Rules for thee, but not for me
Government and central bank rule-bending undermines financial stability.
In a nutshell
- Authorities frequently break financial rules for expediency
- Selective rule-breaking erodes trust and distorts markets
- Ignoring fiscal discipline risks political instability and economic damage
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The Euroatlantic political, economic and financial system, with its complex web of regulations, strict rules and draconian institutional oversight, ultimately relies on a foundation of trust, that is often taken for granted. This confidence and stability of the financial markets hinges on the assumption that the rules apply to everyone equally, universally and consistently.
However, time and again, governments and central banks clearly demonstrate a willingness to bend, reinterpret or outright break the rules when faced with economic crises or political pressures. The authorities are astonishingly quick to find loopholes or exemptions to their own rules to navigate the day’s challenges.
This is all playing out today in Germany, the European Union’s largest economy. The government fell in November due to questions about whether it should adhere to the country’s constitutional spending limits. On February 23, German voters will head to the polls to elect a new government that must decide whether to uphold or break the country’s rules as Berlin seeks to address current global challenges.
Unilateral and mercurial rule-breaking erodes credibility, destabilizes markets and fosters a dangerous culture of moral hazard.
But as we saw during the pandemic, it goes much further than fiscal and monetary policies alone. The lockdowns, forced business shutdowns and extreme restrictions on every part of private life were as extreme as they were constitutionally and legally preposterous.
While the powers that be justify such actions as imperative “emergency measures” or as necessary for stability, the long-term consequences are arguably as dangerous as the crises they initially try to fend off. Unilateral and mercurial rule-breaking erodes credibility, destabilizes markets and fosters a dangerous culture of moral hazard. Most worryingly, it creates an uneven playing field that favors large, so-called “systemically important” entities over ordinary taxpayers, savers and investors.
A pattern of rule-breaking
Recent history offers numerous examples of central authorities selectively disregarding or even openly violating their own rules. Although the cases go much further back, one of the most memorable examples was undoubtedly the handling of the 2008 financial crisis and the associated “too-big-to-fail” bailouts. The rule-bending and -breaking was so blatant that it sparked widespread public outrage, not only in the United States, but around the world too.
Nevertheless, this outrage did nothing to prevent a similar approach from being adopted during the eurozone crisis just a few years later. It was a case of rule-bending rather than outright breaking. But let us not forget about the 2013 deposit “haircuts” in Cyprus and the capital controls imposed in Greece in 2015, demonstrating the consequences of ad hoc rule-making and breaking.
This pattern of breaking the rules to satisfy political ends still holds; the latest example is the fiasco surrounding Germany’s ‘debt brake.’
In Cyprus, depositors were effectively robbed, as funds from their accounts were seized, expropriated and used to bail out the heavily indebted government. This unprecedented move shattered trust in the banking system. In Greece, capital controls were introduced to prevent a banking collapse, leaving citizens and businesses grappling with liquidity shortages and forcing countless ordinary households into dire financial straits. These measures, while arguably necessary in the short term, eroded confidence in the eurozone’s commitment to protecting depositors and maintaining financial stability.
Another glaring example was the 2020 Wirecard scandal and the German government’s response. Even though the whole debacle − fraudulent accounting to inflate profits − was a flagrant regulatory oversight failure from the start, it was massively compounded by Berlin’s decision to restrict short selling the stock. That, in turn, actively shielded a fraudulent enterprise from the organic and necessary scrutiny that a true free market would otherwise deliver. This arbitrary, selective and clearly preferential decree not only undermined public faith in the notion of the rule of law but also exposed the inconsistencies in regulatory enforcement.
The Covid-19 crisis amplified this practice. Fiscal rules and basic principles were openly disregarded to allow for unprecedented spending and stimulus measures, including direct cash payments to citizens. To prevent market panic, short-selling bans were also implemented in several European countries, including Italy, Spain and Belgium. This pattern of breaking the rules to satisfy political ends still holds; the latest example is the fiasco surrounding Germany’s “debt brake.”
