979—a rare woman in the male-dominated world of central banking. “Going to these international meetings, I was again the only woman in the room, but because I had the Fed on my nametag, that opened every door I wanted.”23
IN JUNE 1998, four years and five months after Alexandre Lamfalussy left the BIS to set up the EMI, it was closed down—a mark of its success, rather than its failure. The European Central Bank opened for business. Seven months later, on January 1, 1999, eleven countries launched the euro. Technically, the birth of the single currency was an extraordinary achievement, justly earning the former BIS manager the title of “Father of the Euro.” The euro finally replaced national currencies in January 2002. The press coverage, much of which was jubilant, focused on the benefits. These were considerable, at least in terms of convenience and ease of monetary transactions, and markedly similar to those predicted by Funk in his 1940 memo. Travelers could use the same currency from Portugal’s Atlantic coast to Finland’s Arctic border. So could companies trading in the Eurozone. Bank charges for European foreign currency accounts, commission on changing currencies, cumbersome record keeping, all these vanished instantly. The Stability and Growth Pact, signed in 1997, would theoretically ensure budgetary discipline and keep the currency stable. National budget deficits would not be allowed to exceed three percent of GDP.
Among the jubilation, less attention was paid to the political aspects of the single currency. Once again, the creeping removal of national sovereignty was portrayed as a fundamentally technocratic innovation, rather than a political decision—as indeed had been the case since the establishment of the European Coal and Steel Community in 1951.
When a country joined the Eurozone, its central bank automatically became part of the European System of Central Banks, whose centerpiece was the ECB. The member country surrendered control over its monetary policy, although it was represented on the ECB’s Governing Council. There was logic to this: a common currency would soon go out of business if each member state were running an independent monetary fiefdom.
In London the idea of surrendering monetary sovereignty was regarded with horror. In Washington, DC, Paul Volcker took a more nuanced view. He supported the idea of a European Central Bank, but still thought, “It was a very peculiar thing to have a central bank without a government.”24 The chairman of the Federal Reserve could see the reasoning behind a single bank and currency but thought that they needed to be properly integrated with fiscal discipline. “There were negative factors as well as positive ones. Someone was always devaluing a currency. Then they would make attempts to stabilize it, and then it would fall apart. So it made sense to me to have a common currency if you are having a lot of problems. But it was too optimistic to think that the mere fact of a common currency would force discipline on individual members because they could no longer devalue their currencies.”25
For many, it seemed that the introduction of the euro was, in part, a continuation of the Second World War by other means. The real issues were not monetary, but political. French politicians believed that the single currency would solve the German problem forever. Twice in a century Germany had laid waste to Europe. But now that Germany was locked into the European integration project, or even shackled to it, it would neither want, nor be able to go to war again. Germany’s future and prosperity would be inexorably linked to that of its most important neighbor and rival: France. Of course, national rivalries would continue, but the Germans would be part of a trans-European currency that would dilute their monetary sovereignty and finally lay the ghosts of the Second World War to rest. The French believed—erroneously as it turned out—that Berlin would no longer be able to dominate the European economy. In fact, for the Bundesbank shaped the design of the ECB, ensuring that it was focused on price stability, and retained enormous influence over the ECB’s operations.
The creation of the euro was a political compromise, said Zsigmond Jarai, a former governor of the National Bank of Hungary and minister of finance. “France let Germany unify in 1989. But France was worried that a unified Germany would dominate the whole continent and would be too strong. So Paris said, OK, you can unify but without the deutschmark, and we will have the euro instead. The German accepted and also won a new market in Eastern Europe for their exports.” The deutschmark was the basis of the euro, said Jarai. “The aim was to export German economic stability to France and Italy. The deutschmark was always the strong currency, and t
he Bundesbank was the bank that could control inflation. France and Italy were unable to do that. The aim was to use the ECB to force France and Italy to keep their money under control.”26
The new currency, intended to symbolize a new era of European cooperation was really a means of settling old scores, said Rupert Pennant-Rea, who served as deputy governor of the Bank of England from 1993 to 1995.
