It's only 'moral hazard' if it costs Europe
Resolving a bank that’s about to fall over is all about forcing losses on bondholders and protecting essential functions. Sovereign resolution seems to be about the opposite.
Europe bailed out its banks multiple times over. The biggest round was in 2008, but thanks to serial offenders like Dexia and Bankia, the wave wasn’t over until 2013. Now, following the passage of the Bank Resolution and Recovery Directive, this will Never Happen Again (we hope).
It has also bailed out a good few of its sovereigns — Greece, Cyprus, Portugal, and Ireland have all suffered the indignities of EU sponsored loans, along with structural adjustment programmes of various levels of savagery.
But since then, the ideology of bail-outs has gone in opposite directions.
In the banking world, policymakers have made it clear time and again that burning the equity is no longer enough.
If a bank is going to fall over, creditors must feel the pain too. So far, this has mostly applied to subordinated bondholders, but from this year, senior creditors must take a write-down as well. Big and small banks across Europe have to show they have a sufficiently large buffer of wholesale term debt which can absorb losses if need be.
When a bank does go down, regulators step in to make sure essential services still function. Employee salaries, pensions and benefits are super senior; so are certain derivatives trades.
But the opposite seems to be true when European authorities try to resolve a sovereign. There, the ideology of bail-outs is still about making sure creditors get their money back, if not upfront, then with an acceptable grace period allowing everyone to pretend it is still worth par.
Far from maintaining the essential functions of a state, the response of the European Central Bank — the very institution which will lead the resolution and write down creditors of a bank — has been to shutter essential services in Greece, capping liquidity provision, perhaps in the hope of forcing compliance on a recalcitrant government determined to restructure its debts.
The justification for burning bank creditors as well as shareholders in a bank resolution is avoiding moral hazard, whereby bank creditors can lend money to banks with impunity, knowing they will be bailed out by the state if their credit judgment was poor.
Oddly enough, the same combination of words has found currency in the Greek sovereign crisis to justify paying back creditors in full (or at least, sticking to the conditions of the 2012 bail-out). New bail-outs will encourage other states which wish to write down debt.
The role that creditors, private or official, play in lending imprudently is maximised when they are creditors of banks, but minimised when it comes to sovereigns.
For both categories of borrower, their cost of debt has been subsidised by being part of a larger institution. For Greece, this came as part of the package of eurozone membership, and having its debt bracketed with other sovereigns as risk free for banks to hold. For the bigger banks, it is the too-big-to-fail subsidy, the market’s belief that banks will be bailed out (meaning bank creditors will be paid back).
But while the European leadership deplore the implicit subsidy for bank debt, they are doing their best to maintain it in sovereign debt — without seeing any moral contradiction. No doubt they regret Greece ever joining the eurozone, but the ECB is directing its considerable firepower towards ensuring the Spain-Germany spread remains as slim as possible while the Greek crisis unfolds.
One crucial difference, of course, is that seizing control of a sovereign remains difficult. The IMF has decades of experience cudgelling uncooperative governments into making payments, through privatisations, austerity measures, subsidy cuts and other policy prescriptions.
But it’s pretty small beer compared to actually taking over a bank, as a state typically does when it shells out taxpayers' money during a bank rescue or resolution (Varoufakis, Papandreou and Berlusconi might see things differently). Taking over also lengthens the time horizon — a bank bail-out can run and run in a wind-down agency, but a sovereign bail-out will run up against democracy sooner, rather than later.
The other difference is that being a bank comes with rules. Keeping a banking licence is a privilege and comes with a bookshelf full of detailed requirements banks must meet, while banking supervisors have an arsenal of enforcement measures to compel compliance.
The eurozone also has rules — but these are optional, if a member state has the political clout to ignore them. The only real rule is not rocking the boat. Think of the moral hazard if states did that.