Bank guarantees: how to make matters even worse

I can’t quite believe that the EC has said this, but they apparently have. Unbelievable. Its obvious implication is that bank runs in troubled countries, if they ever happen, now risk being nation-wide, rather than limited to failing banks. Hat tip Eurointelligence, who call the statement hugely damaging, and Gavin Kostick in the comments.

Comments

comments

52 thoughts on “Bank guarantees: how to make matters even worse”

  1. Given that bank failure isn’t an option that has been given serious consideration up to now, the relevance and usefulness of the deposit guarantee schemes has been all but eliminated by trying to label the Cypriot depositor haircut as a “fiscal measure”.

    It will be next to impossible to get the toothpaste back in the tube on that one. Will the schemes have to be broadened to include insurance against taxation??

  2. The distinction between bank failure and fiscal measures is likely to become irrelevant. These clowns are likely to trigger widespread bank failures and, as a result, activate the very guarantees they are trying to avoid.

  3. I would like to inform you all of my new venture.
    Its car insurance product that I am sure you would all like to switch too.

    Basically we only pay out if your car is completely destroyed.

    It has to be reduced to the atomic level or we don’t pay out. But in the event that this does happen we will, promise!

  4. The 100K deposit guarantee was always there to protect the Eurozone financial system and not depositors (who are, comparatively speaking, little people). In this case the interests of the core European financial sector were better served by defaulting on depositors (though not bondholders, even in a token way) than by a completely state funded bank rescue. Deposit flight from smaller jurisdictions to larger ones is in the case a feature and not a bug.

    What is so hard to believe about policy being made on the basis of the dominant class interests of the dominant Eurozone powers?

  5. Why has Draghi been so silent in the past few days?

    The ECB is supposedly independent, or does he have to obey the dictates of Schaeuble/EuroGoup/IMF.

  6. Well, de facto deposits aren’t exempt already in the EU. There are wealth taxes in both France and Spain, and deposits under 100k are not exempt.

    With all due respect, many commentators sound like they’d be right at home in a European Tea Party. “The gubnint should keep its stinking hands off my Medicaid.” Taxes are alas a sad part of life, and it would be wonderful if there would be a little garden where taxes could not grow, but alas all European governments are up to their neck.

    If you would really run to your bank on the off-chance you’d be charged 5% on your holdings, then good luck to you, because you will lose far more than that to loss or theft.

  7. The EC is bound by its enabling legislation and the rules, regulations and policies that flow from that. Having worked for governments I can assure you if it was possible to do a partial bail out of Cypriots it would be done. If Cyprus can impose a levy on depositors and the EC provides compensation to the depositors it would immediately lead to every country in the EZ imposing levies on depositors.

    Simon O’Connor is on sound ground.

  8. Nouriel Roubini reporting Russian naval base on the table in talks with Cyprus. If this is true the Brits are as good as gone and NATO is in a shambles.

    Watch the tone of negotiations with the EC, EZ Group improve enormously, even the ECB will find solvent banks to aid.

  9. Why do we still record all the money in the economy as liabilities of the banking sector?

    The argument for recording bank balances as liabilities of the banks seems to arise from the outdated ‘money multiplier’ model of banking which is still taught in universities by our out-of-touch economists who insist on using cash analogies for digital money. The idea is that a customer deposits cash with a bank and the bank records the amount as a liability. All seems well. However the convenience of the chequebook allowed the liabilities of the banking sector to be used as money, money which even the taxman will accept.

    Surely when journalists talk about the ECB printing money it’s up to the economists to point out that the banks’ liabilities are really what money looks like today. (Think of the advances beyond the chequebook and cash forming 3% of euros)

    The negligence of economists deepens when you learn that most deposits don’t even arise from people depositing cash with the banks.

    Most ‘deposits’ arise from a customer taking out a ‘loan’ and the bank simply recording a higher bank balance for the borrower. The idea that these deposits have arisen from people depositing cash is just wrong. How could the cash money supply which forms 3% of money multiply into ‘deposits’ forming 97% of money in an era when banks don’t process loans in cash form?

