There is a widespread perception that some banks are so systemically important that they are “too big to fail,” and that this status gives them a funding advantage because if they do run into trouble the government will bail them out and protect the investments of those who fund them,1 and that this is an implicit subsidy, and is Bad.
Because the subsidy lives entirely in expectation, there is essentially one way to get rid of it, which is to say: no, these banks aren’t too big to fail. This is a very politically appealing approach, because saying things without regard to their truth is pretty much the job of a politician, so the idea that you could fix a problem solely by doing that seems like magic. Is magic.2
But seeing through bullshit is pretty much the job of financial markets, so that approach only goes so far. Saying “we’ll let banks fail” and obviously not meaning it – say, by passing a unanimous symbolic Senate measure “direct[ing] the government to eliminate the advantages in federal subsidies and funding that banks larger than $500 billion in assets derive from the perception that the government won’t let them fail” – works a certain magic, I suppose, but not the magic of eliminating the subsidy provided to too-big-to-fail banks.
Letting nationally important banks fail, whacking creditors, and then giving press statements to the effect of “that’s right, screw your banks and their creditors,” might work though:
“What we’ve done last night is what I call pushing back the risks,” Dutch Finance Minister Jeroen Dijsselbloem, who heads the Eurogroup of euro zone finance ministers, told Reuters and the Financial Times hours after the Cyprus deal was struck. …
“If we want to have a healthy, sound financial sector, the only way is to say, ‘Look, there where you take on the risks, you must deal with them, and if you can’t deal with them, then you shouldn’t have taken them on,'” he said. …
Asked what the new approach meant for euro zone countries with highly leveraged banking sectors, such as Luxembourg and Malta, and for other countries with banking problems such as Slovenia, Dijsselbloem said they would have to shrink banks down.
“It means deal with it before you get in trouble. Strengthen your banks, fix your balance sheets and realise that if a bank gets in trouble, the response will no longer automatically be that we’ll come and take away your problem.”
What they did last night was, of course, casting Cyprus’s large, terrible Bank Laiki into the Mediterranean along with most of its uninsured deposits, and not being much gentler to uninsured depositors at Cyprus’s even larger though less terrible Bank of Cyprus. As Felix Salmon puts it, “the resolution of Laiki is going to give the world a very real example of what happens when a too-big-to-fail bank is allowed to fail,” albeit in microcosmic controlled-experiment form.
Controlled-ish. Various smarter and faster people than me3 quickly interpreted Dijsselbloem’s pronouncements, with two leading theories being:
The former camp thought that forcing the financial sector to internalize its risks is a goal of the Eurogroup, and a mostly sensible one, although it runs into a bit of trouble with the notion that bank depositors are the best monitors and bearers of financial-institution risk. The latter camp viewed Dijsselbloem’s efforts to spread contagion as mainly recreational.4
Dijsselbloem himself quickly signed on to the “just kidding” camp with this two-sentence reversal:
Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.
Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.
Of course just because he said it doesn’t mean it’s true. But it sounds true: “we have no plan and are just winging it each time” seems like a pretty good description of Eurogroup policy so far.
My own assumption is that that policy is a Markov process and nothing that anyone says or does today will have any effect on what anyone says or does tomorrow. This may just be because I sit very far away and don’t pay very much attention, but the level of randomness sure seems high.5 This has an obvious political appeal: on days when too-big-to-fail banks seem like they’re failing, you can rescue them and save your financial system; on days when they’re not, you can make stern responsible-sounding pronouncements like “there where you take on the risks, you must deal with them, and if you can’t deal with them, then you shouldn’t have taken them on.” If you pick the wrong day, you can always change your mind in a couple of hours.
I once speculated that this randomness might have some beneficial systemic effects too – that making it unclear who exactly bears the risk of the next European crisis (small depositors? large depositors? subordinated bondholders? senior bondholders? local taxpayers? German taxpayers? Gazprom?)6 makes it hard to know what sorts of assets to avoid. Why have a run on Greek bonds if your bank accounts aren’t safe? Why have a run on the bank if your actual euro notes aren’t safe?
Is that too glib? Probably: you can avoid the fine distinctions of which sorts of assets in Cyprus or Greece or Spain or Italy are the worst by just getting out of those places entirely:
The chances of European banks being allowed to fail are higher now than they were pre-Cyprus. As a result, we should expect uninsured deposits to continue to flow from the periphery of Europe towards the center. Which in turn means extra pressure on Italian and Spanish banks, just when it’s least needed.
