Guest Post: Sympathy For the Dijsselbloem

23 Apr

Morski: Guest post by Dan Davies (best known to most i suspect as @dsquareddigest) given that his own blog is composed mostly of nuclear launch codes and is hence invitation-only. I actually disagree pretty vehemently with this, but Dan has poked some holes in my argument that i need to address. If you’re interested in bank-run complacency more generally, you might find this worth a look too. Rather discourteously, I’ve left a dissenting comment below the post.

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 (scroll down to page 13; specifics are on p85), 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 expressions 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 versus 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 yaddayadda-ed. 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 by magic 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.

16 Responses to “Guest Post: Sympathy For the Dijsselbloem”

  1. pawelmorski April 23, 2013 at 10:40 pm #

    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.

    This much I agree with, but the logic that because bailouts are ineffective, unfair and expenive (true) therefore we can let nature take its course and let banks go to the wall is pretty much what brought us the Lehman crisis. No, Cyprus didn’t trigger a more generalised run on the banks, but test your bridge by blowing up a medium-sized mainland Eurozone bank before declaring victory. I absolutely disagree that we haven’t seen a bank run – the flood of liquidity out of the periphery into core (pre-OMT) contributed to the liquidity squeeze and recession in the periphery.

    As Lee Buchheit has pointed out, we’ll only know how damaging Cyprus was when things go wrong again in Spain. If we’re going to inflict losses on the bank – use the whole template: shut down the whole banking system and pick and choose which banks to save. And like devaluations, do it, don’t just talk about it.

    I read a lot less than Dan (or Barnejek) into the current calm. Yes, holding cash offshore is a tedious, expensive business, but if Inditex (etc) put their logisticians’ minds to it, I’ll bet that it could get a lot more operationally smooth fast. Banks are creatures of confidence. just talking about bailins (or removing deposit insurance or hare-brained scheme to enforce justice of your choice) is in itself enough to make banks weaker. Rule #1: people respond to incentives. I think we’re getting very casual about giving people a motive to shift their money.

  2. WaltFrench April 23, 2013 at 10:59 pm #

    Wow, €100 for an intra-bank transfer between the branch in Barcelona and the corporate account in Bonn?

    That’s certainly NOT what the proponents of a single currency were thinking.

    Yes, a nuisance, especially for smaller firms, but somehow I don’t imagine many multinationals paying a couple tens of thousand per year in Tobin taxes on their own money. Something else must be the cause.

  3. tigerstr April 23, 2013 at 11:52 pm #

    Very good line of reasoning about why they done it and why they may keep doing it. But I see some flaws on the bank-run reasoning. Greece can be a good example. Deposits decreased by dozens of billions (c 75 billion), a huge number for the Greek banking system, since the crisis started. This had an unprecedented impact on liquidity and the banks funding structure. Deposits started getting back the last months of 2012, continued during Q1 and will see how they trend after Cyprus.

    Two missing points in my humble opinion.

    1. People are not in a hurry to get their money out until they realize that there are rumors/reports about a threat, may it be a bank problem or an economy problem (first Euro group decision on Cyprus contained a levy and opened up this possibility).

    Actually Cyprus proved that there may be an imminent danger without people really understanding it. But that was before yes… Cyprus. Next time it may be different

    2. Big money is already considering alternative banking destinations, out of the Eurozone, with UAE increasingly becoming an attractive one. I have seen advisor documents presenting such options, with strong arguments, after the Cyprus incident. Part of it obviously has to do with tax evasion and anonymity, part of it nowadays has to do with security.

    Their main argument? You have to be prepared in case there is sudden turmoil in the banking system, or economy to avoid haircuts and levies. And you can always transfer between accounts.

    Consider Greece again. Systemic banks are getting re-capitalized, and there is no immediate danger of such nature. But, recession has already exceeded BlackRock scenarios and maybe loan defaults will lead to further needs exhausting the available capital buffers, provided by the Hellenic Financial Stability Fund.

    A lot of people with deposits that can be covered by breaking them down in less than 100.000 euros per bank started doing it right after Cyprus. What will they do if the situation deteriorates?

    And what will the really big depositors do? Get prepared and stay safe someplace else, I presume.

    This may not be a genuine bank run, with people running at the local ATM or branch, but its still very detrimental. In part its already happening in slow motion for wealthy people that consider their options. And if situation permits it might get much worse.

  4. Dario Perkins April 24, 2013 at 10:12 am #

    Great article. I expected more forceful bank runs in 2012, so like Dan I’m starting to think bank runs just arent going to happen – the general public dont always behave as us economists suggest they should (shock!).

    I suspect the nature of the euro crisis has now fundamentally changed. Thanks to the ECB, it is no longer market-led, or even bank-run led. It’s now about politics. The crisis will return if growth doesnt recover and public sentiment shifts against the euro. If it is Cyprus or Greece, markets wont care. If its Spain or Italy, we’re in trouble. This is of course impossible to forecast/time.

