Law forbidding bank bailouts could prevent future crises

Amendment should be passed to stop Government investment in banks

Bank of Ireland looks like showing a clean pair of heels to its own bailout. Photograph: Aidan Crawley/Bloomberg

Bank of Ireland looks like showing a clean pair of heels to its own bailout. Photograph: Aidan Crawley/Bloomberg

Tue, Dec 3, 2013, 12:03

It feels like a long time ago, but EU leaders once proclaimed that the link between sovereign creditworthiness and the banks had to be broken. Never again, it was hoped, would bust banks, even an insolvent banking system, imperil the financial standing of a nation state.

These fine sentiments have almost perished on the rock of German paranoia. The fear is, having shelled out billions to bail out Greece with more to come, German taxpayers must not be exposed to the risk, however, remote, of baling out any other peripheral reprobates.

There is some substance to these concerns. One day, a bill will be presented and someone is going to have to pay. It could well be the German taxpayer but I suspect other nationalities will be involved as well. There is a hope that European banks themselves will collectively solve this problem by contributing to a resolution fund. Until and unless that fund both exists and is big enough, the sovereign-bank link looks as unbroken as ever.

German worries are also based on a myth: to date, not a cent of German money has been handed over to bail out the Greeks. Or anyone else for that matter. That may change - it almost certainly will - but German generosity has stretched only to loans, not gifts (debt write-offs).

As banks slowly heal, or at least some of them do, concerns over another blow up that wrecks national finances are starting to recede. We measure this, as always, by looking at the behaviour of the bond markets. Irish government bond yields show no signs of any concerns whatsoever with the decision to go for a “clean” bailout exit or, more generally, with anything that lies on the horizon, including the results, due sometime towards the end of next year, of yet more bank stress tests.

Indeed, Bank of Ireland looks like showing a clean pair of heels to its own bailout. Cynics, including the grumpy Bundesbank, point out that one reason bond yields are so low is that the banks have been major buyers of those bonds. The Bundesbank loves to publish data that makes this point.

It is true that banks have been buying government debt. They dare not lend the money to consumers or businesses so it has to go somewhere. So the link between governments and the banks remains as tight as ever. Maybe causation in the next crisis will run from nation states to the banks; when governments default, banks will go bust, rather than the other way around as happened in our most recent debacle.

Whatever the direction of causation, banks still receive an implicit subsidy from the state, one that is extremely valuable to the banks. Of course, the no-bank-or-bond holder-left-behind doctrine is well known to us and we hope to get some of our money back, the explicit subsidy we gave to the pillar banks. What about that implicit, ongoing, gift to the banks?

Ahead of a fit for purpose banking union, is there anything an individual country can do to make sure that the next time a bank, or banks, become insolvent, the implications for national finances are minimised? I have one suggestion: pass a law, preferably a constitutional amendment, that stops any Irish government from ever again investing in banks. It wouldn’t be a difficult amendment to get passed. It could be the most popular thing the coalition does between now and the next election. Even if the only effect is merely symbolic, it would nevertheless achieve something. Closure, perhaps. Who would oppose it?

The (limited) deposit guarantee would remain place. So the next time a bank gets into trouble, it is shut down; depositors up to €100,0000 reimbursed, from the taxpayer if necessary; the loan book, whatever condition it is in, passed to a viable institution; bond holders and equity investors are wiped out. It’s called bank resolution and it does happen in other jurisdictions.

A law that forbids bank bailouts could help to prevent another crisis. It will change behaviour, at least in theory. If you know that there is no government safety net, you may not be quite so reckless.

Europe will have a fit of the vapours at the idea, which is probably another reason for trying it. But action to break the link between countries and their banks has to happen in one way or another. The EU may one day have a sensible resolution mechanism in place. Between now and then we need to get on with things and do what we can to build a rational domestic banking system.

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