The euro was a monstrous creation. It was driven by the politics of the Franco-German relationship, which had its obvious echo in the relationship between the Bundesbank and the Bank of France, where, on the whole, what the first did the second did immediately afterward. The French political class hated the fact that they had to dance to the Bundesbank’s tunes. You could argue that, from a French point of view, the euro was little more than a way out of that continuous insult to their national pride. The French felt they were more or less equal with the Germans on most subjects, but on monetary issues they were always, always second and subservient. They hated that.
AND FOR ALL the technical expertise supplied by Lamfalussy and his BIS-in-exile in Frankfurt, the project was doomed from the start, the British former central banker argued. “It was completely misdesigned. You should not create a monetary union of such disparate economies because it doesn’t work. There were a lot of economists saying that, but the politicians said we know better, we are creating history. We have an evangelical legitimacy which you mere mortals don’t understand.”27
Why, then, did the Germans agree? The Bundesbank, said Pennant-Rea, always hated the idea of the euro, because it clearly saw that monetary union would dilute German monetary sovereignty. But Chancellor Helmut Kohl, President François Mitterrand, and Jacques Delors were fixated on their place in the history books. The loss of monetary sovereignty was a small price to pay for redesigning a continent—to a plan drawn up in Berlin as much as Paris and Brussels. “I think it was a matter of great men and their moment. This is us creating the new Europe, where all that ghastly history of the last century we can now firmly say is gone and will never return, because we have now created something utterly different. But that bore no relation to what the great majority of the German people were thinking or wanted, their leaders never tested public opinion. It was horrific.”28
Whatever his inner doubts, Lamfalussy got on with the job of making the euro happen. The Hungarian economist was a modest and likeable person, said Pennant-Rea. “He was trying to find the truth in the economics of it. But he was working on the creation of the euro in a highly politicized environment, trying to be faithful to his economic analyses and not let the politics turn his head.”
Even those more sympathetic to the project admit it was flawed from the outset. The Eurozone had two inherent flaws. First, it was not a homogeneous currency area. Uniting countries as diverse as Germany and Greece—or Italy or France for that matter—each with different cultures, histories, economic and fiscal policies, and attitudes toward the role of the state and rights to raise taxes was always going to be a hazardous enterprise, as indeed Walter Funk had predicted in 1940. Second, the Eurozone needed a credible transnational fiscal system, with rules and an enforcement mechanism, as Lamfalussy had argued. National governments in the Eurozone retained the rights to raise taxes and control their public spending, even though those decisions ultimately impacted on the other members. Thus all the Eurozone members were, in effect, held hostage to each other—with no means of controlling those outside influences.
The counter argument is that the momentum toward full union was now unstoppable. The euro was a currency whose time had come. Like Hjalmar Schacht’s rentenmark that was introduced to wipe out the hyperinflation in the 1920s, or the deutschmark that was brought in to stabilize the postwar economy, the euro would work, or have to work, because enough people, especially among Europe’s ruling class, believed that it would. And the euro was always about more than a common currency. The introduction of EMU, the technocrats believed, would somehow force a resolution of the euro’s contradictions and then catalyse the process of full European monetary, economic and political union. “The member countries of the Eurozone and the European Union have always used somewhat narrow decisions about economic structure to try to build a broader political economy in Europe,” said Malcolm Knight, who served as BIS manager from 2003 to 2008.29
In other words, technical decisions about financial and monetary policy have been used to introduce the supranational state by stealth—often via the BIS. The warnings about the single currency’s contradictions went unheeded and Europe is now paying the price. Some of the Eurozone’s problems should have been foreseen, argued Nathan Sheets, who served as head of the Federal Reserve’s division of International Finance from 2008 to 2011. “When they drew up the treaties, they didn’t have any B-plans. They made it impossible for somebody to leave or be expelled. There are no clear mechanisms for dealing with a country whose sovereign debt is under stress. There was an insufficient commitment to surveillance and making sure people stayed within the rules.”30 These flaws were exacerbated by the subsequent expansion of the Eurozone to seventeen members. “They started the Eurozone with a very heterogeneous group of countries and then they made it even more so by bringing in those additional countries.”31
It was obvious from the outset that the euro could not work, said Zsigmond Jarai, who attended numerous meetings at the BIS and was well acquainted with his compatriot, Alexandre Lamfalussy. “Before the crisis, Lamfalussy told me, because it was clear to everybody, that if you have a common currency you have to have a common economic and fiscal policy from the beginning. Lamfalussy told me that the idea was they create the currency first and that will force the creation of a more common economic and fiscal policy.”32 Europe, however, is still waiting.
