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2010-05-18

Stability vs. moral hazard - a compromise to deposit insurance

Icesave website, as it appeared in February 2010When the Icelandic banks started persuading clients from the UK and the Netherlands with high interest savings accounts, those interested in the offer could be roughly divided into three groups. Some merely saw the interest, and did not think there would be any risk involved. Others predicted that the Icelandic economy would end up in a serious crisis, and thus stayed away. And then there were those, who had a hunch of the emerging problems, but an even stronger confidence that in case of a crisis, deposit insurance would cover the losses - as it did in 2008.

The deposit insurance is not only an important security factor for individuals, it's also an essential element in maintaining the stability of the economic system. Its downside on the other hand is the moral hazard residing in the minds of the aforementioned third group : potential profits are taken to oneself, whereas the risk is socialized to be paid by others. In this sense deposit insurance has a lot in common with the current Greek bailout. Both basically boil down to a conflict between maintaining stability and avoiding moral hazards. The first one (stability) is of course more important, but ignoring the latter entirely may ultimately result in losing the first one too. And it seems to me that moral hazards aren't payed enough attention to.

In case of deposit insurance, perhaps an efficient balance between stability and moral hazards would be to make the deposit insurance reversely progressive. As a simple example, the savings could be fully covered till 20 000 €, 98% covered for the amount of money exceeding 20 000 €, and 95% covered for the amount exceeding 50 000 € up to 100 000 €. Thus, the most basic savings would be fully protected, but with deposits resembling investments, part of the risk would be taken by the depositor. The risk would remain so small that it would not cause a large scale panic on the market.

Another interesting factor is that apparently the promised interests are also a part of the deposit insurance. As a matter of fact, even now and still for about month now, a few thousand clients of the Finnish Sofia Bank are waiting the last 15% of their money - and with interest. By restricting the amount of interest paid in case a bank ends up in receivership and/or by perhaps implementing a reversely progressive deposit insurance, the moral hazard could be avoided. With a model like this there could have been a bit fewer Icesave savings in the Icelandic Landsbanki, which in turn could have made the economic bubble in Iceland at least a tiny bit smaller.



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2010-05-07

Greece and bankers should take their responsibility


Greece has agreed to accept the bailout terms. In other words, it accepts taking the helping hand. It is a little bit peculiar to think that the whole process could have been depending on Greece's approval. It is obvious that with or without a bailout, the crisis will have a serious effect on the lives of ordinary Greeks. Yet based on common sense, one would think that the bailout would make the bumpy road of the upcoming years at least a bit more pleasant. So why shouldn't Greece accept the terms? However, the other countries in the eurozone would have at least two reasons not to...


1. Greece has enough assets to pay the debt off?

A Greek evzon, December 2008The first, yet perhaps less significant reason not to support Greece is partially moral. Why should we support a country, who cheated its way in joining the EMU? Or should we support their ridiculously low average 53 year retirement ages? Or the pensions that the civil servants' daughters are allowed to collect - civil servants who themselves practically can never be fired? Other curiosities like the bonus for arriving to work on time, 14 month annual salaries or the computer usage bonus basically remind me of the rather silly looking evzones of the presidential guard (on the right): is this the kind of circus other eurozone countries are financing?

Of course the most obscure practices in the Greek economy will most certainly be dealt through the terms of the bailout. And the crisis could have been mostly avoided, with a tighter control on Greece joining the euro or preventing it from getting into this much debt. But now this is the situation we have to deal with, so the question remains: should Greece have a greater responsibility for the problems that it has caused by itself? Although control will probably be tightened due to these experiences, the bailout gives an unconstructive message: if we end up in serious trouble, the others will help - so why not continue our irresponsible economy?

If a country didn't have any possibility to deal with its debt, then forcing more responsibility isn't really an option. However, is this really the case with Greece? According to Financial Times, Greece has properties of over 300 billion euro. If this is true, from what I've understood, this is relatively unmatched in most western countries. Iceland has endured significant losses when Icelanders have had to sell their possessions at low prices due to their crisis. Why shouldn't Greece also need to sell some of its possessions - especially if it really has the assets to do so? Couldn't this be a part of the bailout terms?


2. The bailout is supporting the banks

Another factor is that the bailout is basically supporting the creditors, who took a risk when loaning money to Greece. Biggest of the creditors are German and French banks. From what I've understood they might be the biggest creditors even in comparison to the size of the German and French economies, which would mean that Germany and France benefit the most from the bailout. Can this be right? There are also other creditors, some of which are even outside the eurozone. Do we also want to support them?

The purpose here is of course maintaining economic stability and credibility. But couldn't it be done without giving out the message that banks are free to take risks for profits, but the bigger losses will be socialized anyway? Couldn't the debts be organized in such a fashion that the eurozone countries would get shares of the banks that they are basically supporting? Thus, the current owners would have to face the realized risks, but the economic system would be left almost unharmed.


Evzones changing the guard, December 2008

=> Co-responsibility?

Grasping the entirety of the situation, and evaluating the possible scenarios caused by various courses of action, is of course very difficult. The motivation for the bailout is not saving Greece per se, but maintaining economic stability. However, for the aforementioned reasons the current bailout seems morally wrong and transmitting all the wrong messages. Why should the eurozone pay for the mistakes of Greece and the banks that gave Greece loans? Shouldn't at least part of the liability be pushed to that direction? If Greece would sell its possessions for the worth of even 50 billion, and euro countries would receive shares from the banks they are basically financing, the whole crisis would be a far better lesson in economic morals.


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