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Monday, 7 October 2013

Dutch Court of Audit: Exposure of Dutch government to international financial institutions through state guarantees, multiplied tenfold since the start of the crisis! Remember: State guarantees won’t cost the taxpayers one cent… until they do!

Last Monday, 29 September 2013, the Dutch Algemene Rekenkamer (i.e. Dutch Court of Audit) presented a report concerning the exposure of The Netherlands through state guarantees. 

The Dutch state has a large exposure towards international financial institutions, as the ESM [see the explanation in the footer of this article - EL], the EFSF and 6 others. Since the start of the crisis, this exposure has multiplied more than tenfold. The following snips come from the English press release of the Court of Audit.

Since the start of the credit crisis in 2008, the Netherlands' financial ties with the international institutions that are assisting European countries and banks in financial difficulties have grown considerably closer. The Court of Audit has studied the financial ties between the Netherlands and eight of these institutions, their financial profiles and the measures they have taken to mitigate the risks.


The financial volume of the guarantees and interests that the Netherlands has given to the eight institutions audited has increased more than tenfold from €18.5 billion in 2008 to approximately €201 billion in 2012.

This substantial rise has been accompanied by an increase in the lending capacity – and thus risk-taking – of the international institutions. The risks may ultimately be passed on to the countries that have given guarantees, such as the Netherlands. We therefore think it is important that parliament has a realistic insight into the risks that are being run, the measures taken by the institutions to mitigate them, the institutions' capital buffers to cushion losses and the size of the risks to the Netherlands.

Since this information is not yet available in an orderly and comparable fashion, the report provides the following information on eight international institutions [a.o. ECB, EFSF, EFSM, ESM, EIB, IMF and EBRD - EL]: 
  • the institutions' financial ties with the Netherlands;
  • the institutions' financial profiles;
  • the institutions' risk mitigation measures. 

Information on an institution's risk profile is necessary when a guarantee is given or amended because a guarantee may have to be honoured.

The Minister of Finance could have informed the House of Representatives more specifically and concretely about the purpose, term and risks of the new or amended guarantees.

Since Prinsjesdag 2012 (i.e the annual day of the King’s speech and the state budget presentation) the Minister of Finance has included a comprehensive risk analysis in the national budget and the central government accounts to explain the risks to public finances.

We recommend that the minister enriches the information provided in the risk analysis with an opinion on the financial health of the institutions and the financial risks to the Dutch budget.

This would be in keeping with the recommendation made by the Risk Arrangements Committee that a separate section be included in the ministerial budgets to explain risks, whether the ministry has formed a reserve in its budget and, if not, how it will deal with any losses and how risks are mitigated.

We recommend that when new financial arrangements are proposed, the Minister of Finance informs parliament promptly and explicitly of:
  • the considerations underlying the proposal (why this particular arrangement?);
  • the specific relationship between the Netherlands and the institution concerned (what precisely is the term and what assets and events are being guaranteed?);
  • how the guarantee would change the institution's financial profile (how does the new guarantee affect the institution's lending capacity and the risks to the Netherlands as a 'participant'?). 

In spite of the stately language by the Dutch Court of Audit, there is not a single word in this advice that could be misinterpreted. The message is crystal-clear: in name of the Dutch state, Finance Minister Jeroen Dijsselbloem and his predecessors have handed out huge financial commitments towards a number of European financial institutions. Commitments that multiplied more than tenfold in value in just over five years  

Therefore the Dutch parliament – and thus the Dutch tax-payers – have the right to know how rock-solid these financial institutions and their underlying collateral are (see red and bold text). Regarding this desire, I totally agree with the Dutch Court of Audit.

I read the official reply from the Finance Minister towards the conclusions and recommendations of the Court of Audit. Dijsselbloem seemed not very pleased with these conclusions and recommendations.

His reply contained a lot of mumbo-jumbo about the correctness of the financial/economic data and technical discussions about the heritage and goals of the mentioned financial/economic instititutions, seemingly to put the independent reader to sleep.

Nevertheless, I was able to filter some information out of Dijsselbloem’s reply that was akin to an answer. I will print these lines (translated from Dutch by me) and will add my comments to it.

Dijsselbloem c.s.: The Dutch financial interest in the eight institutions was exceptionally high in 2012, due to the joint Dutch guarantees for the temporary emergency fund EFSF and the permanent emergency fund ESM, which combinedly cover more than 50% of the total amount involved in the investigated guarantee-arrangements.

