Sorkin’s Column, My Response
David R. Kotok
June 12, 2012
On Sunday, we published a note after the news broke that Spain had negotiated a €100-billion capital infusion for its banks. We applauded the move because it showed that Spain and eurozone leaders realized a run on their banks and bank failures would sink their system. We discussed the importance of bank deposit safety in Europe in a recent commentary.
On Tuesday morning, Andrew Ross Sorkin’s column in the New York Times identified me and quoted my Sunday missive. Sorkin characterized “analysts” who “applauded” the European move as being “wrong.” Sorkin’s piece can be found here.
Sorkin’s column described the necessity of protecting bank deposits, as I did in my commentary. I agree with Sorkin when he states that TARP was not the only bailout approach that helped in the US. Sorkin cites the increase in FDIC insurance limits from $100,000 to $250,000 as the reason depositors in the US calmed down during our crisis. He notes this occurred after the pressure mounted on money market funds.
But Sorkin’s piece ignores the unlimited, non-interest-bearing deposit guarantee by the FDIC. That guarantee is what stopped the liquidity drain on our banking system. The increase in the FDIC insurance coverage from $100,000 to $250,000 certainly helped; however, the key item was the extension of the FDIC guarantee so that cash-operating deposits of any amount were protected. Companies could meet their payrolls and not have to worry about the domicile of their deposits; they could pay their bills efficiently, instead of allocating cash to many institutions. The unlimited guarantee of cash deposits is what really saved the US banking system, and that guarantee is what is missing in the eurozone.
I thank Andrew Ross Sorkin for mentioning my Sunday missive. I would be happy to personally discuss it with him at any time. I think his views about the need for a comprehensive deposit-protection system in the eurozone are consistent with mine. As for who is right or wrong, readers can decide.
More importantly, markets can decide. Here is where I point to my second disagreement with Sorkin’s analysis.
Sorkin cites the reaction in stock markets and bond markets as evidence that the Spain bailout deal is failing. Let’s take this conclusion apart. Spain’s stock market has already been clobbered, for a variety of reasons, including a contracting economy and the ongoing crisis. The same is true of stock markets in many countries in Europe. But the short-term reaction of the stock market is not a reason to declare a policy initiative either successful or failed.
Jump to the bond market. The Spain bailout deal adds to the sovereign-debt burden of Spain. Bond vigilantes quickly figured out that the Spanish debt-GDP ratio would jump by approximately ten percent in response to the bank bailout package. Here is a more important message than that from the stock market. Debt-GDP ratios and the cost of rolling the debt are the critical factors in Europe. In Greece the cost is now impossible to cover. In Portugal it is nearly so. In Spain and Italy, the cost is reaching the level at which debt rollover by the sovereign is a losing proposition.
Sorkin properly acknowledges the debt burden, but to attribute the reaction of the bond market to the bank-bailout depositor-protection plan is to misconstrue two items. They are related; however, the causality that is alleged by Sorkin is incorrect.
Readers are invited to dissect the debt burdens with the Sorkin’s approach and with mine. Compare debt-GDP and GDP growth rates versus “shrink” rates. You will see that the reactions in the bond market are entirely consistent with the structure of the proposed Spain bailout plan.
David R. Kotok, Chairman and Chief Investment Officer