Time for a Central Bankers Strike

Deutsche Bank’s travails show we have bigger problems than too big to fail.

By Holman W. Jenkins, Jr.

Outside a Deutsche Bank branch in Frankfurt.

Outside a Deutsche Bank branch in Frankfurt. Photo: Kai Pfaffenbach/Reuters
 

Another panacea of the too-big-to-fail obsessives has bitten the dust. At least that’s the prevailing thesis. Contingent convertible bonds, or CoCos, were embraced with an unhealthy passion after 2008, goes the claim, and yet failed to save the day last week for Deutsche Bank, DB -4.16 % the big German bank whose stock was whipsawed by solvency fears.

That’s the narrative you can read in many sources. In fact CoCos worked exactly as they should have, giving an early warning of trouble at Deutsche Bank. CoCos can be an excellent contributor to bank stability if—big if—CoCo selloffs are interpreted as a signal to reduce risk by reducing leverage and increasing capital so a taxpayer bailout can be avoided down the road.

Exactly the opposite happened in the Deutsche Bank case. Management dealt with the selloff by using existing resources to buy back some of its senior unsecured debt while falling back on too-big-to-fail assurances from people like Morgan Stanley MS -1.40 % ’s John Mack and German Finance Minister Wolfgang Schäuble.

There’s a deeper lesson here, but let’s deal with bank regulation first. Those who say CoCos failed to live up to billing are focused on the wrong “c”—not contingent, but capital—in keeping with a universal post-2008 fantasy about how to fix too big to fail.

CoCos are a form of debt that becomes capital when a bank’s financial condition deteriorates.

Yes, more capital means a bank can absorb more losses before its ability to honor its own IOUs to depositors and other creditors is endangered.

The banking system supposedly is safer—unless banks respond to higher capital costs by taking on more risk in order to keep producing competitive returns. That’s why capital regulators inevitably become risk regulators, telling banks not just how much capital they must hold, but what they can and can’t do (as in the U.S. Volcker rule) and by allowing less capital to be held against what regulators judge to be safe assets (as if regulators know).

Capital regulators, recall, were the ones who decided that banks could get by with less capital against mortgages and Greek bonds. Oops.

A better solution is something like CoCos—a mechanism-cum-incentive for institutions always to have enough capital, or raise enough capital,to assure the market that a bank is solvent now.

But you have to be willing to force banks to act on the messages the market is sending. Deutsche Bank is a giant bank. The German and European economies are perceived as being so fragile, so ready to tip into deflation, that politicians are afraid of any steps that might impose costs on Deutsche Bank’s shareholders, workforce or customers in the current environment.

The real lesson is how little the problem of too big to fail is connected with the challenges facing the advanced industrial economies now. Fixing too big to fail doesn’t fix their low-growth demographics, mounting debt, or the regulatory burdens and welfare obligations that so heavily tax the productive sector.

And anybody who still thinks monetary policy is the solution isn’t paying attention. Monetary policy cannot fix structural defects, and creates new problems by trying.

But let’s proceed on a happier note. To readers who in the past have been confused on this point, we’re not saying that dealing with the Western world’s welfare excesses means junking all existing socioeconomic institutions and reverting to some libertarian dream castle.

One upside of a century’s accretion of bureaucracy is that there’s a lot of incremental, low-hanging fruit available to improve incentives—such as flattening tax codes, trimming back excessive labor regulation, recasting welfare handouts so they aren’t quite so punitive toward work.

Coupled with the native resilience of Western arrangements—democracy, rule of law, free markets—the bounceback is likely to surprise those who think our problem is some inescapable, demographically mandated secular stagnation.

Alas, it’s becoming obvious that the key obstacle to progress is central bankers themselves.

Their ministrations everywhere have been adopted by politicians as a substitute for reform or as an excuse (as in the U.S.) to go on piling up regulatory and welfare excesses.

The central banks have a club, known as the Bank for International Settlements, in Basel, Switzerland, which last year in a message to members stated the obvious: “Monetary policy has been overburdened for far too long. It must be part of the answer but cannot be the whole answer. The unthinkable”—large-scale asset purchases, negative interest rates—“should not be allowed to become routine.”

Exactly. And now maybe it’s time for the BIS to take its critique to its logical conclusion—calling on the world’s central bankers to go on strike until politicians and fiscal policy makers start doing their bit to get growth restarted and put the industrial economies back on a path to solvency.

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