Guidance to central banks, finance ministries, regulators, financial institutions in developing a co-ordinated policy response, design of bank restructuring and resolution
As a veteran European mortgage sector specialist uniquely plugged into the U.S. housing finance scene through my work with World Bank and U.S. housing finance institutions such as Fannie Mae I played both an analyst and policy co-ordinating role during the Great Financial Crisis. I had learned techniques of bank restructuring around 2000 at the Capital Markets Development Department of the World Bank, when Jonathan Fiechter of the U.S. Resolution Trust Corporation ran our neighbouring department focusing on bank restructuring and resolution in South East Asia after the Asia crisis.
European central banks and financial regulators when the Great Financial Crisis started had insufficient housing and mortgage sector intelligence to see what was coming their way. I surprised German financial regulator BAFIN in July 2007 with a juicy first approximation on the likely losses incurred by Landesbanken and commercial banks through their sponsoring of Asset-Backed Commercial Paper conduits, purchasing of Collateralized Debt Obligations and similar instruments backed by U.S. mortgages. This came weeks after I had completed a publication on suspicious Subprime and Near-prime (Alt-A) U.S. lending practices on behalf of a German trade group of housing lenders (Verband der privaten Bausparkassen).
As the U.S. mortgage crisis culminated in late 2008 with the collapse of major lenders and investment banks, with Oliver Wyman I advised the British FSA on consequences to be drawn from the abundant regulation failures. At that point it became clear that European banks and their major investors tried to use their political connections to bail out hybrid and junior bank debt instruments at the expense of taxpayers in their bank rescue efforts. I started working through colleagues in various institutions – from New York Fed via IMF to ECB – as well as the media, to stop this bleeding of capital originally designated to cover the losses. This was an uphill struggle as basically all of these institutions had convinced themselves that a bail-in of subordinated creditors and even hybrid capital owners rather than solving the problem would destabilize the entire financial system. The notable exception, with presence limited to the United States, was the FDIC.
During 2009 when this struggle for rescuing banks, in reality bank investors, heated up I became widely involved in media and advisory work with the German parliament and regulators, esp. regarding the failures of the Landesbanken which had enjoyed the protection not only of state politicians but also in some corners of bank regulation, esp. Bundesbank. My critique of the failures of the bank regulation system hit many nerves as the discussion for the restructuring of bank regulation intensified.
The bailout issue became even more acute with the general European mortgage sector, and – beginning in early 2010 with Greece – sovereign debt crisis. My experience in European mortgage and covered bond markets helped to unearth many trouble spots – from Spanish property lending via Irish index tracker mortgages to German covered bonds invested in shaky sovereign debt and feed this information into central banks, regulators and the financial press. During 2010, I doubled down on fighting the German bailout mentality that was largely the result of a cover-up attempt of the massive financial regulation and financial sector management failures. As a mortgage and covered bond specialist I wrote the first and so far only concise critique of the failure of the Pfandbriefbanken system, in parallel with the Landesbanken the largest bond issuers – and buyers – in the German financial system.
In 2011 in view of the widening European mortgage market disaster, in particular in Spain and Ireland, I co-chaired a CEPS (Brussels think tank) working party on mortgage credit reform with the largest European commercial banks present. The banks were not happy to hear a critique of high-LTV lending (Netherlands) or excessive variable-rate lending despite the presence of fixed rate bonds (Spain, Ireland) that had exacerbated the European crisis. In sovereign finance I developed in August for CEPS a proposal akin to partial bail-in of bank creditors on partial sovereign bond insurance that the EU Commission later bapticized ‘purple bonds’. Another focus during the year was my involvement in the U.S. mortgage market reform debate. I was retained by a German Bausparkasse to write a critique of the highly leveraged U.S. mortgage finance system, our proposal to push for greater savings and less high-LTV lending was welcome by a small group around Paul Volcker, but brushed off by the GSE-Wall Street coalition. I tried to convince the FDIC to introduce a decentralized covered bond system in the U.S., which failed due to the institution’s phobia against becoming subordinated to secured creditors in any way. Until the present day the U.S. has thus kept its toxic high-LTV centralized government-sponsored system. Bizarrely, it was a conference initiated by Korean Vice Minister for Housing Kyung-Hwan Kim in Seoul at the end of the year that brought U.S. and European critics of the transatlantic mortgage crisis together and for which I prepared a long paper.
The key financial policy struggle in 2012 was to preempt Spain from using German taxpayer money into bailing out her failed bank’s hybrid and junior bond holders, a burden on Spain to be traded against a German commitment to support Spanish sovereign bonds. My work in pushing that deal behind the scenes, with banks and central banks involved, and through media appearances, cleared the way for the EU’s Directorate General Competition to demand bail-in for hybrid and junior bond as a rule that came later in the year.
A final point was my involvement as an advisor to German Bundestag in 2013 in the Cyprus bank restructurings which involved bail-in also of senior unsecured debt. As a former Cyprus central bank governor informed me later that that operation was based on faulty assumptions about Greek losses of Cyprus banks spread inside the ECB, an issue that never got fully clarified. Sound asset analysis clearly matters as much as financial restructuring technique. Later in the year I wrapped up my work on bank creditor participation in a joint study for Bundestag and European Parliament.
