Tuesday, March 26, 2013

Confusion in Europe over Failed Banks

Yesterday, there was much consternation over the comments of Jeroen Dijsselbloem, Dutch finance minister and the chairman of the Eurogroup.  What did Mr. Dijsselbloem say?
"If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?'," he said.
"If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders."
See this Telegraph article for more details.

Here is the Federal Deposit Insurance Corporation's (FDIC) statement of how it resolves an insolvent bank in the US:
VIII.  Priority of Claims
In accordance with Federal law, allowed claims will be paid, after administrative expenses, in the following order of priority:

  1. Depositors
  2. General Unsecured Creditors
  3. Subordinated Debt
  4. Stockholders
Mr. Dijsselbloem's comments seem to be a pretty straightforward statement of the FDIC policy.  How can anyone object to that?  Well, I guess if the understanding had been that general creditors and stockholders had a higher priority in the capital structure than the general taxpayer then Mr. Dijsselbloem's statement is a change of policy.  Why anyone with economic efficiency in mind would want bondholders and stockholders of banks, or even uninsured depositors, to have a higher priority than the general taxpayer is beyond me.  Seems like a recipe for moral hazard.

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