Solvent countries are all alike; every insolvent country is insolvent in its own way

You leave the computer switched off during the holiday weekend, and look what the Eurozone does while you’re away! I guess we don’t know yet what the final outcome is going to be in Cyprus, and I fully share Sharon Bowles’ hopes that we haven’t seen the final word yet.

But if small depositors are going to take a hit, then, as a reminder of what we will have lost, here is a handy set of links to various EU documents and regulations regarding banking deposits. This citizen’s summary which reflects the media reports of the time helps explain why people have persisted in leaving their money in peripheral European banks for so long. It seems mad to tear this guarantee up on the grounds that Cyprus is sui generis, since as Tolstoy (almost) said…

Update: Tuesday morning, and we still don’t know what is going to happen; maybe the guarantee for savings of less than €100,000 will be honoured. But I fear that Karl and the many other commentators weighing in on the issue this morning are right, and that the long run reputation of the EU’s claim to guarantee such deposits will suffer a big hit as a result of this debacle, no matter what ultimately happens.

Comments

comments

29 thoughts on “Solvent countries are all alike; every insolvent country is insolvent in its own way”

  1. If Serious People keep insisting that mortgage holders should be on the hook 100% and that bond holders should get back 100% of their investment and that the ECB must absolutely not print any extra money – well, the money has to come from somewhere.

    Eventually some bright spark is going to realise they can tax mortgage holders.

  2. It may be useful to add a link to what the Eurogroup actually agreed with Cyprus.

    http://www.eurozone.europa.eu/newsroom/news/2013/03/eg-statement-cyprus-16-03-13/

    Notably;

    “The Eurogroup further welcomes the Cypriot authorities’ commitment to take further measures mobilising internal resources, in order to limit the size of the financial assistance linked to the adjustment programme. These measures include the introduction of an upfront one-off stability levy applicable to resident and non-resident depositors. Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders. The Eurogroup looks forward to an agreement between Cyprus and the Russian Federation on a financial contribution.”

    What is at issue is not a failure by an EU government to honour a legal guarantee on deposits in the event of a bank failure but a taxation measure adopted by a sovereign government (of which there is no shortage of examples).

    Were all the banks in Cyprus to fail – which is not beyond the bounds of possibility – the question of the means available to the Cyprus government to honour the existing guarantee would be rather up in the air, to say the least.

    As market reaction today has demonstrated, there is no evidence of any systemic risk being posed for the euro. The debate in the Bundestag – to take the leading parliament dealing with the other side of the coin – may well centre on whether any assistance should be provided!

  3. I don’t see quite the relevance of the links to depositor protection to bank default. This case concerns a special official levy. And if public budget deficits are extraordinarily large and persistent, you don’t have to be an economist or even an economic historian to figure out that there will be a payback time, somehow or other.

    There are a number of special government levies I can think of since the 1950s in European countries, up to the foundation of the euro. Budget deficits and debts were much lower for these countries than today, but they also faced tougher external financing constraints than euro area countries today.

    This would be a great topic of research for a budding economic historian! Admittedly though, getting the sources would take some hard work… I’ve tried a bit; online information is poor… all these episodes happened before the internet took off. But that’d be economic history research quite pertinent to today’s troubles.

    Each episode I know of was quite different. What they have in common though, is that a sovereign, with its back up to the wall, can find internal resources, if it really wants to. It is rather the period since 1999 that has been special (i.e. no special levies, up until now). Since 1999, euro area sovereigns, instead of cutting spending / raising taxes (and special levies), have been looking instead for “solidarity”; meanwhile large and persistent public budget deficits weigh on the long term potential for growth.

    Again you don’t have to be an economist or even an economic historian to figure out that there will be a payback time, somehow or other, for these years of hysterity.

  4. @DOCM

    “What is at issue is not a failure by an EU government to honour a legal guarantee on deposits in the event of a bank failure but a taxation measure adopted by a sovereign government ”

    A rather peculiar taxation measure. One that taxes a citizens assets if held in banks in his own country, but lets the citizen off Scot-free if those assets are held in some other country banks.

    The ‘markets’ will take a little time on this, but the message is clear. If you
    do not want to be subject to an imposed levy, put your funds, if you have any, in a country and currency not subject to EZ mismanagement.

