“Well written and an interesting perspective.” Clan Rossi --- “Your article is too good about Japanese business pushing nuclear power.” Consulting Group --- “Thank you for the article. It was quite useful for me to wrap up things quickly and effectively.” Taylor Johnson, Credit Union Lobby Management --- “Great information! I love your blog! You always post interesting things!” Jonathan N.

Wednesday, March 20, 2013

Bernanke on Too Big To Fail

On March 20, 2013, more than two years after the Dodd-Frank financial reform legislation became law, Federal Reserve chairman Ben Bernanke made it clear that the problem of too-big-to-fail banks had not been solved. “Too Big To Fail” is not solved and gone,” he said in a press conference. “It’s still here.” Apparently providing an orderly liquidation process for bankrupt banks is insufficient in keeping the U.S. economy free of banks of such size that their failure could threaten the economy itself. This point should have been apparent to all in 2010 as Congress was fashioning the Dodd-Frank Act. The fact that it was not points to the power of Wall Street in Washington.
Suggesting that more legislation might be needed, Bernanke said, “Too Big To Fail was a major source of the crisis . . . and we will not have successfully responded to the crisis if we do not address that successfully.” Dodd-Frank had not done the trick. More would be needed to rid the U.S. economy of the threat of banks too big to fail. If holding more capital does not make the big banks safer, “we will have to take additional steps.” This, he said, “is important.”
Because the mammoth size of big banks such as Citibank and Bank of America makes their failure a threat to the viability of the financial system and even the overall economy, it is important to realize that such size is an advantage because the market assumes the U.S. Government would have to bailout such banks if they get into financial trouble taking on too much risk. The sense of invincibility, plus lower borrowing costs, could lead big banks to take bigger risks and thus trigger yet another financial crisis. Bankers at such banks may even feel free to commit fraud, as U.S. Attorney General Eric Holder admitted that large banks are nearly immune from government prosecution for crimes, given the risks to the economy from the failure of a convicted bank. In other words, the risk taken on could easily outstrip even the additional capital requirements in Dodd-Frank.


Source: Mark Gongloff, “Ben Bernanke: ‘I Agree With ElizabethWarren100 Percent’ On Too Big To Fail,” The Huffington Post, March 20, 2013.


Monday, March 18, 2013

On the Ethics of the E.U. (or Germany) Making Large Cypriot Bank Depositors Pay

After an initial assessment of Cyprus’s bank shortfall of around €17.5 billion in January 2013, the matter of a bailout came to a head two months later. The sticking point was whether depositors in Cyprian banks would be charged a one-time levy as the Cypriot part of the bailout. The E.U. and the European Central Bank, backed up internationally by the IMF, insisted that the bailout be limited to €10 billion, with the remainder of the shortfall’s bailout, over €5 billion, being necessarily supplied by Cyprus through a levy on depositors. Not having been culpable in the Cypriot bankers’ decisions to buy Greek bonds, the depositors spontaneously rose in protest. For a time, that seemed to work. The Cypriot legislature initially rejected the troika’s proposal. In the end, the Cypriot legislature narrowly approved the loan agreement 29 to 27 in late April, 2013. The question I address here is whether the obligations assumed on the Cyprus side are ethical or unethical.

                                                                                 Cypriots protesting a proposed levy on all bank accounts.  CNN

By passing the legislation, Cyprus agreed to “a range of public spending cuts on everything from government travel expenses to pension benefits, as well as higher taxes on companies and consumers,” the Wall Street Journal reports. The Cypriot government also agreed to shut down the state’s second largest bank, Cyprus Popular Bank, otherwise known as Laiki Bank. The largest bank, Bank of Cyprus, would be overhauled. Consequently, depositors with accounts of over €100,000 could end up losing as much as 60 percent, yet smaller accounts, which were insured, would be untouched. While the broad-based nature of the sacrifice seems fair enough, I want to concentrate on the depositors. A consequentialist ethic would look at the outcome of the bailout in assessing whether the consequences to the depositors are justified ethically. A utilitarian ethic would “calculate” whether the combined benefits exceed all the costs to assess whether the consequences are ethical. I briefly perform this analysis before turning to one based on the principle of fairness, which I believe is more pertinent in this case. Part of “doing ethics” is determining which ethical theory (and principles) are most fitting to a particular case.
                          Cypriots facing daily withdrawl limits as the state legislature considered whether to tap into the bank accounts as part of a bailout.    Financial Times

In terms of consequences, the bank holidays and capital controls imposed by the Cypriot government effectively limited the decline in household and company deposits at Cypriot banks to only €1.8 billion ($2.3 billion)—nearly 4% of the total amount deposited. In other words, capital flight was averted. Additionally, private deposits increased in Spain, Portugal, Greece and Italy, according to the ECB. This is strong evidence that the feared contagion to other weak states was successfully blocked.

Considering the scale of a possible spread of capital flight, the costs would have been huge—far outstripping the actual costs borne by Cypriots and the large depositors in the two major Cypriot banks. As if ethics consisted of costs and benefits, a utilitarian could conclude that the direct and indirect costs of the bailout to the Cypriots, the contributing E.U. states, the ECB and the IMF are less than the benefit to the E.U. (and the world) of the capital flight being stopped in its tracks in Cyprus. Put another way, the costs of contagion would be more than the actual costs from the bailout, so the latter is ethical in terms of the greatest happiness for the greatest number.