    The fact that the banks’ liabilities are accepted as money and now form 97% of money is a relic from the days when your bank balance recorded an amount of a gold or silver or nowadays cash at the bank. The system is so outdated.

    Economists don’t seem to recognise that a reduction in debt to a bank destroys a ‘deposit’ also. This is why there’s less money during a recession and yet the only explanation from the subject of economics is collective saving. Hence also why reducing our debts doesn’t leave the economy in a better position.

    As an extension economists also don’t seem to realise that it’s not possible for the banking sector to behave prudently. Even if banks lent only to those with the highest credit rating it’s still the case that the economy only has the partial principal of every recent loan and yet it’s expected to pay the principal plus interest.

    When the economy finally can’t increase its rate of new loans over loan repayments the money supply shrinks and the proposed solution in this case was to cancel out some of the banks’ liabilities, and hence money. Again it’s unlikely the economic advisers involved understand the accountancy procedures that would have happened but if this ‘tax’ would have happened. The banks would debit their customers’ accounts, and credit a token account, probably their bad debts account. The result would be that the money wouldn’t exist anymore. With the Cypriot economy short on money how would deleting money for the sake of satisfying accountancy rules help?

    Under full reserve banking, bank balances would be recognised as the money they are, as opposed to an agreement from a bank to pay you money. The money of the economy would not be recorded as liabilities of the banking sectors. In today’s digital world to have 97% of the money supply at risk of deletion to satisfy accountants shows how out of date the system is.

  10. The FT reports Michael Sarris, finance minister, said in Moscow on Wednesday there was no breakthrough in his meeting with Anton Siluanov, Russia’s finance minister.

    “We had constructive honest talks,” he told reporters. “We understand how difficult the situation is and we will continue negotiations, in order to find a solution which would enable us to receive support from Russia”.

    He said he would “stay here” until an agreement was reached before meeting Igor Shuvalov, Russian deputy prime minister – a discussion that also failed to produce a deal.

    Cyprus’s interior minister warned that international lenders would not accept a “Plan B” being hatched in Nicosia. This involves nationalising pension funds and an emergency domestic bond issue to be backed by future revenues from an offshore gas discovery.

  11. On the original proposal from the EU to haircut uninsured depositors, the FT refers to the extent to which Cyprus’s political classes have defended foreign depositors.

    Erik Nielsen of UniCredit (an Italian bank) argues, depositors in Cyprus have benefited from higher rates of interest than elsewhere in the eurozone: “A Cypriot (or foreigner) who placed €100,000 in deposit in Cyprus in 2008 would by now have earned just around €15,000 more than if he had placed that money in Italy or Spain (and some €23,000 more than if he had placed it in Germany).

    Why does the Cypriot parliament (and many commentators) seem to suggest that a 15 per cent tax on such deposits (which would cover the bill also for the sub-€100,000 deposits) would be unreasonable now the banks are in trouble, but that German, Italian and other eurozone taxpayers should rather foot the bill? To me, the Cypriot position is simply unsellable in the rest of the eurozone.”

  12. “Nouriel Roubini reporting Russian naval base on the table in talks with Cyprus. ”

    The Turks would have something to say about that. They’ve invaded once for less.

  13. The high priests of the Euro say that guarantee on deposits doesn’t apply now to naughtie countries who displease their Odin.

    Giving due respect to the Northern Gods, someone needs to threaten the run the Cypriot Euro Presses.

    For, the prohibition on member states printing their own money to solve economic problems obviously shouldn’t apply to Athena.

  14. “”That is the distinction that we need to make, O’Connor said.”

    but the consequent:

    “…if we want Eurozone depositors to perceive that, in the event of a bank run, the deposit guarantees will be circumvented and they had better be early in the queue…”, he wasn’t bright enough to work out.

    Clowns.

  15. “Nouriel Roubini reporting Russian naval base on the table in talks with Cyprus.

    Maybe they’ll give up on the Alawis in Syria if that comes to pass. Assad gets great mileage out of Russia’s naval access to the Eastern Med.

