The Dijsselbloem Principle

By Felix Salmon
March 25, 2013

If a gaffe is what happens when a politician accidentally tells the truth, what’s the word for when a politician deliberately tells the truth? Dutch finance minister Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts.

Those comments are now being walked back, because it’s generally not a good idea for high-ranking policymakers to say the kind of things which could precipitate bank runs across much of the Eurozone. But that doesn’t mean Dijsselbloem’s initial comments weren’t true; indeed, it’s notable that no one’s denying them outright.

Dijsselbloem’s interview can be summed up simply: we’re not bailing out banks any more. Instead, we’re going to let them fail.

When a European bank runs into difficulties in the future, under this view, the EU is not going to help bail it out. Instead, it will go down a list: the bank’s executives come first, then its shareholders, then its bondholders, and finally its uninsured depositors. All of them will take losses before the national or European authorities step in with bailout money.

In principle, this makes perfect sense. Given the choice between Ireland and Iceland — between guaranteeing all bank creditors, on the one hand, or just letting the banks fail, on the other — the latter seems to inflict pain where it’s warranted, on irresponsible lenders, including foreign lenders, rather than on the country as a whole.

What’s more, what you might call the Dijsselbloem Principle does help to remind people that depositors are creditors, and that when you deposit money with a bank, you’re lending that money to an entity which might not pay you back. Deposit insurance is basically a government guarantee backstopping that loan: if the bank can’t pay you back, the government will. But deposit insurance is only there for insured depositor — it can’t mission-creep its way into backstopping uninsured depositors and even the bank itself.

Such a principle would have consequences, of course, both intended and unintended. Paul Murphy provides the requisite parade of horribles:

It’s a direct call to depositors across the eurozone — retail and corporate alike — to move cash now and spread it across a portfolio of the largest available banks. It’s direct advice to dump bank debt. And it’s a direct invitation to speculate that the EFSF, the ESM, and the rest of the alphabetic bailout soup is going to be discarded in favour of calling on depositors’ money across the Continent.

Much more unnerving than the potential future consequences of the new policy, however, was the immediate reaction of bank stocks to Dijsselbloem’s comments: the Euro Stoxx Banks index fell almost 4% on his comments.

Which brings up what you might call the Other Dijsselbloem Principle: you can do anything you like, just so long as it doesn’t spook the markets. This was the crucially-important background to the negotiations between Cyprus and the EU: the Europeans were emboldened to be tough on Cyprus by the fact that global markets seemed utterly unconcerned about what was going on in an economy which accounts for about 0.15% of European GDP, and shrinking.

After all, anything that the Eurogroup did in Cyprus would have set a dangerous precedent somehow, even if they had simply capitulated and agreed to a full €17 billion bailout of both the sovereign and the banks. We still don’t know what kind of capital controls Cyprus might impose on its banks when they reopen for business in the morning: those controls ensure that a Cypriot euro is not fungible with a German euro, and as such represent Cyprus’s first steps towards fully-fledged exit from the eurozone.

Indeed, for all that Dijsselbloem’s comments caused the most immediate market reaction, traders with a slightly longer-term time horizon would do well to pay attention to the real powers in Cyprus: people like  lawmaker Nicholas Papadopoulos, Nobel laureate Christopher Pissarides, and even Archbishop Chrysostomos II, the head of the Cypriot Orthodox Church. All of them are talking openly about exiting the eurozone — the one degree of freedom which Cyprus really has, now that the Troika has imposed austerity, bank resolution, and everything else onto the island from above.

Think about it this way: exiting the euro is a bit like the US hitting its debt ceiling and defaulting on its Treasury bills. Both of them are meant to be unthinkable, impossible. But both of them are thought about at length, and entirely possible in theory. What’s more, the opportunity is always there. No country has exited the euro in the past, just as the Treasury has not defaulted in the past. But even if the probability at any given point in time is small, over a long enough time horizon it still grows. And right now, the probability of a country exiting the euro is not small: no country has ever been more likely to exit than Cyprus is right now.

Dijsselbloem’s interview today was undoubtedly a prime piece of political incompetence: there’s no reason at all for anybody in the Eurogroup to be drawing broader lessons from Cyprus at this point. The market can speculate about the Cypriot precedent all it likes; it behooves no politician to to be clear about what they think it means, least of all the Eurogroup president. Maybe, in a few months’ time, when the Cyprus chaos has died down, the EU could start putting out extremely long and dry papers about what has been learned from Cyprus, along with a detailed look at the costs and benefits of letting banks fail rather than bailing them out. But if you’re making policy on the fly in Cyprus, the last thing you want to do is turn that cobbled-together precedent into something semi-binding on the rest of the continent — whatever the policy might be.

