Is the bank bailout free lunch coming to an end? While I would not hold my breath, given that financiers have proven quite skilled at watering down proposed reforms to thin gruel, a story from the Financial Times indicates that Eurozone leaders are no longer willing to give banks handouts with no strings attached.
It appears the banks are about to be hoist on their own petard of pushing austerian policies. If the populations of Greece and Ireland are expected to suffer the aftermath of a debt binge, why shouldn’t banks who are revealed to be bust or too undercapitalized to be competitive be subject to similar belt-tightening, downsizing and unpleasant changes in how they operate?
Per the FT:
In draft guidelines, seen by the FT, for the operation of the enhanced European financial stability facility, EU governments say a “planned restructuring/resolution of financial institutions” is “the sine qua non condition” for assistance
The article continues by observing that the banks intend to retaliate by shrinking their balance sheets instead, which is code for cutting lending. They would presumably do that by letting existing loans roll off. This is blackmail, and it would be nice if the media named and shamed the bankers making these threats.
But the conundrum is that the banking sector is too large relative to the real economy, so having it downsize is a desirable outcome. But without some from of government deficit spending to offset the depressing effect of the reduction of credit, the deflationary forces in Europe will only get worse.
Notice too how the banks hold the real economy hostage, and make no mention of cutting their own pay levels as part of the effort to shore up bank balance sheets. I don’t have comparable figures for Europe, but in the US, in the post war period prior to the 1980s, compensation in the financial services industry ranged from 99% to 108% of average worker wages. On the eve of the crisis, it was 181% of average worker wages. Given how well incomes in the banking industry have held up, thanks to the tender ministrations of Hank Paulson, Timothy Geithner, and Ben Bernanke, if anything the divergence has probably widened. I suspect bank employees in Europe are similarly paid better than average workers, although the gap may not be as large.
It is not at all clear how this power struggle will play out. French banks are widely recognized as being among the first candidates for rescues, yet the French government is now taking the line that the banks are earning their way out and will get assistance if it proves necessary. But bank executives have this funny way of denying they need help until it is too late.
Update 3:30 AM: Reader Swedish Lex in comments clarifies a point that was not made explicit in the Financial Times article, that the Eurozone treaty prohibits governments providing permanent subsidies to private companies, and it would be hard to deem a bailout to be “temporary assistance” which is allowed in certain circumstances. This means the toughmindedness is not the result of politicians developing unexpected nerve, but of recognizing there is no way around the existing constraints given how soon weak banks are likely to get in real trouble. Per Swedish Lex:
Under the EU Treaty, EU Governments are not allowed to subsidise companies in ways that distorts competition in the EU. To this main rule, there are numerous specific conditions, exemptions and libraries full of case law.
Governments are allowed to hand out temporary subsidies to companies and industries that are facing acute problems. Temporary subsidies cannot become permanent support, however. A specific scheme for state aid to the banks was developed at the financial crisis.
Governments can thus not subsidise the TBTF on a permanent basis on conditions that are different from what a normal investor would have done. Since no private investor would be prepared to recapitalise the European banks with a few hundred billion, without getting full control and the complete (or almost) potential upside for such risky investments, bank defaults with immediate nationalisation would have to follow. Existing shareholders and management’s options would have to be wiped out, or almost, or be so much under water that bank managers would have to work until 80 to be in the money.
If governments decide to ignore the Treaty, there would be challenges in the courts that could take years and that would create huge amounts of uncertainty as regards the legality of the TBTF’s capital base. Hardly a position that the EU and the governments would like to find themselves in these days.