Cyprus: FT's Wolfgang Münchau and Gavyn Davies are missing the point

Even good men, have bad days. Wolfgang Münchau and Gavyn Davies are the living proof of it.

In today’s FT, Wolfgang Münchau argues that bail-ins “à la Cyprus” would only be logic if there was already a fully-fledged Eurozone banking union in place”. Gavyn Davies says that "the critical separation of sovereign from bank debt, promised in the Eurozone summit last June" is not being complied with "leaving the vast majority of the current banking problem still lying at the door of member states, and therefore the separation of sovereign from bank debt would not be achieved"

Is that right?

Let’s start from the beginning: whenever the problem is one of excessive debt and there is no realistic way to grow out of it, as is right now the case in many Eurozone countries, the way to solve it is through comprehensive debt restructuring followed by a thorough recapitalisation of the banking sector.

So, the questions are:

a) Why should the taxpayer foot the entire bill of the banking sector's recapitalisation? Why should an European banking union be designed to fully bail-out banks' shareholders and creditors with taxpayer's money (via the European Stability Mechanism’s – ESM)?

b) Shouldn't taxpayer's money only be used to close the gap left, if any, once shareholders and non-secured bondholders (both junior and senior) have been bailed-in and debt-to-equity swaps taken place, with the bondholders becoming the new shareholders?

c) Is a European banking union not perfectly compatible with debt restructuring and banking recapitalisations along the following lines:

1. Debt restructuring across the board for both private and public debt

2. Resolution and recapitalisation of the then insolvent banking sector done via bail-ins of shareholders, all non-secured bondholders and only the then potentially left gap with European taxpayer's money (i.e. ESM money)?

d) Once the banking sector is recapitalised and solvent, is it not the ECB's job to provide unlimited liquidity to counter potential capital flights? Once recapitalised the banking sector should be solvent, shouldn't it? But then there is no risk for the ECB in lending it money. Once things have calmed down, the recapitalised banks will be able to assess normal market financing and repay the ECB, won't they?

e) The only grey zone is what to do with uninsured bank depositors (> Eur 100k). Then again, if there are no bondholders to be bailed-in (as in the case of Cyprus) doesn't it make sense to bail-in, at least partially, the large depositors before taxpayer’s money is used to recapitalise the banks?

f) Why and how exactly wouldn’t a Eurozone banking union working along these lines comply with "the critical separation of sovereign from bank debt, promised in the Eurozone summit last June"? And "leave the vast majority of the current banking problem still lying at the door of member states, and therefore the separation of sovereign from bank debt would not be achieved"?

By forcing bail-ins of shareholders and private creditors and closing the gap left with ESM money, national  governments' resources are not being used (with the exception of the national governments' contribution to the ESM) to recapitalise banks. I can't see any more effective way to break the link between sovereign and banking sector than this one. And I wonder, how can this be seen differently?

g) Germany is afraid of agreeing to a fully fledged baking union now, because it fears that it will lead to a situation where the European (led by the German) taxpayer, via the ESM, ends up footing the entire bill of the unavoidable European banking sector's recapitalisation following the unavoidable EU periphery's public and private sector debt restructuring over the coming years. And in a market economy, no European banking union should be designed to fully bail-out banks' creditors with taxpayer's money (ESM). Private sector participation has to come first. After all, in a market economy, freedom and responsibility go hand in hand. The decision makers (shareholders, non-secured bondholders, uninsured depositors) have to be held accountable for their actions.

Then again: if a proper and fully-fledged European banking union will allow for the bail-in of shareholders, unsecured bondholders (both junior and senior) and even uninsured depositors above Eur 100k, with the European / German taxpayer only closing the then still potentially left recapitalisation gap, Germany will be surely happy to agree to such a banking union.

If the problem is winning Germany's agreement to a comprehensive banking union, the problem is then solved. Isn't it?

PS Links to Wolfgang Münchau and Gavyn Davies today's articles:

http://www.ft.com/cms/s/0/1e4547c8-9554-11e2-a4fa-00144feabdc0.html?ftcamp=published_links%2Frss%2Fcomment%2Ffeed%2F%2Fproduct#axzz2PCeHAYLX

http://blogs.ft.com/gavyndavies/2013/03/31/preventing-contagion-from-cyprus/