A Comment on Jeroen Dijsselbloem And a Few Charts

Tough Guy Becomes Whipping Boy

To say that Jeroen Dijsselbloem 'ruffled feathers' as Der Spiegel does here is an understatement. It would be more precise to state that he has provoked howls of outrage and disbelief all around. Der Spiegel berates him for not being diplomatic enough. Allegedly he was also 'too rude with the Cypriots' (meaning the negotiators). And – horror! – he lacks the 'gravitas' of his predecessor J.C. Juncker, the euro-group's former self-confessed liar-in-chief. Only now can we see what an irreplaceable super-human bureaucrat Juncker really was. Woe betide us now that he's gone!

Can the euro-group even continue with a ruffian such as J. Dijsselbloem heading it, even though he has merely a 'ceremonial post' as Der Speigel assures us?

We like the guy better and better actually. If we disregard for a moment that the Cyprus affair could have been handled better and that the entire evolution of the problem there was not solely the fault of the Cypriot bankers but that the EU's broken promises played a prominent role as well, and if we further disregard that Dijsselbloem's often frank remarks may cause a bank run here or there for which the fractionally reserved system is ill-prepared, we are left to ask: what's not to like?

Take a look at an interview he recently gave to Bloomberg, or rather, the portion of the interview that many apparently regard as the height of euro-induced insanity (it is a bit lengthy, but do read on. It has its moments): 

“Q: To what extent does the decision taken last night end up setting a template for bank resolution going forward?

A: What we should try to do and what we’ve done last night is what I call “pushing back the risks”. In times of crisis when a risk certainly turns up in a banking sector or an economy, you really have very little choice: you try to take that risk away, and you take it on the public debt. You say, “Okay, we’ll deal with it, give it to us.”

Now that the situation is more calm and the financial markets seem to have become more steady and easier, we should start pushing back the risks. If there is a risk in a bank, our first question should be: “Ok, what are you the bank going to do about that? What can you do to recapitalise yourself?” If the bank can’t do it, then we’ll talk to the shareholders and the bondholders. We’ll ask them to contribute in recapitalising the bank. And if necessary the uninsured deposit holders: “What can you do in order to save your own banks?”

In other words, taking away the risk from the financial sector and taking it onto the public shoulders is not the right approach. If we want to have a healthy, sound financial sector, the only way is to say: “Look, there where you take on the risks, you must deal with them. And if you can’t deal with them, you shouldn’t have taken them on and the consequence may be that it’s end of story.” That is an approach that I think we should, now that we’re out of the heat of the crisis, consequently take.

I’ve tried to do so as far as I could in nationalizing the SNS bank in the Netherlands. We’ve completely wiped out the shareholders and the junior bondholders. We have to bring down the tab to be picked up by the taxpayers.

Q: What does that say for other countries in the eurozone that have very highly-leveraged banking sectors, Luxembourg, Malta even? Much larger than Cyprus’.

A: It means: deal with it before you get in trouble. Strengthen your banks, fix your balance sheets, and realize that if a bank gets in trouble, the response will no longer automatically be we’ll come and take away your problems. We’re going to push them back. That’s the first response that we need. Push them back. You deal with them.

Q: That sounds a whole lot like what people were suggesting before Lehman Brothers. They made a bad investment in Lehman Brothers; let it go down. And we saw what happened after that. Is there any risk that this change in thinking risks coming back to the ‘too big to fail’…

A: I think we have to realize before we come to a decision can we let a bank fall over, is it too big to fail, there are a lot of things that can be done. To start with, we should not waste any time in fixing balance sheets. Banks have to build up their reserves, have to become much more stable and strong within themselves.

Secondly, we need mechanisms to deal with risks in terms of: if a bank is in trouble, can you take out the bits you want to save and let go of the bits you don’t want to save, the “living will” approach.

Thirdly, if a bank does get in trouble, to who can we shift the account? Who’s going to pay for it? That’s what I was talking about just now, to shareholders, etc. Then there comes a point where you, as a government, may have to step in, but that should be the order. You take preventive measures, you make sure banks are more stable, more robust. If there still is a problem, you need mechanisms to address them, to pull banks apart, etc. You need to bail in those people whose equity is involved, etc.

