Economics and similar, for the sleep-deprived

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Update: seemingly not

Update: Oh yeah!

Monday, April 22, 2013

Sympathy for the Dijsselbloem

At some point, and the one-month anniversary of the fabled interview seems as good as any, I think we have to start taking seriously the possibility that the reason why we haven't had a generalized bank run in Europe is that we're not gonna to have one. And as I said at the time, if there isn't a massive bank run, then this idiot scheme starts to look a bit more like a genius solution. As the man said, it's such a fine line between stupid and clever.

I think the issue here is that, as the lady said, money talks and bullshit walks. It's pretty costless to speculate in your FT column (OI, MUNCHAU! NO!) that it's rational for everyone to run on their local banking system - if you're of an academic turn of mind you can even find a model to tell you how right you are. But in the real world, running on a bank is hella inconvenient, which is why people usually don't do it. Northern Rock was the anomaly.

(Quick finger exercise: it's been suggested to me more than once that corporate deposits are going to start "sweeping" cash balances on a daily basis out of places like Spain into a head office account in Germany, or even outside the Eurozone. Maybe. But say your cash float is EUR200,000 in a branch of a Spanish bank, and it has to be in that branch because you can't persuade your cashiers to walk to Frankfurt every evening (this setup is not impossible for, say, a supermarket). You are unlikely to get the bank transfers for less than EUR100 round trip. So if you sweep it daily, over the course of 200 business days you have given yourself a 10% haircut on that float, simply with the cost of bank transfers. You're protecting yourself against a Cyprus-like loss, but it isn't cheap insurance.  This is true of retail customers too - shift your money to Rabobank? Now every time you go to an ATM in Rome, it's an international Cirrus transaction, which you will be lucky to get away with for less than EUR1.50 a go).

The frictional costs of running on even a single bank (let alone the logistical difficulties of running on an entire local banking system) are very significant. People run on banks when they're specifically worried about something nasty; they don't get round to it on the basis of general policy uncertainty. They hardly ever run on transactional deposits (as opposed to savings deposits) at all. Even last year in Greece, when there was a very genuine danger of getting one's entire deposits redenominated into drachma-denominated claims on a bankrupt guarantee scheme, nobody managed to get up anything much more than a "jog".

Furthermore, it's worth being aware that although the concept of a bail-in is brand new to the newspapers, it's actually been around for a couple of years .I can make a reasonable argument that careless handling of the original proposal was a contributing factor to the 2010 Irish bank run. The current proposal is up on the Commission website, and as long as you keep a clear head, it's pretty easy to understand, although in fairness, it is also very easy to get confused. The trick is (a very useful piece of advice given to me by a wise old head who was the Bank of England's tax expert at the time) to remember that official documents appear on the page as intimidating long lists of specific cases, but they are written as sets of general underlying principles, and if you keep your eye on the general principle then not only will you understand the reasoning much clearer, you'll be much better placed to spot the departures and loopholes and guess at the reasons for their exclusion.

In the case of the bail-in rules, the general principle is a division of the banking sector's liabilities into "basically risk capital" and "basically financial sector plumbing". You want to, if at all possible, restrict losses to the first category, leaving the payments infrastructure intact. Into the at-risk category falls equity (of course), subordinated debt and bonds, while the protected category ought to include short term interbank credit and retail deposits. Because this is Europe, nothing can be simple, so there are loads of weird and ambiguous cases like covered bonds and high-value deposits which might go either way, but the general principle is clear. So Cyprus isn't a "template" - it's the application of an already existing template to the particular oddity of the Cypriot financial system.

So, the more I think about this, the more I think that the risks of the new Dijsselbloem era in European policy are perhaps not as great as I initially thought that they were. The strength of a bridge is tested by the weight of the things you drive over it, and the fact that the European deposit system has survived not only Jeroen D's bumbling, but also considerable cheerleading for bank runs from the press should surely update our estimates of its underlying robustness. Even looking at the prices of term bank debt, or CDS on instruments which are indisputably in the "risk capital" part of the liability structure, I'm seeing a lot of discrimination; a few known peripheral problem children are trading at no-market-access levels, but the majority of core well-capitalised banks (including a number of peripherals) are basically unchanged on 18 March.

But ... "it doesn't appear to have blown the whole thing apart" is hardly the sort of thing that would justify a rating of "genius move" - even in the context of Eurozone politics, we've got to set the bar higher than that. So where's the genius bit?

It's about Spain. It's always been about Spain. This whole sorry spectacle has always been about Spain. Greece and Ireland, forgive me, are small. So's Portugal. But Spain and Italy are too big to be successfully yaddayaddaed. And the way that the contagion dominoes have stacked up, it has been clear for a few years that if you win the battle in Spain, you won't have to fight it in Italy, while if you lose the battle in Spain, you're probably not going to get a chance in Italy. And Spain (unlike Italy) has always been a case where it's basically a banking sector problem that has infected the sovereign, rather than basically a sovereign problem that has infected the banks.

There are "a few tens of billions" of real estate lending losses, which are hanging around in Spain. They are not meant to be on the credit tab of the Kingdom of Spain, but they are standing close enough to the Kingdom of Spain that people worry that they might be. To a first approximation, the Eurozone sovereign/bank crisis could be substantially ameliorated if this mountain of excess debt could be made to go away.

Now there are only three things that can happen to an excess debt problem. Either it gets inflated away, or someone else pays it, or it doesn't get paid. Monetisation, mutualisation or default. The ECB constitution means that monetization is off the table, and mutualisation (ie, Germany pays) is what we wasted most of 2012 finding out wasn't politically or constitutionally possible.

[we pause here for a short break in which readers may, if they wish, conduct a brief Three Minute Hate aimed at "Germany". Other countries, of course, are allowed to have democratic politics and to have constitutions and legislatures which constrain the ability of other people to write unlimited cheques on their behalf. But the Germans, of course, could make everything go away if they wanted to and only refuse to underwrite literally unlimited deficits with no control over how the money is spent because they are being awkward]

Anyway, "not politically possible", in context, means the same thing as "not possible", which narrows the space of possibilities down to "default". And so it really is a big win if Europe can overcome the taboo against banks ever defaulting on their creditors, a taboo which, we should note, does not exist in the USA. Ask IndyMac's uninsured depositors what they think about what happened in Cyprus, for example. The Kingdom of Spain needs to get the bank bailout liability shifted, in order to make room for a sane fiscal policy, and the way to shift it is going to involve some hefty defaulting; on bonds and "risk capital" instruments for choice, but on deposits if necessary, and I suspect that unless someone can come up with some fairly swift corporate-finance footwork, we are going to have to cut quite deep into the "plumbing" part of the balance sheet in some cases. Not nice, but there really never was a way out of this mess that didn't involve confiscating somebody's life savings, and doing it this way is no more morally shitehouse, and potentially considerably more practically effective, than letting it fester and putting the cost on taxpayers for the rest of forever.

I think my bottom line here is that this was a clearly high risk but potentially high return strategy for Europe, and all of the play-it-safe gradualist stuff had been tried and wasn't working. Dijsselbloem clearly talked out of turn, but what he was saying wasn't untrue, and the whole of Europe is going to have to be let in on the secret sooner or later. So maybe the guy is effing stupid, but he's stupider like a fox.

0 comments this item posted by the management 4/22/2013 06:15:00 AM

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