Germany’s conundrum: To spend or not to spend
Enshrined in Germany’s constitution, the debt brake rule was designed to limit government borrowing and enforce fiscal discipline. However, mounting economic pressures led to its suspension, and the resulting political fallout contributed to the collapse of Germany’s coalition government. German Chancellor Olaf Scholz demanded a pause to the debt brake, something his finance minister and coalition partner Christian Lindner could not abide, so Chancellor Scholz fired him the same day, triggering a tsunami of criticism.
The debt brake, adopted in 2009 in response to the previous year’s financial crisis, can be suspended in extreme circumstances, as it was during the Covid-19 crisis. However, this time, the chancellor’s arguments that Russia’s war in Ukraine and climate change present equally urgent challenges were less convincing.
As many critics have pointed out, these are political problems of the same nature that every elected government has faced since time immemorial. They are tasked with solving them without resorting to cherry-picking their constitutionally delineated powers and limitations. Yet, in Germany, the rules may be redrawn. This incident underlines how even the most robustly codified fiscal rules can be circumvented when it is politically expedient, undermining both domestic and international confidence in governance.
Far-reaching implications
Every time a government or central bank decides to flout its own rules or change them on the go, it weakens the trust placed in them by the public and, often, irreversibly so. They also damage the fundamental mechanisms that support and facilitate a healthy economy. Take the short-selling bans in Europe, for example. While these bans temporarily prevented cascading market panic, they also eliminated a vital mechanism for price discovery, preventing investors from using important signals and adjusting to underlying risks.
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The mainstream press has long demonized short sellers as “vultures.” Yet such childish assessments ignore that some of these vultures have exposed some of the biggest frauds in the market well before regulators suspected anything was amiss. Short-selling bans create a skewed environment that leaves the broader market blind to essential risks.
Looking at this problem from a more long-term perspective, it is also clear that it strongly contributes to structural deterioration. When rules are applied selectively, they dramatically distort elementary economic incentives, as systemically important institutions – those deemed too big to fail – are often the primary and sole beneficiaries.
The 2008 financial crisis, for example, clearly demonstrated that the claim “no one is above the law” is patently false. Major banks engaged in reckless behavior, confident that government bailouts would shield them from the consequences of their actions. That is precisely what happened. In subsequent years, similar interventions have only further encouraged complacency and a lack of responsibility among large players while penalizing smaller entities and individual investors.
Scenarios
It is difficult to see how the present trajectory could be changed in the foreseeable future. Governments the world over have already dug themselves into a deep financial hole, and they continue to dig deeper by accumulating more debt and spending beyond their means for political gains. In other words, they need to break their own rules to sustain their “print and spend” approach to governing without defaulting.
The scale of misallocated capital, recurring market bubbles and today’s too-big-to-fail entities present such enormous threats to economic and political stability that all kinds of rules must be bent and broken to cover up the problems and postpone the inevitable.
We saw this during the last banking crisis and the collapse of Credit Suisse in 2023. The Swiss government applied unprecedented pressure and offered substantial incentives to UBS to absorb the failed lender and prevent a disastrous crisis of faith in Swiss banks in general.
Most likely: Authorities continue ignoring rules when it suits them
It is extremely likely that this approach of breaking the rules for political expediency will persist. This short-sighted approach will further weaken public faith in institutions, worsen inequality, and fuel resentment and division. At some point, however, the sentiment of mistrust and discontent is bound to morph into anger and trigger serious sociopolitical tensions.
It is very likely that the next “Occupy” movement will not fade into oblivion as quickly as the last, and it is conceivable that it will not be as peaceful. This could, in turn, force a political shift to more fringe ideologies, whether on the extreme left or right, leading to the adoption of even more catastrophic policies.
Less likely: Hard choices are made and long-term stability is bolstered
A possible, but much less likely, scenario is that change could come from the top. We could see renegade politicians take the lead and take necessary, albeit painful, steps to reign in their nation’s excesses so that they do not need to resort to the above-mentioned measures to stave off crises.
A good example is Argentina’s President Javier Milei. While he remains a controversial figure and the merits of his leadership so far can be endlessly debated, the fact remains that his focus on reducing debt and government waste is a policy priority we do not commonly see in modern democracies.
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