  16. Was wondering about that Seafoid. Would be surprising, but you never know. The key player, Germany, likes to imagine all that geopolitical, militaristic stuff the US, UK and France are into is all just silly, old hat, academic, imperialist nonsense. There is nothing wrong with being dependent on Russia for energy supplies etc.

    Brits out of Cyprus – less need for UK deficit spending on defence.

  17. I was wondering about the Falklands as well, Grumpy. How much does it cost the UK in the age of Osbornomics? I’m sure that if push came to shove they’d override whatever the islanders want. They did it with Diego Garcia once.

  18. To be honest, this is what I expected to happen in Ireland four and a half years ago. At the time, I moved all my cash savings into non-Irish banks. I expected the Irish system to go bust, though, because they were all at it.

    What continues to surprise in Cyprus is the idea that an entire banking system should endure collective punishment, or rather, that the savers of the entire banking system should. There’s no talk to increasing every debt owed to the banks by 10% in a special tax? No talk of halving every bank workers’ salary?

    These are measures as ludicrous as the tax on depositors, but if it is going to be a collective punishment, then you really should punish more widely.

  19. @yoganmahew

    There’s no talk to increasing every debt owed to the banks by 10% in a special tax? No talk of halving every bank workers’ salary?

    These are measures as ludicrous as the tax on depositors, but if it is going to be a collective punishment, then you really should punish more widely.

    Ludicrous, are they? And, yet, in Ireland, bank workers’ salaries have been protected. It’s the public sector who got it in the neck repeatedly (because it’s easier to target 25% of the population than 100% of it). Which is even more ludicrous. But you, of course, were in favour.

  20. @ Frank Galton

    A trying experience for them without any doubt. Not that either has the right end of the stick. Or Asmussen, for that matter, but he is at least half right. The problem is that he does not see the mote in Germany’s eye.

    http://www.lesoir.be/210336/article/actualite/belgique/2013-03-19/vande-lanotte-et-coninck-portent-plainte-contre-l-allemagne

    If there is a continuing economic downturn ahead of the German federal elections, will the stratagem of kurzarbeit be again trotted out? Or can it credibly be?

  21. Who were the idiots who were in favour of the euro in the first place? It now seems such a disastrously bad idea and so ill-conceived. It could take another decade to unwind all the damage the euro project has done.

  22. Its an omnishambles. I wouldnt blame the cypriots for walking out of the EU, hangin up a shingle saying “dictators? Money laundered here”, flogging bays to the chinese and the russians and maybe the north koreans, and basically pulling the house down.
    And we , via our government “welcomed” this. What a bunch of idiots.

  23. @Frank

    no you’re wrong! He says if ONLY they had more women in management, things would be better!

    I keep meaning to fill out an application form for those state boards…..

  24. @Shay

    “What is so hard to believe about policy being made on the basis of the dominant class interests of the dominant Eurozone powers?

    Nope. Can’t identify any at the mo. “Finance” has, quite simply, captured all.

    @Gregory Connor

    “Who were the idiots who were in favour of the euro in the first place?

    Well, certain neo-kon groups in the U.S. have always perceived the Euro as a potential threat to the dollar. I could live with ‘well_intentioned idiots’ considering the flaws in the system, but the lack of a qualifier here signifies either sloppiness, intent or latent intent.

    Minor point: not all who were in favour of the Euro were ‘idiots’; then again, one may find not a few ‘useful idiots’ representing certain ‘interests’ or ‘ideologies’ on this blog alone.

    BTW, do you still teach the efficient markets hypothesis wrt to the financial system?_We have more than sufficient ‘useless idiots’ at the mo!

