Back to the Willem Buiter interview in Financiëele Dagblad. Here Buiter continues with some comments on Jeroen Dijsselbloem’s admission that bail-ins will be the preferred vehicle for conducting rescues going forward so as not to burden the public balance sheet.
This is an extremely important point because the difference between the bailout and the bail-in is that the bail-in recognizes that private debt is the problem and that these debts need to be recognized and written down rather than shifted to the public balance sheet. Bailouts are a form of loss socialization that shifts the burden of debts rather than reducing them. And for the euro zone, this is important because the eurozone state debtors are currency users that cannot rely on the ECB to monetize their debts if they run into trouble. They have no fiscal space whatsoever. As I have been saying for months, Germany is concerned about its own public finances. They know full well their own banks are going to need money too. The only way forward for insolvent banks really is a recognition of losses by private creditors and bank recapitalization.
Buiter says that even if Dijsselbloem had not said that Cyprus was a model for the future, it was clear this approach was going to be the way forward. “Even if he had not said it, it was clear that Cyprus was a laboratory.” Personally, I found Dijsselbloem’s intervention completely thoughtless because it’s clear policy makers haven’t decided on a comprehensive approach. Talking about future bail-ins in the wake of a contentious deposit grab can only make bank runs that much more likely. If you are going to recap these banks by bailing in creditors, you need to do so in a way that doesn’t create panic and contagion.
Part 2 of the interview is below for subscribers. Part 1 can be found here. Note, Buiter’s pessimistic view of capital controls in Cyprus at the end of this section and compare it to my comments when running through unilateral Cyprus exit scenarios last week. You can see that Cyprus already has a de facto national currency which will make their further existence in the euro zone untenable for more than a few months. If Cyprus does exit, it will be a model for others to follow.
Interview
What do you think of the crisis in the eurozone?
“That it’s still a mess. One learns very slowly and is not ready to take action fast enough. If there are still weak, shaky or zombie banks elsewhere, they will run straight away into financing problems. Now that there is a bail-in model, there must be rapid and coordinated action.”
And especially now that Dijsselbloem has broached this new approach?
“That was already clear by Cyprus. Even if he had not said it, it was clear that Cyprus was a laboratory. “
But was Dijsselbloem right with his statements?
“Absolutely. The Dutch are known to prefer being more direct than tactful. But he did the world a favor by saying this so directly. No one is denying it. They only says that Cyprus is unique; and that is true. It’s like Billy Bunter, a special child, and that’s it. But ultimately each country is special. “
Politicians can no longer wait to recapitalize banks?
“They must take action now. Not only in southern European countries, but in the whole euro area. There is no euro country without bank restructuring and recapitalization needs. And with all these banks, the new model should be used. Thus do we bind ourselves into a banking union.
Some people think that the new approach undermines banking union, but that is absolutely not the case. We get European banking supervision. The end of national banking supervision is a good thing, because that was disastrous. And with European supervision comes a resolution mechanism for the resolution of distressed banks. “
Even the remark Dijsselbloem that the emergency fund ESM (European Stability Mechanism) is no longer needed for bank aid doesn’t undermine the banking union?
“No, that’s mostly a hope that he is speaking to. If a systemically important banks is to be recapitalized through a bail-in, shareholders will be wiped out by dilution, because senior and subordinated bonds and maybe uninsured deposits will be converted into shares.
It is possible that even that is not enough. In that case, you go to the national taxpayer. Only if that were not enough, would the ESM comes into play. It is quite conceivable that Dijsselbloem is right that it would be very rare for the ESM to be used support banks. “
How long do policy makers have to solve the bank problems?
“It depends on how much damage they want to risk. If they want to minimize, they start immediately after Easter. “
What’s the damage?
“That all banks that are seen as potentially weak can no longer obtain financing. Then you get bank runs and a sudden stop on all market funding. Especially now that most euro area countries have almost no fiscal space to do their bank bailouts.
Look to the Netherlands, where households have mortgage debt of approximately €600 billion, as large as in Spain. Insane. Imagine that you need writedowns of 10%, then we are talking about € 60 billion. Add to that the likely losses on real estate – amounts that are large enough to increase those gaps. Banks cannot get market funding. And if they knock on Dijsselbloem’s door, he will not and cannot pay for that.
It would be disastrous for the creditworthiness of the Dutch government. This is no different in Germany and France. Both the fiscal space as well as the political acceptability for bank rescues without bail-in is no longer there. “
Is Europe creating zombie banks?
“They’re here already. It is only getting more acute. The zombies eat the living banks. Most banks are zombie banks. There is hardly any new lending to businesses and households. A zombie bank doesn’t lend more money even for good projects and that is in great measure already the case. “
With how much money should banks be recapitalised in the eurozone?
“The balance sheet of the banking sector in the euro area is € 38.000 billion. I think a sum between €1 and 3 trillion would be enough to de-zombify the banks and make them the finance engine of the real economy again.
A serious amount, but certainly attainable if the restructuring of the banking sector happens all at the same time and as quickly as possible using the same model. All three ingredients are necessary, otherwise it becomes a financial and economic disaster. “
What is the outlook for Cyprus?
“The crisis is devastating for the economy of Cyprus. There will certainly be more a contraction of more than 10%. The estimates of the troika are far too optimistic. Presumably, the ESM loan of €10 billion will be restructured through longer maturities and lower interest rates until it is zero. Private creditors of the Cypriot state will probably have to take a haircut. “
Will the euro survive with all of its countries?
“That depends on the developments in Cyprus, where restrictions are being imposed on capital outflows, as well as on savings and currency trading. This is totally incompatible with a currency union. De facto Cyprus is not part of the common currency. If it is temporary, you can get away with it.
But if it takes too long, it will be a way out of the euro. There will then be informal exchange rates between the euro and the Cypriot euro, a black market, all undesirable developments that we saw in Argentina. “
How long can that last?
“A few months. If it takes longer, Cyprus can not remain in the euro. “