On the other hand, the chances of the next European bank to get in trouble being allowed to fail are higher than they were pre-Cyprus only if there’s a positive serial correlation between Eurogroup banking bailouts. The fact that Cyprus was in some ways the opposite of Greece does little to prove that the next situation will be like Cyprus. Maybe the template is not “do Greece – no, wait, do Cyprus” but rather “do the opposite of whatever you just did.” The next bank that fails will probably see all its creditors get 100 cents on the dollar, plus a little present for being such good sports. Maybe Europe’s goal is to confuse people into buying the dip.
Or something? Dijsselbloem’s original statement is a little mean to depositors, but in general the notion that bank creditors should bear some responsibility for assessing and controlling the risks of the banks they lend to makes sense. Everyone who funds European banks probably should be thinking hard about their chances of getting their money back. It’s just that the main input into that analysis these days is Dijsselbloem himself. And he’s kind of hard to predict.
Cyprus Gets New Bailout Deal [WSJ]
EU ministers approve Cyprus bailout deal [FT]
Cyprus to be model for future bailouts [FT]
After Cyprus, eurozone faces tough bank regime – Eurogroup head [Reuters]
Dijsselbloem, do remember that careless talk costs lives… [FTAV]
The Dijsselbloem Principle [Reuters / Felix Salmon]
2. David Graeber has in several places talked about the magical properties of politics: “If you managed to convince everyone on earth that you can breathe under water, it won’t make any difference: if you try it, you will still drown. On the other hand, if you could convince everyone in the entire world that you were King of France, then you would actually be King of France.” The phrase “there are no too-big-to-fail banks” works the same way.
3. WITH MORE RELIABLE BLOGGING PLATFORMS I might also add.
It’s a direct call to depositors across the eurozone — retail and corporate alike — to move cash now and spread it across a portfolio of the largest available banks. It’s direct advice to dump bank debt. And it’s a direct invitation to speculate that the EFSF, the ESM, and the rest of the alphabetic bailout soup is going to be discarded in favour of calling on depositors’ money across the Continent.
Jeroen Dijsselbloem … is openly promoting the Cyprus bail-in as a template for the rest of financially fractured Europe. Except it’s not. It’s a way to deal with the political impossibility of German taxpayers bailing Russian gangsta finance. … Would the Eurogroup leader like to torpedo the Italian and Spanish economies in similar fashion? How about France? Probably not, but the immediate result on Monday was six per cent off the price of Intesa Sanpaolo stock, six per cent off Unicredit, five per cent off SocGen and so on.
One of the major steps the euro zone has taken over the past three years has been to set up a rescue mechanism with guarantees and paid in capital totalling up to 700 billion euros – the European Stability Mechanism. The expectation was that the ESM would be able to directly recapitalise euro zone banks that run into trouble from mid-2014, once the European Central Bank has full oversight of all the region’s banks. The goal of the ESM and direct recapitalisation was to break the so-called “doom loop” between indebted governments and their banking sectors. Now, Dijsselbloem says the aim is for the ESM never to have to be used.
Imagine being one of the people who put together the fancy recapitalization mechanism, and then waking up today and opening your newspaper to find that Dijsselbloem blew it up. Would you be pissed? Would you believe him? Would you believe his quick reversal? Mostly pissed, right?
When a European bank runs into difficulties in the future, under this view, the EU is not going to help bail it out. Instead, it will go down a list: the bank’s executives come first, then its shareholders, then its bondholders, and finally its uninsured depositors. All of them will take losses before the national or European authorities step in with bailout money.
So sure that’s today’s principle but notice “executives.” I’m not entirely sure what theory would put them first on that list – where executives rank vis-à-vis shareholders seems like a nontrivial question – but there is this, from March 15:
Under threat of litigation, the Bank of Cyprus has awarded former CEO Andreas Eliades compensation to the tune of some €2 million. The move comes after a majority decision of the bank board last Friday. No money has been disbursed yet; given that the bank has requested state assistance, the final say rests with regulatory authority, the Central Bank. On resigning his post in July last year, Eliades demanded €3.5m in total. The €2m figure awarded last week is seen as a compromise.