    If it was a genuine taxation measure, it would have hit all bank creditors and all deposits of Cypriot citizens, wherever situated, at least in the EZ.

  5. And let me add that I certainly don’t see such a levy as in any way likely anywhere else over the coming years. Nor will it ever be a need, as long as policies of prudent fiscal management continue to be followed. The banking problems in Cyprus grew over many years (atrocious BICRA numbers from S&P already in 2007-8) and was always a special case.

  6. “As market reaction today has demonstrated, there is no evidence of any systemic risk being posed for the euro.”

    Market reaction this week is one thing, and perhaps things will go well. This does not avoid the possibility that this precedent will add to market instability / bank runs in the run up to long weekend “bail out” negotiations with Portugal, Greece, Spain, etc.

  7. @docm

    “What is at issue is not a failure by an EU government to honour a legal guarantee on deposits in the event of a bank failure but a taxation measure adopted by a sovereign government ”

    I don’t think so, I think you are missing something.

    Prior to the announcement of a ‘levy’ in Cyprus the deposit making EZ public, and for some, their financial advisers, perceived that there was a guarantee of 100% of 100,000, that this was “risk free”.

    Post the announcement, it has been flagged up for the more astute among them (a significant portion of the rest will follow) that, like the Maginot Line, the guarantee can fairly easily be circumvented if push comes to shove. They are now aware that the ‘deposit guarantee’ is, as you are careful to state merely applies “in the event of a bank failure”. It does not protect the depositor in any way from losses of deposits taken in the form of a ‘levy’ or ‘tax’ to PREVENT the failure of an insolvent bank.

    You also comment:

    “As market reaction today has demonstrated, there is no evidence of any systemic risk being posed for the euro.”

    This is a bit like getting a phone call advising you the brand of brake pipes used in the car you are driving along in has been found to be manufactured from a material which does not meet the designer’s specifications and has been known to fail when the brakes are used hard. However, because the road you currently survey from the drivers seat is empty of traffic and straight, you decide there is no evidence of systemic risk.

    The point of deposit guarantees is that as and when and if there is an atmosphere of credit crisis, the principle systemic risk is that of bank runs, and deposit guarantees negate the reason for ordinary depositors to pull their savings. There is currently the very opposite of the sort of market sentiment that can occur during a market crunch. Investors are currently about as gung ho as they ever get.

    That damping mechanism for potential EZ bank runs has now been undermined at least partly. Bank deposits are guaranteed until and unless expediency dictates that they are not. The loss will be via a ‘levy’ rather than a liquidation though.

  8. @ grumpy

    What you say would be correct if the EA was a federal state with the equivalent of the FDIC. The fact is that it is not. All the guarantee schemes, although agreed at an EU level, remain a national responsibility and their perceived soundness is a function of the perception of the soundness of the sovereign.

    I pointed out on the other thread that the action in respect of depositors in Cyprus marks a turning point IMHO with regard to the management of the euro but not in the manner that most assume. Responsibility for national banks remains, and will remain, with the sovereign, only large banks still in the international arena and representing a genuine systemic risk will become a shared EA responsibility.

    FYI

    http://www.guardian.co.uk/commentisfree/2013/mar/18/cyprus-wealth-tax-good-thing

    I would question the rather heroic assumption about economic growth in the bailed out countries recompensing Germany had the bailout been by way of grant rather than loan. In any case, it is not how the international financial system works. But the basic point made is sound.

    Incidentally, contrary to the view expressed by KW on RTE this evening, I do not see how developments in Cyprus help us in relation to the legacy debt issue. Quite the contrary, in fact.

  9. @DOCM

    ““The president is not going to discuss this plan because he wants a solution that will come from the EU,”

    It doesn’t sound like a no to me. The Russians are in the driving seat.

    So, the Russians get Cyrpus, its banks and its gas reserves. All for no cost. Gazprom will simply shift some deposits from an EZ core bank to Cyprus.
    All because Schaeuble wanted to skin the Cypriots for €7 billion.

  10. @ Joseph Ryan

    I don’t think it is that black and white. Incidentally, you may find it interesting to google Schroeder+Gazprom for some of the more intriguing background.

  11. @docm

    Given that I think you know that I know the EA is not a federal state, which part of my typing above do you think is incorrect?

