October 11, 2011
David R. Kotok


I have been to Bratislava. You drive east from Vienna, across farmland and past windmills of the modern type, generating electricity for Austria. Instead of armed guards, searches, and moneychangers, you cross the open-border bridge spanning the Danube and enter Bratislava, the capitol of Slovakia.

The city has been rebuilt since the war. It is colorful now that the years of gray communist pallor have been replaced by the open border and a growing economy. It has a generation of young people who do not remember the era of Moscow’s domination. It has an older generation that does not want to return to that era. It has a stock exchange. It has a free press. It has international visitors and easy transit.

In addition, it has a central bank. I visited that bank. As part of the GIC central banking series programming,, the governor of that central bank visited our group in Philadelphia.

Slovakia is an indicator of the development of the European Union and the euro zone. Now it is in the limelight. It is a newer member of the 17-nation euro zone. To join the euro zone, it met the requirements on budget-deficit limits, inflation, and debt/GDP ratio. Now it is asked to assist Greece, the 12th member of the euro zone and the one that restated its numbers, after the fact, and was thereby caught in an economic prevarication.

The other 16 member countries of the euro zone range in size from Germany, the largest, to Malta, the smallest. Those 16 have agreed to the EFSF, the fund to be used to bridge the financing requirements while Greece sorts through the inevitable restructuring of its debt. The attempt in Europe is to do it in an orderly way, without sinking the European banks that hold that Greek debt.

This political showdown in Bratislava is about banks. Moreover, the banks are the bigger ones in the larger countries of the euro zone. In addition, this political fight in Bratislava is about the role and power of a member state vs. the evolution of a more central governing system that spans the European Union. Throw open the history of the United States and examine the debates about states’ rights vs. the federal government’s role, and you can see the forerunner to the present tension in Europe. We had our fights here. We still have them. In Europe, they are having their versions.

Slovakia will not sink the euro zone. It loses if it does. In the end, we believe that Barclays’ assessment of this momentary high-risk political gambit by one political faction in Bratislava is the accurate outlook. However, we admit that it is a high-stakes game. If Slovakia becomes an obstacle to the EFSF and then Germany, France, and others have to do a small-country carve-out in order to prevail, then Germany and France will have opened a Pandora’s Box that cannot be closed.

This is how the game of moral hazard is played. It is now years ago that the European Central Bank allowed a downgraded, previously investment-grade Greek bond to remain acceptable collateral for pledging to the ECB. That was the first chink in the armor against moral hazard. The cost of that erroneous decision is mounting. In the US, we did it by allowing Countrywide to merge with Bank of America when the Fed suspended a rule. Countrywide was the first primary dealer to fail, and the Fed took moral hazard up to prevent it from defaulting. The price tag was revealed when Lehman failed. The price tag is also revealed in the present charges taken by BofA. In Europe, the price tag will be revealed in the eventual size of the EFSF and other rescue funds.

Moral hazard is costly. Systemic banking failure is costly, too.

Here is Barclays’ assessment today. We shall watch this evolution closely. Barclays analyst Francois Cabau wrote:

“All in all, it seems that a solution exists for the EFSF 2.0 bill to be approved by the Slovakian Parliament but it could be very costly for the ruling SDKU-DS (15% of seats) and, thus, for the handling of domestic issues, as conditioned by a potential fall of the government. Furthermore, according to Slovakian law, the EFSF bill could be resubmitted to Parliament in an unchanged form if the composition of the current government were to change. Although this could imply significant amount of time lost for the EFSF, we remain of the view that Slovakia will eventually join the other 16 countries that have approved the bill. To sum up, the question is not ’what if it does not approve’ but rather ’when it approves.’ ”

David R. Kotok, Chairman and Chief Investment Officer

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:

Posted Under