  25. In a nice turn of phrase: the elephant in the room woke up only to start busting some china.

    Russian prime minister Dmitry Medvedev, who yesterday blasted the EU’s “elephant in a china shop” response to the Cyprus debt crisis, has threatened to slash the share of Russia’s foreign currency reserves held in euro. He also complained that accounts of Russian government agencies in Cyprus had been blocked.”

    http://www.telegraph.co.uk/finance/debt-crisis-live/9945121/Cyprus-bailout-live.html

  26. Now there’s a way to solve 2 problems in 1 go. Give the Russians a base in Cyprus to bail it out and in return they can quit their Syrian base. Voila prosperity and peace in our time

  27. @Gregory Connor,

    I remember having a conversation with an economist, whose opinion I greatly respected, a few days after the euro was launched. It would be a disaster, he warned. It was ill-conceived, badly designed. Worse, when push came to shove, with little old Ireland inevitably on the wrong end of the pushing and shoving, the big boys in Europe would happily watch us fall over the cliff edge – for our own good, of course. Some time later I had a coffee with a well-established europhile, whose opinion and knowledge of such matters I also greatly respected, and who was only too pleased to pay for our drinks in the new currency. My friend extolled the alacrity and enthusiasm with which the citizenry of little old Ireland had made the transition from the old to the new. I felt compelled to state the reservations of my economist acquaintance as to the long – even short – term sustainability of the euro project. Not at all, he assured me with a beatific smile. The euro was a political project. The names and titles of the great and the good who had inspired and directed, historically and contemporaneously, this great project rolled off his tongue like honey off a spoon. So too an assertion that the peoples of Europe, in due course, would pay tribute to the geniuses who had conceived this great project by erecting their statues in every village square throughout the European Union. Before too long, he assured me, the euro would rank as the greatest currency the world had ever known. And in a concession to our nationalist heritage, he added that the British would live to regret the day they had spurned the euro.

    In short, when it came to the euro project, politics trumped economics every step of the way.

    I have no idea how the situation in Cyprus will be resolved over the coming days. But I fear that the euro project, and the EU itself, has been fatally undermined by this debacle. The EU institutions no longer have any credibility with the average citizen, whether here, or in Cyprus, or in any of the other ‘peripheral’ states. Their bullying has been exposed. For me, as an Irish citizen, it revives memories of what happened to us in late 2010. The parallels are obvious. It’s not just the old arguments about ‘democratic legitimacy’ that the EU Institutions have to grapple with anymore; they are now confronted with a crisis of lost confidence which may yet lead to the unravelling of the entire European project.

  28. What were the alternatives for Ireland vis a vis the Euro,can anyone explain to me? What benefits would we have lost? What would our (realistic) options be to deal with the crisis outside of the Euro? Would the property bubble etc have happened? Geopolitically what would it have meant for a small country (in trade deals, market access etc)? Is there any politically realistic counterfactual where we could have stayed out of the Euro?

    “politics trumped economics every step of the way.”

    Politics always trumps ‘economics’. If economists still dont want to recognise this then there’s not really anything that can be done. I know of very little europhiles who thought the Euro was a pefect compromise, but it was what it was. We live in the real world, not one explainable by an economists model.
    And there were just as surely interest (business) based explanations for joining the Euro as much as there were ideological.

  29. @rf,

    No doubt it seemed like a good idea at the time…for us, anyway, it was a matter of ‘national pride’ that Ireland met the criteria for membership of the eurozone. There was a national political consensus that the ‘euro’ could only work to Ireland’s benefit, further endorsed by the social partners and business interests. The ‘real’ boom in the economy was still bounding along at that point and optimism filled the air, and the airwaves. And then there was also an element of national sentiment – if the alternative was pegging the Irish pound to sterling, then joining the euro appeared infinitely more attractive.

    Of course politics trumped economics in this case, as it always trumps everything in the end. In this case, though, there was no sober analysis of any possible downsides. Arguably, the capacity didn’t exist within the system to conduct such an analysis and the cautionary notes of a (very) few contrarian economists were not going to be allowed to rain on our happy national parade.

    The point is what we can learn from our experience: first, that major policy decisions should be backed up by expert analysis, and not of the kind that simply reflects what the majority want to hear; and second, that those who shout ‘now, hold on a minute…’ should be listened to, however cranky and annoying they may appear to be at the time.