Still, the toothpaste is out of the tube now, and the traders selling off bank shares were acting entirely rationally. The chances of European banks being allowed to fail are higher now than they were pre-Cyprus. As a result, we should expect uninsured deposits to continue to flow from the periphery of Europe towards the center. Which in turn means extra pressure on Italian and Spanish banks, just when it’s least needed.


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Felix: Please explain to me why it is reasonable to hit the BoC deposit holders for the ELA funds lent to Laiki. It’s all well and good to argue that depositors are also creditors, but they are generally considered most senior, and it is only through gimmickry that ELA funds are senior to deposits, never mind senior to deposits held at other banks..

Posted by Foppe | Report as abusive

Why do you think the guy is incompetent?

Look, you have the situation that the banks in the North are also under water and it is clear that the Eurozone cannot survive on the long term, given that now 5 out of 17 countries have already been bailed out.

So, how do you prepare yourself, as a Minister of a Northern country for what is coming?

How about “accidenty” causing a bank run in the South?

Sure, quite a lot of money will dissapear elsewhere, but quite a lot will also head North. And now that it is clear that the Northern countries will no longer just bail anyone out, this may turn out te be not too stupid after all. IF indeed a significant part of the southern money heads there where I would want it to be if I were to make such a “mistake”…

Posted by lamare | Report as abusive

And this no matter how quick he turns back on his words will have dire consequences.

Now all the inhabs in Europe cannot longer trust that their money is safe in the bank.

Do not underestimate that small savers make up the bulk of the banks capital.

I,m quite sure that this renegades comments will cause a bankrun all over Europe.

Posted by lyingdutchman | Report as abusive

> Dijsselbloem’s interview can be summed up simply: we’re not bailing out banks any more.

I thought it was closer to “We’re not bailing out the first bank.” As long as some reasonable separation can be created between “episodes”, this seems like a reasonable compromise between the moral hazard problem and the crippling financial disaster problem; you say “the next time a big bank goes under, all other big banks will be backstopped for a sociable amount of time thereafter”, whereupon creditors don’t have to worry, as the disaster approaches, that all of the banks are going insolvent; they just have to be sure to stay away from the worst one.

It’s an elegant solution, especially in theory. I’d hate to let practice get in the way of that.

Posted by dWj | Report as abusive

It is good that the other tax havens have to start sweating after Dijsselbloem’s candid statements, not in the least that of his predecessor Juncker. Tax havens, like The City, do and have done enormous damage to the world economy.

Posted by johaster | Report as abusive

Cyprus is a unique case… the pro-gov EU had little interest in bailing out the untaxed earnings of Russians.

The model for fixing bad banks is exactly what we did in the U.S.

Step 1 you kill the equity of the worst actors like Bear (90%), Lehman (100%), Wachovia (I forget but I think 100%)

Step 2 you “save” the other too big to fails. By save I mean fire all of the top executives force them to accept hugely dilutive equity and kill the common dividends.

Step 3 you fine the survivors for tens of billions of dollars as they begin to recover. Someone add up what we’ve extracted from BofA, Citi, Wells, MS, Goldman, and JPM. Count the equity, the GSE pushbacks, the servicing settlements, the loan mod commitments. I’m pretty sure you’re most of the way to 50 billion in extracted wealth… with a bit more to come I’m sure.

Too big to fail is still an issue but 48 months after the crisis trough our banks are the strongest in the world and both the FED and the Treasury are cash positive from their rescue involvement (I am NOT including the GM/Chrysler money.)

Posted by y2kurtus | Report as abusive

Felix, what you call the Dijsselbloem Principle, I call ordinary bank capital ladder. All that Dijsselbloem is doing is pushing back on this notion that we have gradually come to accept over the past five years: that banks have to be saved by the taxpayer, no matter what.

While there is systemic importance, TBTF and so on, we have definitely overshot the goal a number of times in the past years when shareholders and bondholders escape relatively unscathed while billions of public funds get handed over for a bail-out. Why were Citi’s depositors not hit harder? How come RBS is still listed? Why did preferred shares of the likes of ING happily continue paying dividends even as the bank went cap in hand to the government for a capital injection? Why were AngloIrish bondholders treated so kindly?