    In 1919, Keynes predicted German war reparations would create a political crisis. Thanks to a financial boom in the mid-late 1920s, he was wrong for a decade. But then he was right – spectacularly so. (And no, I’m not talking about another war – merely the rejection of the euro.) I’ve written a lengthy report on this – if anyone wants a copy, let me know.

    How do I get an invite to Dan’s blog?

    • ciaran April 24, 2013 at 2:31 pm #

      personally I’d actually pay to read Dsquared’s blog

  5. Robert Ackerman April 25, 2013 at 12:11 am #

    It’s great to see Dan Davies being self-righteous and indignant on the part of the Germans. They can hardly manage that attitude themselves. Let’s remember, that they lent money hand over fist to the countries on the EU periphery when they joined, and then lent them more, which helped drive interest rates down, which fueled the property boom, which then went bust. That’s the house that Hans built. Now Hans is like your friendly neighborhood drug dealer: You got addicted, too bad, you should know better, look at me, I’m not addicted, good luck with that cold turkey thing, and by the way, it’s good for you. Buttheads, the lot of them.

    • PPP Lusofonia (@ppplusofonia) April 25, 2013 at 8:35 pm #

      No pity for the “poor” cross-border creditors.
      If they didn’t want to run risks, they should have kept their money at home, under the watchful eye of their prudential(?) regulators.
      Dijsselbloem et al fail to distinguish between local retail depositors and savers and the speculative and even predatory foreign investors who “lent money hand over fist”, in a veritable tsu-money that slammed small fragile economies, and now want someone to to bail them out.
      The latter are part of the problem, the first are part of the solution.
      Treat accordingly.

  6. RichardB April 25, 2013 at 8:59 am #

    On the column. Yes, it’s always been about Spain. About not setting precedents that nobody can cover.

    On the “there won’t ever be a bank-run”:
    There actually was a bank run in cyprus, a real-life one. Not a “bank-jog.” November 22nd 2012, after well-founded rumours that the bailout-talks with the Troika had broken down. Cyprus being small, the global media never actually noticed.

    http://www.cyprus-mail.com/christofias/operation-bailout-dramatic-backstage-scenes/20121125

    Key sentence: “substantial deposits started being withdrawn from Laiki from early morning”. But the whole piece is interesting for political skullduggery too.

  7. dsquareddigest April 25, 2013 at 11:39 am #

    Thanks very much to Pawel for hosting this!

    One point I would like to add is that I don’t really believe in or understand the concept of a “bank jog”. We need to be clear about concepts here.

    The definitive characteristic of a bank run, and the thing which makes it so frightening, is that the bank loses deposits at a faster rate than it can generate liquidity to meet the payments. That’s the engine that drives the Diamond/Dybvig model (and the rather more general Bagehot analysis) – the way in which a liquidity problem turns into a solvency problem is that the sudden demand for liquidity forces the bank to take losses on its assets in order to realise them.

    In other words, the speed is a necessary component of the problem. If you have the same amount of deposits leaving you over a longer period of time, then you don’t generate the fire-sale liquidation problem. So it makes a qualitative difference.

    A “bank jog”, or whatever happened to build up the German TARGET2 asset, is not, in my book, a bank run. It’s better analysed as a “credit crunch” or “capital flight” or just “things just generally starting to economically suck”. That’s not to diminish the importance of the phenomenon, just to say that it’s fundamentally an economic question rather than specifically a banking policy one. A bank jog can be intermediated by the central bank without taking specific lender-of-last-resort risk onto its own balance sheet.

  8. Worsel April 25, 2013 at 6:54 pm #

    point of order: the global universal banks: rbs, barclays, jpmc, citi all off euro sweep facilities for corporates that do not cost the client anything to sweep funds ‘off-shore’ ie out of ez back to london on an overnight basis.

    • dsquareddigest April 26, 2013 at 3:45 pm #

      I’m not sure they’re actually costless, and it depends on being able to have your transaction account with either RBS or a partner bank. If you’re a supermarket in Fuengirola, it’s not really logistically possible to schlep your takings to the nearest branch of JP Morgan every night.

      • Worsel April 26, 2013 at 7:15 pm #

        well costless in the sense that it will not cost you any more in bank charges than you are already paying. if you’re a supermarket in fuengirola, it’s only the cash element of your takings you could be concerned about in the first place; credit card transactions can post to an account anywhere. also, if you take your cash to the bank that evening (presumably after the bank has shut), you won’t get credit for the transaction until the following day anyway. finally, it’s pretty easy to wire same day funds from el bank local to my sweep account in london. your hypothesis does not work.

  9. afuhz April 26, 2013 at 10:00 am #

    I must have missed it when peripheral euro countries were “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.” Iceland was able to do that, but something mysterious was stopping the euro countries.

    Basically the German political establishment needs to get it into their heads that they are not running a small open economny, but rather are the defacto leaders of the world’s largest economic unit.

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