Yesterday morning, I wrote a comprehensive post on the Cyprus bank deposit bail-in. Go there for the details of the bailout package. I want to expand on that here today with some thoughts on the politics.
The latest news out of Cyprus is that the Cyrpiot government has delayed the vote on a bank bailout and savers tax by one day to Monday and that it has also extended the bank holiday from just Monday to Tuesday as well. Reports are that the votes for a clear approval are not there yet. The central bank has asked banks to freeze all money orders and transfers temporarily (link in Greek). In my view, the news flow suggests that the bailout in Cyprus is not going well and I fear there will be severe negative consequences for the euro zone’s economy and the stability of its banking sector as a result. As to the economics and politics of the matter, the bailout terms were driven by unavoidable politics in Germany and I want to explain why.
The prevailing view in Germany is that the economic crisis was driven in the main by profligacy by governments, lenders and debtors in periphery countries. There was a sense of scepticism about the finances in countries like Italy well before the crisis. See my German-framed post from 2010 on “how Belgian debt, Italian anarchy and Greek profligacy lead to economic chaos in Europe“. The solution, therefore, in this framing is austerity. And that means less credit and less debt all around in both the private and public sectors, an outcome which inevitably leads to economic stagnation.
The Germans do not just have this view about the periphery. There is a widespread sense amongst many in German policy circles that Germany itself and the German banks have lived beyond their means. Before the crisis, Germany’s government debt was around 60% of GDP, the level set as a sort of demarcation line in the Maastricht Treaty in 1992. But the bailout of German banks and large deficits ballooned this number considerably. Now, the large 82.8% German government debt to GDP ratio is a source of shame for many because Germany was a driving force in enshrining the 60% government debt to GDP hurdle into the Maastricht Treaty that set out terms for the euro zone. And there have been many rumours in the German press that Germany will make budget cuts to reduce this number after the general elections. Similarly, the CDU/CSU/FDP ruling coalition often hit out at the SPD and Green Party because the Union and FDP believe the Schroeder government’s taking Germany over the 3% Maastricht deficit hurdle last decade set the EU up for its present lack of fiscal rectitude. According to this world view, the stability and growth pact was not stringent enough – and this was the principal cause of the present problem; fiscal rectitude equals no crisis whereas profligacy and lax regulation led to crisis. According to this world view, a super SGP would solve things and an ECB paper on just this idea was formulated last year.
In short, the ideological view that predominates in German policy circles is that a lack of fiscal rectitude and a lax bank regulatory environment was the problem from the start and that fixing these things by further reducing wiggle room for mischief will reduce profligacy and prevent crisis. The data contradict this view considerably. The euro has been destabilising for a number of reasons I can’t go into here but Spain is the perfect example of a country that never should have joined the euro zone. Low government debt and surpluses in Spain and Ireland stood in stark contrast to the soft depression and difficult finances in Germany. Moreover, the interest rate policy of the ECB, geared as it was to the slow growth core, produced negative real interest rates and credit bubbles in Spain and Ireland during the last decade. German banks piled in to those countries as prospects domestically stagnated. None of this matters politically though. There is no sense in telling political masters in Germany this because they see Germany’s recent history as one of severe belt-tightening and an economic success that they believe is a direct result of that tightening. Extrapolating the German model Europe-wide is the goal.
The average German has suffered tremendously during this period of belt tightening. For example, a questionnaire given out by the leftist “Die Linke” party in Germany elicited a remarkable result, that German pensioners have lost 20% of their purchasing power since 2000.
As I wrote last July about bailout fatigue in the German electorate:
“If you are an average (West) German worker, you have witnessed the following in quick succession over a twenty-year period:
- A solidarity tax, payoff to Russia, and promise to join single currency as the price for re-unification
- A loss of the Deutsche Mark, the symbol of Germany’s post-war economic discipline and success
- A loss of the German economic miracle of the 1950-1980s and a soft depression due to a confluence of events including reunification, a property bubble, aging society, and poor demographics
- A breach of the Maastricht debt and deficit hurdles due to the soft depression
- A stagnation of wages and a loss of economic security and some of social safety net benefits with Hartz reforms because of soft depression
- A bailout of reckless German lenders pushing government debt to GDP well over 75% and now 81%
- Successive bailouts of other euro area members who have not gone through the same trauma and reform
“The average German worker feels like a cash cow being sucked dry by a quick succession of reforms and bailouts that take money out of her pocket. First it was for reunification, then for European integration, then to right the economy, then to bail out German banks, and finally to bail out the European periphery. Fatigue has set in.”
