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The politics of bailouts

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Last week, I had also meant to discuss the “bailout culture” which is of some relevance to the Zimbabwean financial sector given our erstwhile experiences with the Troubled Bank Fund during the 2003-2004 banking crisis and also given the imminent deadline for local banks to comply with the regulatory capital requirements, but felt it was worthy of a separate article.

Incidentally, one wonders how recapitalisation will pan out in the absence of pre-emptive announcements which could give credence to the promising prospects of shot-gun weddings.

Under the circumstances, a bailout of any sort is currently of academic interest in Zimbabwe given the lack of financial capacity on the part of government to carry out such interventionist rescue activity, but that’s not an excuse for us not to engage with the issue.

The subject of bailouts is made even more topical because in other places, policymakers are already talking about how best to administer tax levies on banks in such a way as to pre-fund their bailouts at the next inevitable crisis in line with the concept of the so-called living wills.

This, we are made to understand, is supposed to protect taxpayers but there are some who contend that it does nothing of the sort, and argue instead that the cost of banking crisis is lost output, not the financial price of providing rescue capital.

Critics of the “bailout” culture argue that it actually increases moral hazard and might even incentivise banks to take excessive risks with the comfort that a fund to bail them out, should things go south and they go belly up, exists.

While there may be an element of truth in this assertion, I think it is too simplistic in that it assumes that banks do not care about reputational risk and do not mind the ignominy that goes with a visit to the Central Bank in the dead of the night, cap in hand, to beg for liquidity support which often comes with the condition that the bank’s top leadership should promptly relinquish their positions.

You can’t solve problems at the same level at which they were created, I suppose.

On the other hand the argument that the availability of a bailout mechanism may cause moral hazard may, at a basic level and in part, be supported by what has been happening in Zimbabwe since the adoption of the multi-currency regime.

In the absence of a lender of last resort banks have tended to be more cautious in their approach hence optimising their risk- taking behaviour at levels commensurate with the market’s constrained liquidity profile, lest they are caught short and are unable to cover their positions.

Assuming that the Reserve Bank of Zimbabwe’s role as a lender of last resort was fully restored and there was a bailout mechanism in place, what would be the lending posture of local banks given the pent-up demand for credit and the banking sector’s quest to quickly return to sustainable profitability?

Unlike in the European Union (EU) and US, as recently noted by local economist Brains Muchemwa, the Zimbabwe government does not have any fiscal space for bailouts.

However, even where capacity or fiscal space is not an issue, the authorities are always wary of the serious, multiple and sometimes protracted effects of bailouts hence the firestorm of protest that often accompanies them.

Despite being for the most part well-intentioned, probably the biggest downside of bailouts is their inflationary impact.

Through programmes such as the Federal Reserve’s current Quantitative Easing Part 2 (QE2) and Ireland’s bank bailout battle, governments seek to generate cash to support banks’ weakening capital bases and promote lending because without lending, consumer and corporate confidence is killed and economic growth inevitably slows down.

Ultimately, despite the tale of good intentions, bailouts bingeing begets inflation.

The Fed’s recent decision to buy a further $600 billion in US government debt with new money has generated outrage among policymakers in many nations, who are accusing the United States of seeking to weaken the dollar in order to gain export advantage, an accusation which the US government itself often levels at China.

Rolling Stone writer Matt Taibbi who recently wrote a book called Griftopia; Bubble Machines, Vampire Squids and the Long Con that is Breaking America, lambasting the whole bailout culture recently said, “every time Wall Street blows itself up with a speculative bubble, the Fed slashes interest rates to zero, that is essentially a bail-out mechanism.

When banks can borrow money for nothing that is bailout.”
“You cannot just throw money from helicopters . . .You have to create confidence in institutions, in the state, in public authorities,” said the German

Economy minister Rainer Bruederle, underlining the need to not simply throw money at every conceivable problem but also to institute complimentary confidence building measures at all conceivable levels.

The phrase “throwing money from a helicopter” is economic slang for how a government may create endless amounts of money to pour into its economy until it finally gets some traction, even if the ultimate cost is higher inflation and a debased currency.

In the Eurozone, for instance, inflation has been creeping up and the European Central Bank (ECB) recently said that it intends to put a stop to its program of pumping liquidity into banks.

Another negative effect of bailouts is their ability to blow huge holes in a country’s public finances.

Ireland’s public deficit for instance it this year is set to surpass 30% of GDP – 10 times the permitted EU standard and double last year’s Greek deficit – after the Irish government had to pour billions into its crippled banks to keep them afloat.

This has resulted in the effective nationalisation of the country’s biggest banks through the guaranteeing of their debt, meaning that government is also on the hook for the losses those banks have to endure, which have risen far beyond initial estimates.

So far, the Irish government is obligated to cover losses amounting to 175% of the Irish GDP, an unsustainable burden by any standards. The Irish bank debacle has been grabbing the headlines lately due to its potentially distabilising effect on a Eurozone that is still licking wounds inflicted by the Greek sovereign debt.

Typically, bailouts come with tough conditions, otherwise known as austerity measures. For a banking institution for instance, one of the conditions might be to fire the chief executive officer like what happened in Nigeria in 2009.

The Nigerian government had to embark on a $4 billion bailout of nine banks whose reckless lending left them so weakly capitalized they were deemed to be posing systemic risk.

Executives from the affected banks were dismissed and charged with offences ranging from conspiring with stockbrokers to manipulate their own share prices, to granting credit facilities worth billions of dollars without adequate security.

Closer to home, Trust Bank, Barbican Bank and Royal Bank are examples of banks where key executives had to leave as a condition for the banks to access central bank liquidity support.

For a country, tough demands to restructure the economy might affect the ability to make own fiscal decisions.

This is why Ireland has been resisting pressure for an EU/IMF bailouts, preferring to have the ECB continue to lend money to Irish banks at low interest rates.

Apparently, as in George Orwell’s Animal Farm; some bailouts are more equal than others.

Finally, we all know about conditional aid in Zimbabwe, don’t we? Prior to the formation of the inclusive government, African institutions pledged an estimated $1 billion in support of Zimbabwe’s economic recovery process, essentially a form of bailout.

Only a few of these institutions have since put their money where their mouths are. Instead of continuing to agonise about why we were denied the money, perhaps we should consider there were conditions which we didn’t — or couldn’t — meet?

The African Development Bank for instance, has made it clear that without a debt strategy in place, no substantial support will be forthcoming from them.

Omen N. Muza is a banker and Managing Director of TFC Capital (Zimbabwe) (Pvt) Ltd. He writes in his personal capacity. Feedback: omen.muza@gmail.com

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