Andrew Rosenberger, CFA, Brinker Capital
History is littered with examples of “unintended consequences” – a term referring to the fact that decision makers (and more importantly, policymakers) tend to make decisions that later have unforeseen outcomes. I was reminded of such a fact this weekend as my wife and I launched into our annual (and seemingly unending) springtime yard cleanup. In addition to the mulching, planting, trimming, and other routine undertakings associated with yard maintenance, every year, we spend more time and money than I care to admit trying to rid our yard of the dreaded English Ivy. As any other homeowner with a similar problem can sympathize with, there is no amount of weed killer, weed-whacking or online product remedies that seem to tackle the problem. Our English Ivy problem is the unintended consequence of the prior homeowners’ decision to turn their yard into an “English Garden”.
On a much grander scale, unintended consequences pop up everywhere. Most go unnoticed by the broader public. As one such example, The Wall Street Journal recently ran an article titled “U.S. Ethanol Mandate Puts Squeeze on Oil Refiners”. The article highlighted that consumers could see higher prices at the pump due to government enacted mandates that force refiners to purchase market-based ethanol credits. The original idea was that increasing the amount of ethanol used in gasoline would make gasoline cleaner burning and be better for the environment. However, since the policy was enacted, two unforeseen issues have unfolded. First, prices for these ethanol-based credits have skyrocketed in the past few months. The higher ethanol credit prices mean that refiners will be forced to pass along higher prices for gasoline to the end consumer. Second, automakers are suggesting that cars and trucks aren’t well equipped to burn the new gasoline blend. As a result, we have a policy that was intended to produce cleaner burning gasoline which ultimately turned into higher gas prices for a product which most cars aren’t able to use.
The reality is that the vast majority of consumers will never be informed of policy misstep. Only industry experts and select individuals with knowledge of the matter will truly understand the costs involved. Sometimes; however, unintended consequences have a much more visible impact on the broader economy. That’s been the case over the past two weeks as policymakers have tried to tackle the banking problems in Cyprus. If we rewind to last year, Greece was the conversation of topic. Ultimately, policymakers decided that private sector bond holders should bear the brunt of the losses on Greek debt. Fast forward to today and we have insolvent Cyprus banks. Why? Because Cyprus banks, which were one of the largest holders of Greek debt, were forced to write-down their assets. So while at the time the policy of having private sector investors take the loss on Greek debt seemed like a good idea, ultimately the unintended consequence was that it would later result in Cyprus banks becoming woefully undercapitalized.
The European Union’s response to the Cyprus banking issue was subsequently just as perplexing. As initially proposed, depositors, regardless of their size, would be taxed to cover the insolvency of the local banks. Ultimately, while the policy was later reversed to preserve deposits below €100,000, the sanctity of small deposits suddenly disappeared. Most market pundits will agree that Cyprus is too small and irrelevant in the grand scheme of things to bring down the European economy. I worry, however, that the unintended consequence of Europe’s policy response will make depositors in other peripheral countries a bit more anxious when it comes to where they store their money for safekeeping. After all, one of the tenants within economics is that if two investments have equal return, investors will choose the one with lesser risk. With interest rates near 0% across the developed world, wouldn’t it make the most sense for depositors to store their wealth in a place with little chance of future default? While we often like to believe that these matters are completely thought through and weighed carefully by policymakers, unfortunately, this most recent policy decision appears to driven more for domestic political purposes as opposed to European “Union” driven.