What Dijsselbloem is doing puts at least some of the risk of bank restructuring back where it belongs: with the shareholders and bondholders who stand to profit when things go well. And he has made it clear that the depositor participation is an ultimate measure, only to be used in extremely messy circumstances, like the Cypriot banks.

And indeed, even though there are fair share of troubled banks in Europe, you’d have to look long and hard to find another example of the level of undercapitalisation and bloatedness that was Laiki/BoC. Surely you’d agree that it would not be ok for a bank to fund itself with large swathes of deposits by offering high interest rates, minimal equity and other capital (because investors smell the rotten fish from afar), drive a business model on this, and then expect the government to pick up the bill once the house of cards collapses.

If by putting the risk back where it -largely- belongs, we spook bank shares and ‘the markets’ – so be it, for that is what the market should be focusing on: pricing the risk/reward potential accurately. A perception of willingness by authorities to always rescue banks from themselves is moral hazard in its most elementary form and will end in teats sooner or later anyway, even if it is only because of gross risk mispricing in such circumstances.

Posted by JohnHill | Report as abusive

Mr Dijsselbloem is right. Regardless of the consequences.

Posted by bv36 | Report as abusive

It’s important to remember that this global economic crisis is COMPLETELY MANUFACTURED.

Posted by greydogg | Report as abusive

Who would have thought we’d be looking back wistfully at the days of Jean-Claude Juncker?

Regardless of whether the Cyprus situation is the new paradigm, you can’t deny that Dijsselbloem has botched the PR aspects of the job.

Posted by MWellerGFT | Report as abusive

y2kurtus, you must work at a TBTF bank or on wall street or just be in general an apologist for the banksters, because what you wrote isn’t even remotely what happened in 2008 and 2009. What you wrote is so unhinged and detached from reality that it’s almost not worth responding to.

In the U.S., we didn’t “fire all of the top executives” except in the case of GM, which of course you aren’t including in your universe of discourse. All of the top executives at the banks which were rescued indirectly from the 100% bailout of AIG, for example, were left in place.

Vikram Pandit was still there at Citi after the bailouts up until very recently.

The CEOs of JP Morgan Chase and of course, most notoriously Goldman Sachs are still there, in place.

Posted by Strych09 | Report as abusive

This type of blog annoys me. I have the impression that the parasitic part of the banking system can only survive because as soon as someone really says what is going on, he is called “incompetent”, by some blogger. Oh, we have to be so careful, as to not hinder these bankers in their freedom to take risk that destroy the economic backbone of entire states and not to restrict the market in any way, because else we are immeditely punished and pummeled by the media. Short-term fear makes a real solution impossible. It is of course quite sour for some people that the limits of the system are in sight.

Posted by Vrijhoeve | Report as abusive

@Strych09, I work at a mutual savings bank (no stockholders public or private) with 265 employees. I work at one of the banks who pays into the FDIC fund every year never to draw on it. I work at one of the 5,000 strong small banks now paying the price (as we should) for the horrible actors at the TBTF banks.

I’m man enough to say that you are right, the CEO of GS is still in place. (Lehman, Bear, Citi, BofA, MS, Wachovia, are have all been ousted… yes with golden severance but outed just the same.)

Lets see if you are man enough to admit that I am right about at least some of the things I wrote. At a minimum that most of the TBTF’s have new management in place, that the equity holders of Wachovia, Lehman, Merril, Countrywide, & Bear were wiped out entirely or almost entirely, and that at todays market close BofA and Citi are still looking at losses of 70 and 80% from 5 years ago. (take a peek at their 5 year charts to verify that.)

JPMorgan stepped in to rescue the national banking system in 1907. The bank that carries his name stepped up to the plate again in 1998 to backstop the Longterm Capital Management failure. When the world was burning again in 2008 the Fed called upon the house of Morgan again to ride to the rescue. Yes the JPM minions are well paid but if you think a bunch of government workers were going to work 80 hours a week for a year unwinding the unholy mess… well than we’ll just have to agree to disagree.

I consider myself one hell of a patriot but there is EVERY INDICATION that this nation will fall before the house of Morgan.

Posted by y2kurtus | Report as abusive

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Posted by traducere romana daneza | Report as abusive