  30. @Veronica

    It wasn’t about National Pride. Retrospective piety isn’t much use here. The doomsayers were right about the fundamental flaw in the euro, (Thatcher saw it coming for sure) but once it was going ahead, staying out wasn’t an option.

  31. @Sarah

    “It wasn’t about National Pride”

    It largely was imho. Being allowed into the Bundeslega giving the finger to the Brits, and not having to bother with FX for European holidays.

    “once it was going ahead, staying out wasn’t an option.”

    Why?

  32. @grumpy

    It largely was imho. Being allowed into the Bundeslega giving the finger to the Brits, and not having to bother with FX for European holidays.

    Those were my reasons (except for the first one, unlike many Europhiles I never had continent envy).

    The lesson for anti-imperlialists is to not get fixated on the last empire you had trouble from.

    Another reason for enthusiasm for the Euro was profound ignorance about who the architects of EMU were and what were their intentions (Mundell et all.) and lack of awareness of German political requirements for a central bank (essentially that it be a unaccountable pillar of government with a gold beetle as its mascot).

    We screwed up.

  33. Even if Ireland hadn’t joined the Euro the post Lehman crash experience would have been brutal. Imagine the financial power short selling the punt the minute trouble appeared at the banks.

  34. Totally agree with grumpy that those were Bertie’s reasons for joining the Euro. The more Maggie was agin it the more the national green psyche was for it.

    We should not have de-hooked from sterling in 1979 – even de Valera knew that a currency independent of sterling was nuts, and he was Britophile.

    If we hadn’t joined the euro, I think our false boom would have been less pronounced as we wouldn’t have had the ready access to such huge quantities of continenetal cheap credit. Having said that, the UK didn’t completely escape the crisis so we would have had a crisis, though possibly not on such a record breaking scale.

    One thing is absolutely for sure, if we had adopted a semi detatched approach to either sterling or the euro, we would have none of this austerity nonsense. No pensions levy or pay cuts for public servants, no increases in taxes, continued boom spending on infra structure. Happiness would abound except for those who saw their punt denominated savings slashed by 50% in value as the punt sank like a stone.

    And there’s the funny thing. Cyprus not in the Euro would see deposits devalued in exchannge rate terms far more than this putative levy and nobody would fuss too much.

    @ Sarah

    Something to be said for these complex calls to be made by technocrats; however, judging by some of the contributions on this blog from those who would presumably qualify for that role, I am not at all convinced.

  35. @grumpy

    How could we have stayed out? We have so much trade with the mainland. It would have been crazy to try and maintain currency independence – the costs of trading would be so high. Or for example, we attracted so much FDI because they needed a euro base.

    The only other alternative would have been to go back to either an official or unofficial peg with Sterling. Either way, we’d have been pegged to either the euro or the pound and ended up being at the mercy of those currencies anyway.

    I’m not saying the euro was a great idea, I just can’t see how it would have been practical to go it alone.

    It’s on the main evening new that a girl from Donegal, admittedly a Rose Of Tralee finalist, didn’t have the right accent for a nanny job in Russia.

    Seriously. On the news.

    Look the oligarchs want safe havens for their money and posh accents for their kids. It’s PERFECTLY understandable.

    You see, I am practical to the end.

    The end maybe nigh…..

  36. @ Sarah

    There is a world of difference to being in a monetary union and being linked to a currency. The Swedes and the Danes stayed out of the Euro but maintained a link, which I think has been rock solid in both cases.

    Ireland took a huge risk in plumping for a monetary union given that it was such an open economy and that it had at least three contenders for the optimal reserve currency, sterling, euro or the dollar.

    It would have been a difficult call as to which would be the official link, probably the Euro.

    The key difference is that there is the long term parachute of changing the value of your exchange rate. A negative of this would be that creditors would build in a price for this risk and we would not have been awash with cheap funds. But that turned out to be the problem, we suddenly had access to cheap funds from a monetary union 100 times our size, the rest is history.

    I don’t even recall the option of a semi-detached link being discussed and yet this was the choice of two of the countries who opted out. We were out and out Europhile anti Brits and nothing but full blown participation would do.

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