    With regard to

    “All the guarantee schemes, although agreed at an EU level, remain a national responsibility and their perceived soundness is a function of the perception of the soundness of the sovereign”

    The whole point of the guarantees is that the money weighted average investor thinks that there is rather more of an implicit guarantee than this and/or the relevant sovereign would be stuffed with long term “official sector” (yes, I know) debt to whatever extent were necessary to allow the guarantees to be fulfilled – or rather the banks in question to be recapped (recently learned behaviour).

    There are plenty of cynics like me who would largely concur with your statement – but letting everyone understand that rather defeats the PR point of the guarantees.

  12. – The Greek PSI was voluntary.
    – The Cyprus deposit guarantee scheme was not subverted; instead a needed revenue-raising measure was introduced.
    – It’s unique and exceptional, just a one-off – I guarantee it – trust me.

    OK – no matter how hard I try to get into the Ciaran O’Hagan/DOCM mindset and repeat these mantras, it just isn’t working for me. Perhaps there’s a re-education camp somewhere that I could go to that might help.

    The rules of the game are pretty simple:
    – All private bank losses are firstly the responsibility of the local sovereign
    – EU backed money will be lent to a sovereign to cover all liabilities (sovereign and bank-related), up to the “magic number” limit that denotes “debt sustainability”. This is apparently about 120% debt/GDP.
    – If your debt exceeds that limit then PSI will be mandated by the EU lenders, in an amount that shows the trajectory to the magic number limit can be met in some “reasonable” timeframe.
    – He who controls the growth forecasts and magic number determination, controls the outcome.

    Whether bank deposits in other countries will be hit in the future has little to do with whether they are like Cyprus or not, and everything to do with the rules above. Some countries are hovering close the magic number limit already (e.g. Ireland), so there’s very little headroom if more EU money is needed. Also the magic number limit may be lowered over time, to bring the “debt sustainability” limit closer to what is envisaged by the Fiscal Compact.

    Now you could do your sums and make your projections and conclude that on balance the risk/reward is just fine and there’s no need to worry. However the argument that it couldn’t happen in county X, because Cyprus is “unique” and “exceptional” is simply not credible. It can be put into the large bucket of not credible things that includes growth forecasts made by the EU Commission, the protection offered by your DGS scheme when it is most needed etc.

  13. Brian G,
    You should not joke about camps, reeducation or otherwise. The Eurobots might take you up on your offer. Compulsory study of the Treaties in the morning followed by study if the increasingly Alice in Wonderland policy edicts in the afternoon.

  14. @ grumpy

    The best answer is probaably to link to the US organisation in question.

    http://www.fdic.gov/

    There is no equivalent in the EU and no likelihood of any such being created because, as far as I can see, there is, at best, a dubious legal basis in the current treaties for such an operation and no willingness in any case either among European governments or banks to tackle the problem either in terms of institutional changes or substance.

    The perception of the soundnes of the sovereign is, as you say, linked to the “official sector” debt which is in turn linked to fulfilment of the associated conditionality requirements. Which is brings us back full circle to the choices facing the Cypriot parliament.

  15. @ Bryan G

    “Whether bank deposits in other countries will be hit in the future has little to do with whether they are like Cyprus or not, and everything to do with the rules above.”

    “However the argument that it couldn’t happen in county X, because Cyprus is “unique” and “exceptional” is simply not credible.”

    Agreed with regard to the first contention which, however, seems a bit at odds with the second. I certainly have not argued the latter. Indeed, I see a lot of merit in the argument advanced in the Guardian link above (all deposits under a certain limit being, of course, excepted).

  16. @ Ciaran O’H

    “I don’t see quite the relevance of the links to depositor protection to bank default.”

    I have been following the site for a couple of years and have been impressed by Ciaran’s contributions. However his post earlier which started with the above shocked me. What does he think depositors want protection from ? Flooding or subsidence?

  17. @DOCM

    If you are going to subvert a deposit guarantee scheme or take similar action, then a couple of things are necessary.

    (1) You must keep everyone in the dark until the last minute (this includes the government of the relevant country).

