Recent decisions on the Icelandic and Irish banking work-outs and the impact of Eurozone decisions call into question fundamental issues of moral hazard, shareholder risk and common sense. This is seen in recent decisions concerning Landeskanki of Iceland and Allied Irish Bank of Ireland.
On January 28th, the Financial Times reported (Iceland triumphs in Icesave court battle) that the court of the European Free Trade Association (EFTA) ruled that the Icelandic government's decision not to reimburse Dutch and British Landesbanki Icesave depositors using national resources, but with the liquidated resources of Landesbanki, was upheld.
In part, this was due to the fact that the liquidation process has paid back over 90% of the minimum deposit guarantee:
In any case British and Dutch governments are still likely to get most, if not all, of their money back. Landsbanki's estate has already paid back IKr585bn ($4.6bn) of the IKr1,166bn claims from Icesave, equivalent to more than 90 per cent of the minimum deposit guarantee that the two governments were obliged to pay. … It intends to repay the full amount but will only pay interest for about six months, because of an Icelandic supreme court ruling, rather than the full length of time that the two governments demanded.
It is instructive to contrast this with the recent European Central Bank decision on the cost of bailing out Anglo-Irish Bank to the Irish government as reported by Reuters on the same day (Insight: Irish banks at mercy of international paymasters).
The government had made a very modest proposal of converting a promissory note issued at the height of the crisis for underwriting Anglo-Irish with the issue of long-term government bonds. This restructuring would improve the loan term, reducing the EUR 3.1 billion the government is currently spending per year on the note. Ireland's 2012 GDP is estimated by Eurostat at EUR 162.3 billion, so this promissory note amounts to 1.9% of 2012 GDP.
As reported by Reuters, the ECB rejected Ireland's preferred solution for restructuring the cost of propping up Anglo Irish because it amounted to "monetary financing" of the government.
This is extremely ironic, given that the ECB's EUR 1 trillion Long Term Financing Operation (LTRO) to private banks was extended with the precise objective of monetary easing.
As reporting previously (Navigator, Eurointelligence, FT Alphaville), a significant part of LTRO was precisely invested by private banks on sovereign debt. This implies that the low-cost LTRO funds (1%) was re-invested in higher-yield sovereign bonds, resulting in indirect "monetary easing" as well as a significant carry trade interest for the banks.
This contrasting approach, which is currently being implemented in Cyprus, calls into question a number of issues:
· When and under what conditions should a government, and by extension the citizens of a country, be made responsible for the mistakes of a private bank?
· What special interests have been served (primarily by European banks over-exposed to bad loans in other countries) in the current Eurozone bailout and LTRO approach?
· Who has paid more in the European banking crisis: bank shareholders and bank management? Or citizens and taxpayers?
· At what point does European monetary policy and European competition policy contradict common sense in financial restructuring? (And how many years ago was this point passed by?)
These recent decision illustrate more than the technical issues such as bank deposit insurance or bank regulation in the Eurozone or European Union. They illustrate a very real problem of regulatory capture and embedded moral hazard, as well as the total immunity of bank managers and government officials responsible for regulating banking as well as sovereign debt.
It should come as no surprise if popular anger and dissatisfaction at the "democratic deficit" of Brussels and Frankfurt continue to rise, and increasing numbers of European citizens and voters become fundamentally disillusioned with the idea of sharing national sovereignty any further.
© Philip Ammerman, 2013