Colm McCarthy has some trenchant remarks on Mr Sarkozy’s recent populist speech:
Category: European economy
Paul Krugman has a thoughtful survey of the Euro crisis in this week’s New York Times Magazine (forthcoming on Sunday but available on-line now). This is not stockbroker-economist-type research, which tends to be long on buzzwords and hyperbole. It is a well-reasoned feature-length review with some policy suggestions. It has a central focus on Ireland and the other troubled peripheral states.
Just arrived in my inbox, a link to this IMF article, containing the following paragraph:
Meltdown avoided
It is too early to pass final judgment on the success of the Baltic strategy. Adjustment is still far from complete, and the current problems in the eurozone may yet complicate recovery. What is clear, however, is that the most dire predictions have not come true. Despite an unprecedented economic downturn―cumulatively, GDP has shrunk by about a quarter―devaluation and banking crises have been avoided.
So they’ve lost quarter of their GDP but a meltdown was avoided? I guess this shows that the definition of a meltdown is in the eye of the beholder.
The European Commission has released a “working document” that “seeks views on the technical details of a possible EU framework for the management of failing credit institutions and an appropriate class of investment firms.” There’s a press release here and an FAQ here.
The document contains a lot of sensible proposals that would lead to a common future European approach to dealing with failing banks, in contrast to the chaotic and disorganised approach that was seen during 2008-2009.
There’s plenty in the document worth discussing but, given the particular focus of this blog, it is clear that the most interesting aspect of the document is the annex starting on page 86 titled “Debt writedown as an additional resolution tool”. It’s worth reading in whole but here’s the basic idea:
Thus, to provide additional flexibility and to ensure that any write down power is sufficient to deliver the policy objectives, this consultation outlines two possible models for additional write down powers. Building on the minimum powers above, the first ‘comprehensive’ approach aims to make a broad range of senior creditors face the real risk associated with bank failure. The second ‘targeted’ approach aims to create a more focused tool for resolving in particular, institutions which have been assessed as likely to prove difficult to resolve with traditional resolution tools at a time of fast moving idiosyncratic or systemic crisis.
Resolution authorities could be given a statutory power, exercisable when an institution meets the trigger conditions for entry into resolution, to write off all equity, and either write off subordinated debt or convert it into an equity claim. However, in some cases this will not be sufficient to ensure that an institution in difficulty returns to viability so as to maintain market and creditor confidence when the markets next open. (For example, RBS’ balance sheet at the end of 2007 contained £38bn in subordinated liabilities, while losses before tax in 2008 amd 2009 amounted to around £43bn.
As is de rigeur these days the Commission argues that “Such a power would only apply to new debt issued (or existing debt contracts renewed or rolled over) after entry into force of the power.” In other words, existing European senior bank debt cannot take a haircut in this way.
However, the problem with this argument, as well its sovereign cousin (the idea that only post-2013 sovereign debt will be open to restructuring) is that it is subject to what economists call time inconsistency. As described by Wikipedia, “time inconsistency describes a situation where a decision-maker’s preferences change over time in such a way that what is preferred at one point in time is inconsistent with what is preferred at another point in time.”
Today, Europe has lots of troubled banks and some troubled sovereigns. Ideally, the powers that be would like financial markets to not worry about being defaulted on and to keep lending to these banks and sovereigns. No agreed EU resolution regime for banks or sovereigns is in place, so the authorities would like to reassure current lenders that they will be safe when such a regime is put in place and that it is future lenders who will take the hit.
However, when the future arrives, it becomes the present and future senior bank bond investors will consider a regime in which only they are subject to a resolution regime involving selective haircuts as totally unacceptable.
The time-inconsistency of the current sovereign debt proposals are clearly recognised by sovereign bond markets, which are pricing current Irish and Greek government bonds at yields that clearly indicate the likelihood of default. For banks that are already in trouble, it seems unlikely that these proposals will really comfort bond investors that they are genuinely safe from getting haircut by a future resolution regime.
Hans-Werner Sinn provides a provocative assessment of the current crisis in Europe here. His take on the recent robustness of the German economy is novel. The slides are particularly entertaining though not always flattering to Ireland.