Q: This is basically the [Michel] Barnier proposal [for a common EU bank resolution regime]. The priority seems to be removing that moral hazard.

Q2: Those proposals now look like they’re going to be delayed, I think, from Barnier. In a way, you’ve had a chance with Cyprus as a kind of test case, if you like. Does it feel like that?

A: Like I said, it’s very hard to do this if there’s a lot of nervousness in the markets and there is still a crisis atmosphere. Now that the crisis atmosphere is disappearing – we had a little upheaval last week after the levy discussion – but looking at it a couple of days later now, a week later now, the markets have really been very wise in responding to this whole levy thing. So now that the crisis seems to fade out, I think we have to dare a little more in dealing with this.

Q: It just makes me think of one thing, off the cuff, which has to do with the ESM [European Stability Mechanism] and the direct recapitalisation of banks. Does that change the kind of calculus in terms of how that is used going down the road? There have been suggestions it may never be used if you have fully-functioning bail-in systems. Is that what we’re saying?

A: I think that’s what we should aim at. We should aim at a situation where we will never need to even consider direct recap. The interesting thing of course that in the Spanish situation, because that where the demand for a direct recap instrument started, from the Spanish banking crisis. We are now dealing with the Spanish banking sector – restructuring it, recapitalizing it, bad bank, some bail-in – without this instrument. If we have even more instruments in terms of bail-in and how far we can go in bail-in, the need for direct recap will become smaller and smaller.

I can just repeat what I said. I think that the approach has to be: Let’s deal with the banks within the banks first, before looking at public money, be it direct recap or any other instrument coming from the public side. Banks should basically be able to save themselves, or at least restructure or recapitalise themselves as far as possible.

Q: Is that new philosophy, was it hard among the 17 [finance ministers], are there people who it’s been hard to convince this is the right approach?

A: Well, there is still nervousness, understandably, about can we pull it off, what will it mean in the financial markets, how will the financial markets react to the eurozone, to the financial institutions in the eurozone, etc.

That was one of the reasons why, last week, we didn’t go down the bail-in track [in Cyprus] but went down the levy track. Now we’re going down the bail-in track, and I’m pretty confident the markets will see this as a sensible, very concentrated and direct approach instead of the more general approach [of] let’s levy everyone to gather the money for the banks. So yes, that that is a sort of shift in approach.

Q: Is this something that you’ve sort of market tested, if you like, with the market? You’ve had a lot of feedback? You just said you feel very confident that the market will respond positively to the bail-in approach. Is that the feedback you’ve had?

A: You get two kinds of feedback. There’s the economic analysts that say this is a sensible approach, it makes sense. And then there’s more the investors’ reaction, who will say: “Look, we’re not to going to pay the tab, are we? If you do so, we will make our financing more expensive.”

My reaction would be: Maybe it’s inevitable that if you push back the risks, risks will be priced. Because if I finance a bank and I know if the bank will get in trouble I will be hit and I will lose my money, I will put a price on that. I think that’s a sound economic principle. And having cheap money because the risks will be covered by the government and I will always get my money back is not leaving to the right decisions in the financial sector, it’s not leading to the right risk management in the financial sector.

So there’s those two reactions from the financial markets: the analysts who are saying, let’s be real, this is a sensible approach, and the investors. My response is: If risks are going to be priced, then that is probably the right way to do it. It will force all financial institutions as well as investors to think about the risk they are taking on. They will have to realise it may also hurt them, the risks might come towards them instead of pushing them away.”

So, what exactly should one disagree with here? One may find the concession to the 'too big to fail' concept a bit troubling and his assertion that the absence of a market panic at the moment means one can tease the markets a bit may yet turn out to be misguided, but other than that, isn't he 100% correct?

That so-called 'Lehman moment' is always dragged up as a justification to bail out all and sundry, but people apparently forget that the stock market actually rose in the week after Lehman's bankruptcy was announced.

