Athens News reports today that out of the 1 billion Euro bailout tranche paid to the Greek government in June, 450 million Euro went back to the banks in the form of funding for the EFSF.
I have written before about how the Greek government bail out is creating a simply massive moral hazard.
Let me break it down.
1. Banks let the Greek government borrow more than it could ever hope to pay back.
2. When the inevitable occurred, ie the Greek government not being able to service it’s debt, the Greek government started seizing the assets of the Greek citizens in order to service the government debt.
3. In addition to the seizing of private assets the Greek government then borrowed even more money in order to service the outstanding debt. This extra borrowing is the Greek government bail out.
4. As part of the conditions attached to these bail out loans, the Greek government had to pay 45% of the money directly back to the same banks it borrowed the money from in the first place, at interest. And this is the moral hazard.
Banks are benefiting in 3 ways by creating problems in the financial system.
1. Banks benefit from the interest payments on the original recklessly made loans.
2. When the Greek government ran in to trouble they had to increase their borrowing in order to service the old debt.
3. The banks benefitted from increased funding to the EFSF, the bank bailout fund. Part of the conditions attached to the Greek government bail out fund was that part of the loans had to go to creating and funding the EFSF.
So the banks profited on the original loans, they profited when the Greek government ran into trouble due to the Greek government increasing its debt load. And the banks benefited from the bail out loans because a large percentage of the loans went to a fund which is designed to bail out the banks.
I know I am labouring the point here but I want to make it as crystal clear as possible.
The banks have benefited from the whole bail out process. They benefited from the original loans and they benefited when the borrower ran into trouble.
This is a vicious cycle. Banks are rewarded for making bad loans, banks are rewarded by the borrower getting into trouble and this whole process increases the bank’s protection to making even more reckless loans in the future due to the insurance of the EFSF.
It is hard for me to imagine a more profitable business exercise than this. It seems the banks have stumbled on a no-lose lending policy, and not only that the borrower is simply massive, it the European taxpayer.
I am not saying that the banks are healthy. The bad bets they made with the private sector are not so easily fixed or manipulated, but the extra revenue streams they are generating from EU governments is certainly softening the blow and might actually be keeping many of the big banks afloat.
It is a shame so few politicians recognise the moral hazard they are creating here by buckling to the banks. Sure it would be nice of there were no problems in the banking sector but the reality is, it is simply too expensive to have no problems given the mess that has been created.
Let me use an analogy I have given before.
Thousands of people die on European roads every year. It would be nice if all road furniture and the exterior of all cars were fitted with airbags to stop people from being killed. That is the ideal scenario but the reality is, this solution is simply not feasible due to the immense cost.
And the situation is the same with the banking system. It would be nice if mistakes made by the banks did not have any ramifications for the economy at large, nobody is disputing that, but the cost of doing so is simply too much. The investment required will simply not be worth it.
If the investment were worth it governments would not need to be involved. Private sector investors would be getting on board if they thought it was a profitable exercise. The reality is is that private investors are not bailing out the banking system. This tells me they know it is a black hole which is why they do not want to get involved.
Like the airbag scenario, no private sector company is prepared to invest in the project because it simply does not make financial sense. And neither does government bailouts of the financial system.
And to take the analogy a stage further, there is no way to predict the effects of fitting car exteriors and road furniture with airbags. If drivers knew their car would not be damaged and they would not be hurt by crashing their car, I think it is safe to assume that drivers are going to become more reckless and/or pay less attention to the road. And as the cost of the replacing the airbags will be down to the taxpayer and not the drivers ie the banker, I think it is safe to say the airbags/EFSF is going to be used more and more as a safety net.
You crash at 10mph and no damage to your car, you crash at 20mph and no damage to your car and so on and so forth. The only thing that is happening is that you are setting of airbags that other people are paying for. There has to come a point when there are consequences otherwise people are going to be driving around at 100mph everywhere in order to get ahead of the next person.
Actually, let me adjust the analogy. Instead of the public road, lets make it a race track because it is a competition, bankers are trying to make more money than their collegaue/competitor.
As things are now, drivers have to repsect the track and other drivers, if they make a mistake they could be out of the race.
If you then equip the cars and the track with airbags paid for by the taxpayer I think it is fair to say the racing is going to get considerably wilder. Drivers can now take bigger risks without the fear of hurting themsleves or taking themsleves out of the race. The only cost to crashing, is going to be the setting off the airbags, and given the taxpayer is the one paying for the airbags, why should the bankers care?
Nobody knows the exact consequences of bailing out out the banks, but given that EU governments are installing airbags in the form of the EFSF, I think you can safely predict that bankers are not going to start driving more carefully than before. Given the consequences of bad driving has been reduced and the costs have been passed onto taxpayers.
I don’t pretend I am saying anything new here but they way the media is reporting the bail outs you would think they are a good thing when common sense says the exact opposite.
Why Greeks Want The Bailouts To Stop
Banking Panics/Bank Runs – Government Created?
Banks – Have Governments Forgotten Their Purpose?