A costly but worthy Dutch treat: James Saft

February 5, 2013

Feb 5 (Reuters) – The Netherlands’ nationalization of bank
SNS Reaal underlines the euro zone’s weak spots while
illustrating the dangers of its plans to address them.

In wiping out SNS shareholders and some bond holders the
Dutch government is trying to do the right thing, can’t quite
bring itself to go that far, and may end up paying the price
anyway.

The Netherlands last week seized control of SNS, its
fourth-largest financial services firm, in a $14 billion rescue,
employing powers granted it under a new law passed last year.
While senior bondholders and depositors were sheltered, the
stakes of equity holders and subordinated bondholders were
effectively expropriated.

SNS, which had already received one state bailout, was
struggling under the weight of a large book of bad real estate
loans and was suffering strong outflows of deposits thanks to
worried savers.

First off, the news demonstrates that Europe’s banking
problems are far from over. Though optimists might argue that
the bad loans SNS was on the hook for were already well known,
the fact remains that the banking system across the euro zone
and beyond is still struggling under the weight of bad lending
decisions made before the crisis hit.

Secondly, SNS shows that taxpayers are going to continue to
foot a hefty bill. The Dutch government’s share of the bailout
is nearly $5 billion, poking a sizable hole in the country’s
budget plans. That could have been higher, but for a $1.35
billion levy to be extracted from other Dutch banks in 2014 to
help meet the cost of the bailout, as well as the forced
contribution of investors.

The farthest-reaching implications of the nationalization
may come from the Netherlands’ decision to put subordinated
bondholders on the hook for what will almost certainly be a
complete wipeout of their investment. This has already started
to ramp up what banks in the euro zone must pay to borrow money.

The bank bailouts at the height of the crisis spiked
widespread, and justified, revulsion among taxpayers, who
resented shelling out while investors who took foolish risks
emerged largely unscathed. The Dutch Intervention Act, passed in
2012, was an attempt to rectify that, giving the government more
wide-reaching powers and options for dealing with ailing banks.

In fact Jeroen Dijsselbloem, Minister of Finance, considered
including senior bondholders in the expropriation, but blanched
at how such a move would be received by financial markets.

“Theoretically, even more creditors of SNS REAAL and SNS
Bank might have been expropriated, that is, creditors on an
equal footing with depositors: the ordinary creditors,” he said
in a letter to parliament explaining the move.

“This includes uncovered bank bonds, also known as ‘senior
bonds’. This option was dropped, however, because of expected
adverse effects on financial stability.”

In other words, had the Netherlands made senior bondholders
pay, other investors would have fled the bonds of other banks,
potentially forcing some to their knees. That Dijsselbloem is
the newly minted head of the Eurogroup of finance minister, and
as such will play a key role in the debate over banking
regulation, makes the move that much more significant.

SENIOR BONDS UNSCATHED

Addressing the moral hazard issues embedded in the global
banking system is an important and worthy thing to do: it is
also going to be expensive. When bank investors believe they
will get the upside and the public will pick up the losses,
they, and the banks they lend to, will ramp up risk recklessly.

On the other hand, when you condition investors to believe
in their special status and then start to remove it, they get
cranky. This can most clearly be seen in the performance of the
bonds of European banks, which has been pretty poor for the past
month, particularly since the SNS affair was announced.
That’s particularly true for subordinated bonds, but the higher
funding costs have also bled over into senior debt.

This is one of those times when fixing the problem involves
unavoidable near-term pain. Investors need to be taught that
they will share in the losses, as well as gains, which their
funds generate. As this sinks in, this will cause the cost of
capital, debt and equity, for banks to rise, leaving them less
able than they already are to make loans and otherwise play
their economic role.

That’s not what the euro zone economy needs right now, but
the alternative, a system in which taxpayers insure private risk
taking, is even less acceptable.

The Netherlands, in punishing some bond holders and sparing
others, tried to steer a middle course, establishing the
principle but hoping not to scare investors.

Investors, to judge by the bond markets, are figuring this
out anyway. Expect bank financing costs in the euro zone to
rise.

If this happens little by little, it will be a success.

If it happens all of a sudden, watch out.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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