It started plunging a good while later, and there was actually a huge short term rally at one point between the Lehman bankruptcy and the crash, shortly after the SEC's shorting bans were issued. If one wanted to talk cause and effect, one might as well state 'the market crashed because of the shorting ban'. It's just as impossible to prove as the Lehman theory.

What Dijsselbloem is basically saying here is: “Let's try capitalism for a change. People who take risks should bear those risks. Let's leave tax payers alone.” It is surprising to hear a socialist say something like that, but perhaps Dutch socialists are different. More likely though he reserves his pro-capitalistic feelings only for this particular topic, but surely he is right: risk should be properly priced, and if all and sundry get bailed out at the drop of a hat, that's never going to happen. Maybe someone should mail him a copy of Human Action to wean him off whatever socialistic beliefs he still holds otherwise.

As an aside, the job of whipping boy was established in the 15th century in England. The whipping boy was assigned to a young prince and was punished instead of the prince if the latter misbehaved. This was done to avoid the problem that mere mortal tutors could not very well administer punishment to someone ordained by God to be king one day. The prince thus could only be punished by his father, who usually wasn't around at the decisive moments when punishment was deemed appropriate. And so they came up with the whipping boy.

The final negotiations with the delegation from Cyprus were held at the 'highest level', Der Spiegel informs us. Van Rumpoy, Barroso and Lagarde took it upon themselves to negotiate with Cypriot president Nikos Anastasiades, allegedly a snub to Dijsselbloem who had so 'poorly treated' the man from down South. We actually don't see in what way Anastasiades has profited from this change in debate partners, but there it is.

One thing is certain though: Dijsselbloem turned out to be the whipping boy for that trio of troikacrats. He's the one who got it in the press. In fact, when first thinking about the imminent vaporization of Russian deposit money, our initial reaction was to recommend that Dijsselbloem should get himself a bunch of fridge-sized bodyguards. After all, we hope for many more entertaining moments to be provided by the man.

Contagion Charts

There hasn't been a whole lot of contagion from Cyprus just yet, but there has been some. Below is a selection of our usual suspects charts documenting it. Readers should note that the color-coding is also visible in the price scales, which are dissimilar for the items depicted in the 4-in-1 charts. Many prices that are directionally aligned may actually be at wildly different levels. Not only Dijsselbloem, the dog and all of Cyprus got it this week:  a few CDS writers got it as well.

When country CDS are shown, these are for the sovereign debt of the countries concerned. Where this is not immediately obvious from the legend on the chart itself, we decipher the color coding in the comments below the chart.

As can be seen below, the fall-out is mainly confined to the more dubious (i.e., less creditworthy) CEE countries and the euro-zone fringe, as well as the European banks of course. 

5 year CDS on Bulgaria, Croatia, Hungary and Austria – Hungary and Croatia come under a spot of 'post Cyprus' scrutiny – click for better resolution.

Further in CEE-Land: 5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – Slovenia, which we discussed yesterday, sees its already somewhat elevated CDS spread spike again – click for better resolution.  

Our proprietary unweighted index of 5 year CDS on the senior debt of eight major European banks -the white line (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito), compared to 5 year CDS on the senior debt of Goldman Sachs (orange), Morgan Stanley  (red), Citigroup (green) and Credit Suisse (yellow). That looks like a 6 week high in our European bank CDS index. Potentially bad juju – click for better resolution.

Extras

Below follow two extra charts that have nothing to do with the Cyprus contagion, but which still strike us as interesting. The first is an update of the PBoC's open market  operations – as can be seen, the wild fluctuations have ceased for now, but somehow China's central bank seems to have become a bit stingy lately. We wanted to update that one as some readers were probably wondering what has happened following our previous comments on this time series.

The second chart shows US consumer confidence data as per the Michigan University's survey. Not an overly encouraging picture if you are waiting for US consumers to spend more money they don't have on stuff they don't need.  

The wild swings have ceased, but the People's Bank of China is still draining funds from of the banking system – click for better resolution.  

US consumites remain suitably traumatized by the sluggishness of the recovery – click for better resolution.