And let’s not forget, that while Germany has the lowest unemployment rates in a generation, under the surface deep problems have developed; for example, since the Hartz IV social program reform was established, 1 million people have been permanently relegated to it (link in German). This shows a fraying of the German social safety net as an example of the price German citizens have paid for the belt-tightening policies.
The bottom line is that none of the major political parties in Germany are going to vote for bailouts for other euro zone countries unless massive strings are attached, since these bailouts are political losers.
The present ruling coalition in Germany is made up of the CDU/CSU/FDP parties that led Germany under Helmut Kohl, with both finance minister Wolfgang Schaeuble and Chancellor Angela Merkel being prominent members of the Kohl era government. Here’s the thing though; the FDP have increasingly lost voters in Germany and are in jeopardy of falling under the 5% hurdle that defines whether a party can even be represented in the German Bundestag. Despite Angela Merkel’s popularity it is not clear the present coalition could form a government after this year’s general election. There are three main possibilities outside of the present coalition then: a grand coalition between SPD and CDU/CSU, a CDU/CSU/Green Party government or an SPD/Green/Linke coalition. All of this uncertainty should cause the FDP to become more ideologically pure i.e. more free-market, anti-bailout in tone. The anti-bailout part of the FDP platform is the one part of their rhetoric which could successfully take them over the 5% hurdle. The FDP’s complicity in using German taxpayer money to bail out the so-called profligate periphery is a one-way ticket out of Parliament. And since the FDP is needed for all votes to pass the Bundestag, this fact greatly influences German bailout negotiating tactics.
The SPD can and probably will run the German general election on a platform criticizing Merkel’s bailouts. Therefore, the SPD made their vote in favour of any Cyprus bailout contingent on bank lender losses, widely known in finance circles as private sector involvement (link in German). Within the ruling coalition, there is deep opposition to more bailouts on principal alone, especially in an election year. For example, one German FDP politician called the Cyprus deal a “perversion of the solidarity concept in Europe“. And said he was not voting for the bailout. He also said, “if this goes on like this, we will be rescuing Andorra and San Marino as well, because they have such a strong economic relationship with the crisis countries Italy and Spain.” With parliamentarians like this within the governing coalition, Merkel needs to make sure she has the votes in each and every bailout and that the terms are stringent. That means considering what the opposition SPD’s line for any bailout is, especially as this will have an impact on general election positioning. Some within the ruling coalition reject bailouts under all circumstances, no matter how draconian the terms. This is a main reason for the savers tax.
For example, the Wall Street Journal wrote about the FDP’s position on Cyprus last month:
Mr. Rösler’s pro-business Free Democrat party is junior partner in Chancellor Angela Merkel’s ruling coalition government, and therefore will have a strong say on granting aid to Cyprus. There is a group of euro rebels in the FDP who reject any euro zone bailout.
And many German lawmakers—across party lines—aren’t convinced that Cyprus poses an existential threat to the euro zone, a requirement for any aid from the European Stability Mechanism, the euro-zone bailout fund.
Mr. Rösler’s remedy for the euro zone is continued fiscal reform and free trade to boost growth.
The FDP are not eurosceptical. But they do want austerity and are generally opposed to the bailouts without stringent pre-conditions. However, the advent of a new eurosceptic party in Germany complicates matters a bit. Ambrose Evans-Pritchard thinks the forming of an anti-euro party in Germany is a significant event. Time will tell. The question right now goes to whether this alters Germany’s negotiating stance and tactics on bailouts. It is hard to say. But I believe the eurosceptic voices are louder within Merkel’s own coalition than they are in the SPD or the Greens.