    The Troika and Cyprus were in negotiations for a long time. Some elements, such as the increase in corporation tax had already been agreed. Here’s what a Cypriot presidential advisor said last Tuesday

    Pissarides also said that Cypriot authorities are “almost certain” that the prospective bailout creditors fellow eurozone countries and the International Monetary Fund will not ask that Cypriot bank bondholders or depositors share the cost of a bailout. He said they recognize that such a move, which European officials have in the past ruled out, would destabilize financial markets in Cyprus and across the other 16 EU countries that use the euro.

    Asked about a possible Eurogroup meeting it was reported “However, spokeswoman for Eurogroup chief Jeroen Dijsselbloem, Simone Boitelli said that no new session had been currently scheduled”

    72 hours later there had been a meeting and the deed was done.

    (2) You need to begin the PR campaign to enable (1) to take place again, should that be necessary. An element of this is to focus on all the things that make Cyprus different, and away from the common policy framework that exists, and into which a country could fall, if “growth disappoints” for example, or NPLs get bigger etc.

    The discussion should be about what the thresholds/magic numbers are, how close or far a country/bank is from the threshold, and the form that PSI would take if needed. I’d agree that my second contention above isn’t clear – the assertion that Cyprus is ‘unique’ needs to be accompanied by the relevant numerical data, and the growth/NPL forecasts assumed, compared with another country. This never happens though. From memory a 1% decrease in Ireland’s projected growth rates would bring Ireland into a Cyprus-level 140% debt/GDP ratio. What happens then?

    Also it is worth pointing out that for 2bn, the 100% protection on DGS could have been preserved (i.e. non-insured pay 2bn more). It also appears that the EU Commission, not just the Cypriot government, wanted to hit small savers. I guess you should never underestimate the EU’s ability to snatch defeat from the jaws of victory.

  18. Some seem to believe that raising concerns about money laundering and the large proportion of deposits held by non-residents, is being used as the main reason for the crisis.

    As with Ireland, this crisis did not appear suddenly out of the ether. Poor governance, the lack of banking regulation, the link with the Greek economy and several other factors were in play.

    There is this thingy called parliamentary approval in some EMU countries and it’s naive to think that a prime minister could say that he or she believes assurances given by X or Y.

    In some countries there is citizen concern about getting value for spending of taxpayer funds.

    It’s reported that in Germany both the SPD and Greens declared that Cyprus must abandon its current “business model” of providing a tax haven for wealthy Russian depositors, in particular, before they would approve any rescue. The idea of a “haircut” for uninsured depositors came from the SPD.

    It would be fun to see Angela Merkel saying there’s no evidence at all at all about underhand dealing.

    Then all Peer Steinbrück, candidate for chancellor, need do is to pull a few rabbits from a big hat!

    Ciarán O’Hagan makes a good point about payback time and of course it is already happening in the business world and again size often matters as it does with countries.

    The Examiner group got rid of a long-term print contract by arranging a legal manoeuvre with the agreement of State-controlled AIB.

    Jobs in the bigger group maybe protected while jobs in Webprint are expendable.

    @ grumpy

    There is a perception that deposit insurance is free.

    In Ireland there’s a requirement to deposit 0.2% of deposits in the Central Bank. Where would that go in a crisis?

    Whose going to pay the big rises in regulatory costs?

  19. @ Bryan G

    To be frank, I do not see much to be gained in analysing who said what to whom. It is a fluid negotiating situation and the outcome is what matters. The main negotiation at this stage is between the political parties in Cyprus.

    What makes Cyprus unique has little to do with comparisons of economic models, as many of the contributions on this and the other thread make clear. If there is a uniting factor with other countries it is that identified by the FT in its recent leader i.e. small island countries that allowed their banking sectors to balloon out of control leaving the bill with the ordinary citizen.

    As to the impact on the euro, the FT had this comment.

    http://www.ft.com/intl/cms/s/0/16fbd550-8ff9-11e2-9239-00144feabdc0.html#axzz2NyQxlvoW

  20. Cyprus is in trouble to a large extent due to the bail out in Greece, which caused large write offs for the extremely large banking sector. Now the Cypriot bail in/out might just spill back over to Greece.
    http://gqjftw.blogspot.de/2013/03/cyprus-update.html

    @Michael Hennigan – Finfacts
    All German parties except for Die Linke, who will vote no no matter what, wanted the large depositors to pay to decide for the bail out. Merkel does not have enough votes of her own (a lot of deviators on the bail out question) so she needs the oposition. Still Schäuble could have if he wanted stopped the tax on smaller deposits. (we can veto any bail out in the ESM). He didn’t. Now he blames everybody else.