The DG Competition measure was the starting point for defining bail-inable capital in the form of MREL and TLAC as the banking industry knows them today. Unfortunately, the European Bank Resolution and Recovery Directive BRRD that took up bail-in nominally after 2013 suffered heavy blows from bank lobbyists trying to reverse these results. They found open ears with politicians, and so imposing greater market discipline on banks to remains work in progress, even though much has been achieved. My Cyprus work directly fed into the development of an FDIC-style European deposit insurance system – another ongoing work program on which a few milestones, such as the creation of the Single Resolution Board and a system of assessments on banks have been reached. My work during the GFC ended with a 2014/15 assignment for DG Competition in which I reviewed obstacles and solution to the bail-in of junior debt instruments, with a particular focus on the ‘bail-in-phobic’ countries Germany, France and Italy.
In my GFC work I greatly owe to interaction with and support by many top financial sector economists. I would highlight in particular Klaus Engelen, editor of The International Economy, Martin Hellwig, Professor at the Max Planck Institute for Research on Collective Goods, and Jan-Pieter Krahnen, Professor at Goethe-Universitaet Frankfurt. I also owe deeply to an unnamed buy-side research analyst that supported me with necessary bank solvency, financing structure and deal data to evaluate bailout strategies and costs in different European countries.
Based on this intensive crisis management experience I believe that independent financial sector specialists that are plugged in into the banking industry, into central banks and regulators, academic research and media can play an important role in managing, and resolving, crisis situations such as the one posed by the GFC. As we all are acutely aware of, these situations occur with great frequency, and our institutional setup remains severely fragmented, which requires co-ordination.
Selected project references financial crisis, bank restructuring / resolution
To be continued
Selected papers and presentations financial crisis, bank restructuring / resolution
“Obstacles and Potential Solutions Relating to Bail-in of Junior Bank Debt Instruments“, Presentation given to DG Competition / European Commission, April 2015.
“Verspätete Abwicklung der Depfa Bank durch den Bund“, Paper on the bank resolution strategy of Deutsche Pfandbriefbank, April 2014. In German.
“Creditor Participation in European Bank Restructurings – A Corner Turned ?“, Presentation given at the Cyprus Banking Forum, Nikosia, December 2013. The presentation was given in slight variations at the International Monetary Fund in June 2013 and at the German IfO Institute in November 2013.
“The Capital Structure of Banks and Practice of Bank Restructuring“, CFS Working Paper No. 2013/04, Center for Financial Studies, Goethe-Universitaet Frankfurt, October 2013.
“Creditor Participation in Banking Crisis in the Eurozone – A Corner Turned?“, Study commissioned by the Green party in Bundestag and European Parliament, June 2013.
“Bewertung des Bankenrestrukturierungsprogramms in Zypern und sei-
ner Auswirkungen auf Konzepte und Institutionen der Bankenunion“, Paper prepared for Social Democratic Party in German Bundestag, April 2013. In German.
“After the ‘Whatever-It-Takes’ Bail-out of Eurozone Bank Bondholders: The Eurozone’s Wasted Opportunity for a Banking Union That Protects Sovereign Finance”, CES-Ifo Forum 4 – 2012.
“Specialized Housing Finance Institutions in Crisis – Unwind or Reform?“, Presentation given at the International Monetary Fund, June 2012.
“Transatlantic Mortgage Credit Boom and Bust – the Impact of Market Structure and Regulation“, Paper prepared for the Korean Development Institute International Conference ‘A New Paradigm in Housing Policy’, December 2011.
“Partial Sovereign Bond Insurance by the Eurozone: A more Efficient Alternative to Blue (Euro-)bonds”, CEPS Policy Brief, August 2011.
“A New Mortgage Credit Regime for Europe“, Paper prepared for the CEPS-ECRI Task Force on A New Retail Credit Regime for Europe (with Marc Rothemund), June 2011.
“Rettung der Hybridkapitalgeber der Banken mit Steuergeldern in Deutschland durch den Staat“, Paper on the rescue operations of bank investors, September 2010. In German.
“Reformerfordernisse bei Pfandbriefen und Pfandbriefbanken vor dem Hintergrund der Finanzmarktkrise“, Paper prepared for the Green Party in German Bundestag, June 2010. In German.
“Irrfahrt durch die Finanzwelt: Deutschlands Zukunft muss vom Kapitalmarkt her gedacht werden” A wrong turn in the financial world: Germany’s future must be thought out in terms of the capital market. Paper on the origins of the German leg of the Global Financial Crisis, the self-defeating bailout strategies and the need for sound financial markets management. March 2010. In German.
“Germany’s Path into the Financial Crisis and Resolution Activities“, Presentation given to the PRMIA conference: ‘Regulatory Reform: Defining Issues and Tasks to Enhance Systemic Stability, Washington, November 2009.
“Reform der Finanzmarktaufsicht in Deutschland. Kommentar zu den spezifisch deutschen Ursachen der deutschen Finanzkrise, der derzeitigen Krisenbekämpfungsstrategie und Reformdebatte”, Paper submitted to the Financial Market Committee of Bundestag, May 2009. In German.
“Einstürzende Kreditmärkte – US-Hypotheken- und globale Finanzkrise
Ursachen und Lehren“, Presentation given at Schmalenbach-Gesellschaft, Munich, December 2009. In German.
Selected media work financial crisis, bank restructuring / resolution
“Paying the Price of Procrastination“, Interview with John Vickers of Gold Magazine, Cyprus, November 2013.
To be continued.