One last thought here on the German politics in general. I thought it was curious that ECB board member Asmussen told the Frankfurter Rundschau last August that, “up to now, the rescues have not cost German taxpayers one euro.” What does that mean?
First, let me point out that Asmussen is a member of the SPD but a key ally of Angela Merkel in the ECB because he served as State Secretary for the finance ministry under Schaeuble in the Merkel government and keeps direct lines of communication open between the German government and the ECB. But this statement is interesting because he said it in the context of support for what later became the ECB’s outright monetary transactions program. And it fits well with the narrative I saw developing at the time.
The week before Asmussen spoke, I had already written that we should anticipate the end of European bailouts and the beginning of monetisation. Here was my rationale for why:
“In the German press, there have been a number of stories recently that indicate that the German government will not commit any more money to bailouts in the euro zone. Specifically, the reports of greatest interest have to do with Germany’s neither funding a new Greece or topping up the EFSF/ESM bailout facilities. I think these reports are credible and I am writing this note as to what I believe they mean for European economic and monetary policy.
“First, the Greek reports come via statements made by Michael Fuchs, CDU deputy Bundestag head and a senior member of German Chancellor Angela Merkel’s party. Fuchs warned earlier today that Germany would veto further aid to Greece if the country has not met the conditions of its previous bailouts. Fuchs told German business daily Handelsblatt that “even if the glass is half full, that won’t be sufficient for a new aid package. Germany cannot and will not agree to that.” Fuchs also voiced resistance to allowing the ESM permanent European bailout fund to receive a banking license in order to facilitate ECB monetisation of periphery debt.
“Second, all along Germany has indicated that it is resistant to increasing funding of the ESM and EFSF bailout facilities. This presents a problem in the case of Spain and Italy because of the size of those economies. The reason for the talk of a European banking license for the ESM is a recognition that these funds would be soon exhausted if they were to have to buy Spanish and Italian debt to maintain yields at reasonable rates for those governments. Willem Buiter, Chief Economist at Citigroup, has been most vocal in predicting that these facilities will be inadequate when Spain and Italy hit the wall and that more extreme measures will have to be taken.
“The basic dilemma here is that almost all of the eurozone governments including Germany carry high debt burdens in excess of the Maastricht Treaty. For example, Germany has been in breach of Maastricht Treaty in 8 of 10 years since 2002, has been over the Maastricht 60% hurdle in each of those ten years, and now carries a debt to GDP burden above 80%. The ratings agencies are onto this and Moody’s has recently downgraded all of the remaining AAA credits in the euro zone except Finland.”
The long and short of it was that the Germans had reached the end of their ability to support bailouts. With an election coming up, euroscepticism increasing, and the German debt rating in jeopardy of being downgraded, Merkel had no choice but to allow the ECB to do the heavy lifting of supporting the periphery. She stood behind Asmussen’s view, who supported Mario Draghi, and opposed her own central banker Bundesbank head Jens Weidmann, who like his predecessor Axel Weber, was adamantly against the ECB’s deviating from its inflation-target mandate.
In the Cyprus bailout for example, all press accounts I have read, point specifically to the Germans – and Wolfgang Schaeuble, even more specifically – as driving the need for a savers’ tax as a pre-condition for the Cyprus bailout. The FT reported that the bailout package won praise from the right and the left of the German political spectrum. A spokesman for the government was quoted saying that, “Germany has managed to have its concerns met, both in the interests of Europe and the German taxpayer.” The inference here is that it was the private participation in the form of a savers’ tax which was praiseworthy. Michael Fuchs of the CDU implied that the bailout would have been rejected by the Bundestag if it did not have stringent terms when he was quoted saying it was “not going to be easy” to get a clear majority for the bailout through the Bundestag. He added, “if all the details are as I have heard them, it should be enough.”