CHAPTER FIFTEEN
THE ALL-SEEING EYE
“I had a file six inches thick on Freddie Mac and Fannie Mae.”
— William White
The BIS’s decision to collect statistics on international banking activity and computerize its data repository had paid handsome dividends. The bank rapidly became one of the best-informed financial institutions in the world, especially about cross-border banking transactions and the flow of international capital. Commercial banks, including some that were domiciled in off-shore financial centers, supplied data on their assets and liabilities and foreign currency and cross-border transactions to a central banking authority—usually the national bank or its equivalent—which aggregated the data and forwarded it to the BIS. The bank then published some of the information in its Quarterly Review. The BIS had been designed as a bank for central banks. But agile as ever, it had remodeled itself as an essential point of reference for information on the commercial banking sector and all that flowed from that.
The 65th Annual Report, covering 1994–1995, was 228 pages long and was a veritable encyclopedia of economic and financial statistics and indicators. It covered international trade in both the Western and developing world: monetary policy, bond markets, exchange rates, capital flows in emerging and Western markets, and developments in international financial markets. It offered summaries, analyses, and guidance, and called for greater cooperation and coordination between banks and regulatory authorities.
When William White arrived in Basel from Ottawa in 1995, he took over a highly regarded economic research department. The bank’s prescriptions had remained more or less constant since Per Jacobssen had arrived in 1931 and written the first reports: tight control of credit and the need to control inflation. “If there is one thing that distinguishes the BIS way of looking at things from virtually everybody else,” said White, “it is that they do put more emphasis on the bad things that can happen from excessive lending. That goes back to the 1930s and the bank’s founding after the hyperinflation in Germany.”1
The bank had warned about the excessively easy credit that was fueling the Asian economic boom during the 1990s. When the Asian debt crisis exploded in 1997 and the Thai baht collap
sed and spread contagion across the region, the BIS was vindicated, although that was meager comfort. “People said the Southeast Asian debt crisis came out of nowhere and was impossible to predict,” said White. “This is all nonsense. The BIS banking statistics made it very clear in the 1990s that huge amounts of money were being borrowed in foreign currencies for very short terms, then being lent out in domestic currency at much longer maturities. The Asian debt crisis was an accident waiting to happen.”2
Knowing there was a problem, however, did not mean the bank could always persuade policymakers to take preventative or remedial measures. Just a few years later, in the early 2000s, the United States was also facing a similar potential financial meltdown. The repeal in 1999 of the Glass-Steagall Act that separated banks’ deposit taking and broking activities had helped fuel a credit boom and asset bubble. Glass-Steagall had been passed in 1933 during the Great Depression. The warnings of those who said that repealing the act would trigger another cycle of boom, bust, and depression were ignored.
BIS officials were especially concerned about the Federal National Mortgage Association (FNMA), known colloquially as Fannie Mae, and the Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac. The two institutions were government enterprises that provided liquidity to the mortgage system. They purchased home loans, providing the loans met their criteria, and turned them into mortgage-backed securities. Freddie and Fannie then sold the securities to outside investors and guaranteed both the principal and the interest payments. Thanks to the government’s imprimatur, the system worked and remained stable.
But in the early 2000s, Wall Street worked out how to purchase and securitize mortgages without going through Freddie or Fannie. Finance houses such as Lehman Brothers and Bear Stearns bundled high-risk subprime mortgages—those granted to borrowers with a poor credit rating—into securities. The Wall Street finance houses then sold them to investors, few of whom understood the risks they were buying.
