ready to short the euro, Eurozone banks’ equity and their subordinated debt. That was the advice contained in a note from David Roche’s Independent Strategy emailed out last night – and no wonder. Yesterday saw another outing of Merkozy, that fabled two-headed Franco-German super-politician. Some people got quite excited about the October deadline they conjured up in their statement; but the two leaders offered no details or substance. The problem is that the time for promises and prevarication has long since ended in the Eurozone, as Dexia’s bailout and dismemberment shows only too well.
For the past few years, economists and regulators around the world and especially in the UK have been working on various bail-in, living will and special resolution schemes, all mechanisms to allow banks to fail in an orderly manner while hitting bondholders and protecting taxpayers. Sadly, even though the Eurozone was also meant to have been working on such a plan, no progress has been made. Dexia, a bank born out of continental corporatism (one of its founding components was a French government bank; it specialises in local government finance; its former chairman is a former Belgian prime minister; and so on) is being bailed out in the worst possible way. It is a rerun of the past few years – and it will have disastrous economic, commercial and ideological consequences.
As for the Belgian government’s solvency, this could well be the straw that breaks the camel’s back. Belgium’s credit rating was already put on negative watch by Moody’s on Friday; a downgrade looks inevitable. France too is under pressure. A 40 per cent write-down of the assets held by the new “bad bank” could boost Belgium’s debt to GDP ratio from around 100 per cent to 112 per cent, according to Independent Strategy. It is easy to devise scenarios under which the Belgian national debt shoots up even higher, tipping that already troubled nation into a group that includes Mediterranean nations such as Greece or Italy.
The danger is that when investors digest the magnitude of the Dexia costs to France and Belgium, and extrapolate to other banks across the Eurozone, they will suddenly realise that the potential size of the bailouts could be much greater than the usual numbers suggest. The bailout, far from “ring-fencing” Dexia, could actually trigger increased contagion. Will it really only cost €200bn or so to recapitalise Eurozone banks to allow them to survive regardless of how bad the sovereign debt crisis becomes?
It is imperative, however, that we don’t fall into the same trap in the UK if the crisis were to spread to these shores. Bailouts (in the sense of state provided equity capital or implicit or explicit guarantees for bondholders) must be a thing of the past. If another UK bank hits the rocks as a result of the Eurozone crisis, the UK authorities must force through a bail-in by turning senior unsecured debt (and possibly also other kinds of liabilities) into equity. On top of their equity buffers, all the big UK banks have much more loss-absorbing capacity that could be used to protect taxpayers and allow the banks to recover. Sure, it would be bad news for senior creditors – but it is their turn to take a hit. George Osborne’s motto must be simple: no more bailouts. We’ve already lived through enough of our own Dexias, thank you very much.
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