EU ministers to punish banks, while still obligating them to make stupid investments

EU finance ministers have made a right decision to move the losses of banks to shareholders and creditors. Anyway they have left some options for losses for taxpayers that make the decision not clearly capitalistic.

The main purpose of the new rules is to protect government budgets from losses from enormous bailout plans for troubled financial institutions. But the decision fails to address one of the main reasons for bank troubles – the governments themselves. For instance the Cyprus bank crisis was a direct consequence of the Greek debt crisis. Greece stopped paying on its debt and Cyprus banks that have invested in this debt were hit by enormous losses. This happened after for years exactly the government debt was considered the most secure and low risk asset. And Greece as “A” and up credit rating country (according to official credit ratings, while using my formula it was much lower – CCC - exactly where is for instance also the current USA rating), that was also an EU and Eurozone member, so Greece looked a very reliable debtor. So Cyprus banks cannot be blamed on “bad” investments. But their problems started and ended with the Greek government debt.

There is also an argument more. While politicians, in a right decision want to protect taxpayers from losses, at the same time they are pressing the banks to invest in government debt. Banks are deeply politics dependent, some of them being directly owned by the state, and even the private ones – under a strong regulation. Banks are obliged under many laws to invest serious parts of their assets exactly in government bonds. They are not free to decide whether they will buy bonds. They must buy bonds, declared by the laws as an absolute secure investment. The same is in force for pension funds. So the owners of the money and the managers of others’ money (banks) are not free in their decisions. And some of the obligatory decisions are towards the government debt. So in short, politicians make banks invest in government bonds, then the government goes bankrupt, banks take losses, and politicians decide these losses are for banks’ shareholders. Doesn’t this look like a robbery?  An absolutely legalized robbery using the power of law.

The right decision is to free banks from obligations to finance the government, and the government itself to cut its costs and remove deficits. It is funny to obligate someone to invest in something and then to blame it for losses.

With the current regulation, it is obvious it becomes less attractive to be a bank shareholder. At the same time politicians rely much on increasing the capital base of banks to make them more stable and strong. But who will invest in banks that will be blamed for everything and will be pressed to pay all the losses, including politically imposed ones? So the interest in buying bank shares will decrease and recapitalizing banks will be more difficult.

There is a problem more with the banks-government-default system. It is the level of interest rates on government bonds. As is known in theory, in the interest rate must be calculated a risk premium responding to the risk of the relevant bonds. But at the moment the interest rates on government bonds are artificially pressed down by Central bank interventions. ECB (and FED and BoJ too) print money, buy bonds and keep the rates down. So in these rates (for instance – 2-3% for USA and Germany and 4-5% for an extremely problematic country like Italy) cannot be involved a real risk premium. So this deprives investors of one of the market tools to manage the risk and insure the investments. So they can rely only on the “honest word” of the government. And there is no perspective this to change, as to allow higher and market interest rates, politicians will have to lower their spending, I.e. to implement serious cuts.

So EU finance ministers are thinking in the right direction, but thinking only on a small part of the problematic area. The result cannot be something more than a partial decision and even – risking to lead to a bad overall outcome.

June 27th 2013

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