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Dijsselbloem’s mistake was telling it like it is

26 Mar 2013

The suggestion by Jeroen Dijsselbloem, Dutch finance minister and head of the Eurogroup, that senior bail-in could become the norm in bank bail-outs has spooked the markets. The subsequent retraction was an attempt to reflect the politically acceptable view that the Cyprus situation is a one-off. But in fact he had articulated perfectly how bank bondholders should view their investments. Bail-in needs to be priced in before denial once again takes hold.

Jeroen Dijsselbloem has not had a great couple of weeks. To put it in common parlance, he is having a ‘mare. As any politician knows, U-turns are acutely painful procedures.

This is especially so when you are forced, in the space of two sentences, to publicly discount a view you clearly hold and have recently spent many more sentences passionately espousing. It’s hard to argue that Dijsselbloem didn’t get something wrong, but what was it?

The saddest thing about the media lynching that he has suffered over the last 48 hours is that his original assertion that the treatment of the failed banks in Cyprus would set a template for failed banks elsewhere was surely true. Not only that, it is also what many commentators have spent a lot of time arguing for over the last few years — namely, that shareholders, bondholders and, if necessary, uninsured depositors, should carry the can instead of taxpayers when banks fail.

Yes, many aspects of Dijsselbloem’s — and Europe’s — handling of the Cypriot bank bail-out deserve criticism. Most obviously, even though it has now been put to bed, the suggestion that insured depositors would have to share the burden ran the risk of setting a dangerous precedent. Depositor protection is a central part of Europe’s plans for banking union. And it was foolish to run the risk of sending jittery Spanish and Italian depositors heading for the ATMs.

We already knew that Dijsselbloem thought bondholders should suffer losses when banks fail, because he wrote off SNS Reaal’s subordinated bondholders in full when it was nationalised two months ago. He only spared senior bondholders because he was worried about how bailing them in might affect other Dutch banks’ access to the funding markets.

We knew this, and he knew we knew. So why were senior bondholders spared in the first draft of the Cyprus plan, and sub-€100,000 depositors targeted instead? It was an idiotic idea, and one that has done untold damage to the confidence of a demographic that thought its safety had been guaranteed by the EU’s banking union agreement last October.

Senior bondholders, on the other hand, know that a Europe-wide bail-in framework is on the way. They also know that when they buy senior unsecured debt, they are making an uncollateralised investment that carries a level of risk. That risk is what they get paid for.

They should have been made to share the burden of Cyprus’s bail-out from the very start. Shareholder and creditor hierarchies are there for a reason — you cannot pick and choose who you hit and who you protect.

That is what has made Dijsselbloem’s public mauling so painful to witness. His comments about pushing risks back on to banks and their creditors made absolute sense. His problem, it seems, was that he was too honest.

Was he naive? Perhaps. But in 10 short minutes he had managed to cut through years of winks and nudges from policymakers and spell out what every investor knows but is too scared to admit — that they should be the first to pay when banks fail. And his words carry more weight because they have now been backed up by actions in Cyprus.

Bail-in is coming. Forget the Eurogroup’s attempted retraction. Cyprus was not an isolated case. It has had no special treatment, and neither should any other country’s banks.

Dijsselbloem was right the first time. But investors already knew that — bail-in has simply arrived ahead of time. Perhaps the retraction should be retracted, because it is misleading.

Market participants have long warned that bail-in is not priced in. The Cyprus bail-out — properly communicated, of course — might have provided the incentive for this finally to happen. Now we are left with another fudge, and a finance minister under fire for telling it like it is.

26 Mar 2013