Since the EFSF will not enter into new lending programs anymore, from July 2013 on, the Dutch guarantee ceiling for the EFSF can be lowered substantially. As you have seen in the State Budget for 2014, this guarantee ceiling has been brought back to €49,6 billion from €97,8 billion, from 2013.

My comments: I don’t understand one bit of this statement:
  • Either the EFSF has not lended to financial institutions at all and then there is nothing for the Dutch government to warrant anymore;
  • Or the EFSF actually DID lend large amounts of money to EU governments and financial institutions and then the Dutch state is still on the hook for its share of the risk. 

Probably some lending programs have ended before or during 2013 and then the reduction of the Dutch guarantee ceiling is justified. However, the latter does not become clear at all from Dijsselbloem’s reply.

Dijsselbloem: The recommendation of the Court of Audit, to enrich the risk-analyses with a statement upon the financial stability of individual institutions and the risks that this institution brings to the Dutch state budget, goes further than what has been proposed by the Committee Risk Arrangements. I have some serious objections against this recommendation.

I am of the opinion that the indicators, which are used to set up a risk profile in your draft report – availability of collateral and the status of preferred creditor – will not always lead to an unambiguous judgment.

My comments:  Yet another strange notion from  the Finance Minister. If a financial institution holds collateral from the borrower and it has a preferred creditor status, it has a reduced risk profile in comparison with financial institutions that don’t have both securities in place.

Of course, it is the quality of the collateral that counts, but having it is always better than having none at all. And the difference between being a prefered creditor or not, is like the difference between being first in line or last in line at a one-off Rolling Stones concert.

Dijsselbloem: From the absence of ‘risk-reduction through the availability of collateral’ and a prefered creditor status at the EFSF, people could jump to the conclusion that the risk-profile of the EFSF is substantially higher than at the other institutions.

In this matter is relevant, however, that although the EFSF doesn’t know a formal prefered creditor status, like the ESM does, in practice the EFSF loans will have a high level of preference, due to the guaranties that have been supplied to the EFSF by national governments.

My comments: In plain English: the EFSF will get its money back, due to the guarantees supplied by the national governments in the EU. These governments will enforce that the EFSF gets its money first in case of a default or bankruptcy, even if it doesn’t have a formal right to it.

Well, I am curious how the official prefered creditors of the financial institutions needing EFSF funds, will react to this ‘statement’ by Finance Minister Jeroen Dijsselbloem. If I would be such a prefered creditor institution, I would immediately ask for some extra collateral from the debtor in question and hire a few lawyers, just in case…

Dijsselbloem: A public judgment upon the financial solidity of an international instituion, based upon prudential standards, could have negative consequences for the creditworthiness of this institution.

This explains why certain boundaries should be observed in case of capital raises and replenishments of funds for the investigated international financial institutions, when it comes to the amount of detail in which the variables of creditworthiness and operational capacity should be related to prudential ratio’s.

Based upon these considerations, I am of the opinion, that I should restrain from an all-embracing judgment upon the financial solidity of a financial institution and its risks for the Dutch state budget.

My comments: Hush! Talking about these institutions already makes them weaker.

If you compare the creditworthiness and financial stamina of these institutions to normal, prudential ratios for normal banks and financial institutions, people will know / understand that the financial firepower of these financial institutions is based on too many guarantees from national governments and too little real money, which is available for funding them.

In other words: these institutions are a suitcase full of IOU’s, as we know such from the great movie 'Dumb and Dumber'.

As long as everybody believes that the emperor does have clothes on, then heck, does he indeed have clothes on: a fairytale will be held for the truth as long as most people are willing to believe it. 

However, when a ‘darn young boy’ questions the invisible clothes of the emperor – in this case the creditworthiness of these financial institutions - , than the emperor (aka the financial institutions) might be exposed forever.

Finance Minister Jeroen Dijsselbloem decided to ‘forever hold his peace’ about the suitcases full of IOU’s, which the mentioned financial institutions are, in my humble opinion

And that is not a very comforting thought, as you know my adage: ‘State guarantees don’t cost the tax-payer one cent…, until they do’.

Finding your way in the Alphabet Soup:
  • ECB    - European Central Bank
  • ESM    - European Stability Mechanism
  • EFSF   - European Financial Stability Facility
  • EFSM  - European Financial Stabilization Mechanism
  • EIB    - European Investment Bank
  • IMF    - International Monetary Fund
  • EBRD  - European Bank for Reconstruction and Development

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