Of course, distributional fairness plays no role in utilitarianism.  The subjection of the large depositors at Cypriot banks to a substantial levy as part of the total contribution of Cyprus to the bailout is still vulnerable to ethical critique from the standpoint of what is known as “desert.” In short, did those depositors deserve to lose so much? Is it fair?

It could be argued that because the large depositors knew or should have known that their accounts were too large to be insured, distinguishing those accounts from those under €100,000 is fair. If a driver decided not to insure his car, he knows that he might have to pay a lot should he crash. It would not be fair to make insured drivers who have crashed pay just because the uninsured drivers have to pay. In the case of the bank levy, however, it is not as though the depositors had crashed. In the likely words of the protestors, “We were not at fault so it’s not fair that the troika is taking our property.” In other words, the levy has been viewed as theft. Behind this view is the ethical principle that it is unethical to inflict a harm that is not deserved by the person who is to be harmed.

Of the €70 billion in total deposits at Cypriot banks, many were held by Russians who used the accounts to launder money. Although it might seem ethically justifiable to take from those squalid depositors due to the purpose of those accounts, those depositors’ money-laundering did not give rise to the banking crisis in Cyprus. Nor were other large depositors culpable in the bankers’ high-risk decisions to take on too many Greek state bonds. To be sure, culpability can be assigned—just not to the depositors.

Although the Laiki Bank’s CEO claimed that taking on the Greek bonds had been a matter of E.U. solidarity, he also admitted that he had assumed the bonds would be risk-free. In my view, the solidarity claim is mere fluff. The naïve “risk-free” assumption, however, is believable. In other words, the managements of the two major Cypriot banks are culpable. Winding down Laiki Bank and firing its management are thus ethical responses by the Cypriot government. Reorganizing the Bank of Cyprus is also ethical based on the principle of desert. In fact, clawbacks on the executives’ prior bonuses and a levy on their bank accounts would have been justifiable too.

In a more macro sense, the role of the E.U. (and ECB) in going after bank depositors beginning with the Cypriot bailout is also vulnerable ethically speaking. As a general principle, federal institutions should treat the states fairly—meaning not treating them differently when they are in the same situation. On the state level, Denmark had forced some large depositors of Danish banks to lose some money after two midsize banks collapsed in 2011. Iceland had decided not to repay foreign depositors during its banking crisis in 2008. Lastly, Italy had imposed a small tax on its depositors. Crucially, neither the E.U. nor the ECB had made such a demand. Accordingly, it was unfair of the federal institutions to make the bailout for Cyprus contingent on a new condition. The decision was tantamount to deciding to change the rules in the middle of the game.

Nor is it fair for a powerful state such as Germany on the paying end of the bailout to have such power at the federal level as to be able to unilaterally demand that depositors in another state pay part of the price of the state getting a bailout. For a “net-payer” state such as Germany to have such influence on a federal policy involving bailing out another state represents a conflict of interest. In fact, no single state government should have such power in the European Council, as from the use of a unilateral veto, that such a conflict of interest can be exploited. The financial interest of German taxpayers should not drive E.U. policy; nor should the interest of the depositors in Cypriot banks. Instead, the good of the whole—the state of the Union—should be the basis on which a bailout is formulated and approved.

In fact, merely having institutions like the European Council that highlight the state governments and legislative devices such as the veto that enable unilateralism involved in bailout policy-making may be unethical because it implies that the design was intended to be self-serving rather than for the good of the whole. Additionally, even if a powerful state such as Germany does not exploit the conflict of interest in order to wind up paying less, merely remaining in the position to be able to exploit a situation can be regarded as implicitly unethical. Being in the position has the appearance of selfishness at the expense of the whole and brings with it temptation. Putting oneself or another in a condition in which the person will be tempted to act unethically is itself unethical.

In conclusion, extracting “a pound of flesh” from large depositors in Cypriot banks because such a levy is politically expedient (given the protests) and some of the large accounts are used by foreigners to launder money violates the “desert” ethical principle. Simply put, the policy is not fair. Nor was it fair of the E.U. and ECB to begin with Cyprus in insisting on a levy. To be sure, Cyprus had over-built its financial sector as a tax haven. However, major structural flaws existed in Greece and Spain too. To treat states in a similar situation differently is unethical, as per the principle of fairness. If this principle is violated enough, such as by limiting the real decision-making in the European Council to a few state leaders from Western Europe, the double-standard will become transparent. This in turn would undercut the legitimacy of the E.U. itself. Even though contagion and capital flight were effectively stymied, the structure of the Cypriot bailout may leave the E.U. (and ECB) with some subtler, more intractable, problems bearing on legitimacy of the European project itself.
Gabriele Steinhauser, Matina Stevis, and Marcus Walker, “Cyprus Rescue Risks Backlash,” The Wall Street Journal, March 18, 2013.
Michael Steen, Kerin Hope, Andreas Hadjipapas, et al, “Cyprus Targets Big Depositors in Bank Plan,” Financial Times, March 21, 2013.
Brian Blackstone, “Cyprus Plan Averted Contagion, Says ECB,” The Wall Street Journal, April 26, 2013.
Alkman Granitsas and Stelios Bouras, “Cyprus Narrowly Approves Bailout,” The Wall Street Journal, April 30, 2013.