  21. Hitting depositors demonstrates how misunderstood the monetary system really is.

    First of all very few Cypriot deposits would have come from people depositing cash with the bank. Most ‘deposits’ would have been created when the banks processed loans because banks create the money they lend by simply typing a new bank balance for the borrower. In doing so the banks gain a new liability (The borrower’s bank balance) and a new asset (The borrower’s debt).

    Because banks only create the principal of the loan and expect the principal plus interest back it’s just not possible for all loans to be repaid. It’s systemically inevitable that people will default no matter how careful the banks are.

    Once someone defaults the banks lose an asset (the borrower’s debt) and the proposed solution is to lower people’s bank accounts such that the banks lose some liabilities.

    The money that is ‘taxed’ won’t exist anymore. How is canceling money out of existence a solution to a financial crisis? Our economist/journalists should highlight this very important point. If anyone wants more information on how money is destroyed our paper on the subject can be downloaded at;
    http://sensiblemoney.ie/data/documents/How-Money-Is-Created-And-Destroyed.pdf

    It’s just so important that our journalists and economic advisers understand the monetary system. Otherwise ‘solutions’ like this are on the table.

  22. What is Europe’s plan B if the Cypriot govt cannot find the votes. Are the FANGS willing to destroy the EZ and the project for about 3bn euros-the shortfall from the small depositor?

  23. @Tull

    Past experience suggests they’ll cop on and pull away from the cliff but not before having a good gawk at the blue water below

  24. Karl observes in his article that Ireland’s citizens must be feeling foolish today: “After being reassured time and again that all depositors and senior bond creditors of … Anglo Irish Bank must be saved in the name of European financial stability, they find out that Europe’s leaders now believe hair-cutting depositors is fine and fair and doesn’t cause contagion.”

    In a related dynamic, there appears to have been a subtle turn by many commentators (including on this site) from the “serves them right” school of economics. That School, most righteously established by LBS, argued that Irish taxpayers should carry the can for bank losses because they “should have” sought better supervision on banks. Many from the same School now appear to argue that depositors (creditors) “should have” been more careful in the Cypriot case and deserve to suffer for their stupidity. Serves ‘em right!

    Of course, there is a practical limit on the burden that Cypriot taxpayers can bear in this case but such considerations never bothered the LBS School before. Do they now grant that Irish taxpayers were not fully “to blame” (and that burden-sharing from bondholders was warranted)?

    Would they now agree with Karl that “the moral grounds for a retrospective compensation deal for Ireland have increased substantially with this new development?”

    The problem with theorizing from morals, of course, is that the ground can shift (and come back to meet you).

  25. @DOCM

    To be frank, I do not see much to be gained in analysing who said what to whom. It is a fluid negotiating situation and the outcome is what matters. The main negotiation at this stage is between the political parties in Cyprus.

    The quotes demonstrate that the Troika-Cyprus negotiations were held in bad faith. Bad faith dealmaking leads to poor and unsustainable outcomes, which is exactly what has happened. Everyone is now trying to row back and blame someone else.

    As pointed out by Brick above and others, the problems in Cyprus were mainly caused by Greece. Banks in Cyprus were required to hold large portions of foreign currency/non-resident deposits in liquid assets, and what better liquid asset to choose than a nice investment grade A1 rated sovereign bond (Greece). Cyprus banks also lent heavily into Greece. Since the Greek economy has fallen off a cliff, it took Cyprus down also – demand has collapsed there since Greece blew up.

    I’m all for PSI applied in accordance with the way the rules were supposed to work, but the plan produced was a travesty of a proper plan as it

    – subverted the explicit deposit guarantee
    – upended the creditor hierarchy (inter-bank deposits and senior bondholders not hit)
    – failed to distinguish between good and bad banks
    – hit creditors based on region and not bank (Greek PSI losses were allowed to bleed into Cyprus, but Cyprus PSI losses not allowed to bleed into Greece, as foreign branches and subsidiaries are exempt)

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