High & Low Finance: A Central Bank Doing What Central Banks Do

That should be the slogan of Mario Draghi, the president of the European Central Bank.

In recent weeks, the new president publicly insisted the central bank would never do any of the things that Germany opposed. The bank would not drastically step up its purchases of Spanish and Italian government bonds. It would not directly finance European governments. It would not backstop European rescue funds or print money that the International Monetary Fund could use to bail out governments.

It would do only what central banks normally do. It would lend to banks.

It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.

That fact only became clear on Wednesday, although Mr. Draghi announced his intentions on Dec. 8, when the central bank said it would offer to lend money to banks for three-year terms, in unlimited amounts, at a very low rate.

In reality, it was an offer banks could not refuse. They will initially pay the central bank’s official rate of 1 percent. But if the bank lowers the rate in coming months — as it is widely expected to do — the rate on these loans will drop as well.

There is no limit on what the banks can do with the money. But there is an obvious, virtually risk-free, option. A bank can buy short-term securities of its own government and pocket the difference — up to four or five percentage points — for the life of the securities.

On the same day the central bank announced its lending offer, Mr. Draghi held a news conference at which he talked very tough. He said he was surprised that a speech he had made a week earlier had been widely interpreted as signaling the bank was ready to make large scale purchases of Spanish and Italian bonds. He threw cold water on the idea of the bank funneling money to countries through the I.M.F.

Many observers — including me — focused on what he told reporters, not on what he announced. Bond yields rose. The yield on three-year Italian bonds leaped to 6.6 percent on Dec. 8 from 5.9 percent. For Spain, the comparable rate rose to 5.1 percent from 4.6 percent. Stock prices plunged, with the main Spanish index down 2 percent and its Italian counterpart off more than 4 percent.

It was more than Mr. Draghi’s rhetoric that had misled the market. In normal times, borrowing from a central bank is seen as a sign of weakness, and banks hate to do it for fear word will leak out that they had to do it. And banks have come under pressure to raise more capital in part because of their exposure to dubious government paper. Would they really line up to buy more, even with favorable financing?

The answer is yes. On Wednesday, the European Central Bank announced that 523 banks would borrow a total of 489.2 billion euros ($640 billion). That was above virtually every forecast.

On Tuesday, the same day the banks were putting in their requests for loans, Spain held an auction of Treasury bills. A month earlier, it had to pay an annual rate of 5.1 percent on three-month bills and 5.2 percent on six-month securities. This time the rates were 1.7 percent and 2.4 percent. Credit that plunge to Mr. Draghi.

Rates have also fallen significantly on government debt out to three years, but the declines in longer term rates have been smaller.

It now seems obvious that this was what Mr. Draghi had in mind. Spain and Italy will be able to borrow money from the market at rates they can live with, but this move is unlikely to have much effect on long-term rates. If those stay high, the pressure for austerity, as Germany demands, will remain.

There is no assurance that the banks will use all, or even most, of the money they borrowed, to buy government securities. It would be nice if some of it were lent to the private sector to spur growth and investment. But the logic of putting it in two- or three-year government notes is obvious.

Spanish two-year securities now yield about 3.6 percent, while Italian ones offer 5.1 percent. A bank that uses central bank money to buy them will clear the difference between those rates and 1 percent. The spread will be a little larger when the central bank lowers rates in a month or two. The securities will mature well before the loans come due.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

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