The FDP, on the other hand, is more sceptical. Dutch newspaper Metro reports this with the headline “Bundestag Approval for Cyprus plan uncertain,” writing that the FDP wants to know whether the Cypriot banks involved in the bailout are “systemically relevant”. The Frankfurter Allgemeine Zeitung notes that SPD is satisfied. In fact, the rescue package doesn’t go far enough; their concerns go to the dodgy tax haven status of Cyprus and instituting a European-wide financial transactions tax. But the FDP is “leaving open whether it will ascent” to the bailout at all.
So, as far as German politics goes, the German government doesn’t want bailouts but feels that it has to permit them in order to save the euro. However, in order to get a bailout the pre-conditions are becoming harder and harder as bailout fatigue sets in. At first, it was fiscal reform. But as the crisis continued, policy makers saw this as an opportunity. So it became fiscal and labour market reform and privatisation and pension reform. As German policy makers told Richard Koo last summer, the crisis represented a “once-in-a-lifetime opportunity” to institute real structural reforms like the ones Germany is doing.
Since the Spanish bailout, private sector involvement has become mandatory as the principal way of breaking the sovereign – bank nexus. And this policy is also supported by German academics. This is why private participation was a must for the coalition and the SPD alike in the Cyprus deal. The question in negotiation was and still is how to structure the private participation. Question one is how much Cypriot banks need in order to be recapped successfully. Once the amount of the bank recap is determined, the next question is about where the funds will come from – Cyprus, the IMF and the European bailout funds – and how much from private participation, loans and guarantees.
In terms of the funds coming from private participation, I don’t understand why debt holders are not participating. There is no indication anywhere that any parties outside of Cyprus forced the Cypriot government to initiate a saver’s tax without also having bondholders participate via significant haircuts. As the Economist put it, “there is a case for hitting everyone in Cypriot banks before any taxpayer in another country. But there is no moral imperative for whacking Cypriot widows and leaving senior bank bondholders untouched, as appears to be the case here”.
But once you get into whacking depositors with a tax, the question is who pays that tax. The IMF had advocated simply drawing funds from deposits over the 100,000 euro deposit guarantee threshold. Moscow has said their chief aim is to get information on tax dodgers (link in Spanish). And the Germans have never specifically said – from anything I have heard – that private participation had to include savers, let alone deposits under the 100,000 euro threshold. Clearly then, the levy on small deposits was driven by the Cyprus government, ostensibly to maintain Cyprus’ status as a tax haven. [Update 1715 EDT: Reuters has a post out now in which Wolfgang Schaeuble says that Germany would have protected insured deposits. The decision to levy small deposits was driven by the Cypriot government. UPDATE: 1845 EDT: The FT also confirms this. “The Cypriot president did not want to agree to a levy higher than 10 per cent, and if you do the numbers you get the 6.75 and 9.9 [per cent].” Update: 2215 EDT: Peter Spiegel of the FT writes that the Germans did insist on a saver levy, though they did not insist the levy extend to insured deposits. ]
All evidence is that this levy has created panic in Cyprus. After all, what is the use of having a deposit guarantee if government can arbitrarily circumvent it to impose losses on your deposits anyway? [Update: apparently Cyprus is realizing this belatedly and negotiating to reduce the levy. One can’t just blame Cyprus for this fiasco. The ECB, EC and European Union finance ministers signed off on the insured deposit grab too]. And there is legitimate fear that this panic could spread to other depositors elsewhere in the periphery who believe the same kind of levy could befall their accounts in due course. This kind of panic and disorder is predictable. Nearly every analyst I have spoken to about this is shocked at how ad-hoc and ill-prepared the EU acted in choosing this particular course of action. See Karl Whelan’s take for example. My view? It was inevitable that we would be in crisis again. The austerity world view of crisis resolution is completely at odds with the capacity of the euro zone’s institutional architecture to handle a crisis. And so, we keep doubling down on the same policy of austerity in exchange for reforms which has created the downward spiral to begin with. I wish I could be optimistic here. But I think it is going to get worse. I hope I’m wrong. And I certainly hope that periphery depositors still have enough faith in the euro to ride this one out. If the Cyprus panic metastasizes, it will get ugly.