So Cypriot banks are broke, big-time. They took tons of money from Russian mafiosi and let it to Greece, which has since melted down. I get that.
And the banks were so large compared to the Cypriot economy that the locals can’t possibly pay (the way the Irish are being forced to pay for the misdeeds of their banksters).
Therefore, whatever doesn’t come from other sources in Europe has to come out of the hides of depositors. Check.
And the Germans, partly for domestic political reasons, want to make sure that someone suffers. Right.
Deposits are insured up to €100,000. And the current plan (or what was the current plan until the Cypriot parliament rejected it decisively) is to pay off insured deposits less a “haircut” of a few percent, and uninsured deposits less a somewhat larger haircut. Haggling is now going on about the numbers.
That’s what I don’t get. Why not give insured depositors all of their money back (that’s what “insured” means) and tell people that all deposits over €100,000 that they’re out of luck. If the bank’s assets, plus the bailout money, allow them to get 75% of their money back, that’s what they get. That’s what “uninsured” means.
I’m sure there’s some reason to violate some people’s contractual rights in order to give other (richer) people more than they’re contractually due, but I can’t figure out what it is.
Can someone enlighten me?
Footnote Yes, I like the idea of selling the whole island to Turkey for enough money to save the banks. But since that’s na ga happa’, why not let nature take its course?
My understanding is that Cyprus was trying to hold onto its status as a tax haven. The feeling was that 9.9% would be viewed as a cost of doing business by Russians, but 15% would be a problem.
I don’t know whether Cyprus still wanting to be a safe harbor for dirty money (especially for what is essentially stolen Russian money) but that analysis misses the point, in any case. There are two points: The first is that one of the reasons why people haven’t yet moved all of their Euros to banks in Germany is that most depositors are essentially “insured” at least in the sense that the ECB will function as a normal central bank and essentially backstop the various national governments/central banks that use the Euro and would need a supply of Euros to prevent bank runs. The ECB has now made it clear that it will probably only backstop banks in the Core and maybe only in Germany. I don’t know whether we’re going to see massive bank runs outside of Germany and right now it seems unlikely but the troika was insane to take such a risk, especially as there are much better plans that have been floating around for quite some time.
The second point is one that Matt Yglesias made in a very well thought blog post. Essentially, Europe’s problem is that the ECB isn’t the EU’s central bank—it’s Germany’s central bank and really functions only in support of German interests. He points out: “Germany and the non-Germany eurozone have the exact same monetary policy. It’s made in Frankfurt by the European Central Bank and the revealed preference post-crisis is to stabilize the German macroeconomy and let the chips fall where they may for the rest. That’s a huge problem. If Ben Bernanke stood up tomorrow and announced that he’s no longer interested in the inflation and output situation in the United States and is going to instead focus on German economic data and performance, there’d be a huge crisis here in America. After all, a country who’s central bank isn’t trying to stabilize its economy has a huge problem. And that’s essentially the situation facing Italy and France and the rest right now. Their central bank has abandoned stabilizing their economies in favor of stabilizing Germany. Who wants to invest in a country like that? And what set of policies is going to succeed?” http://www.slate.com/content/slate/blogs/moneybox.2.html
It’s hard to see why any country except Germany would remain in the Euro since we are every day seeing proof of the folly of the currency union. Just as we are seeing proof that a country without its own currency is always in danger of banks runs and totally at the mercy of whoever controls its currency. As I said before, it is increasingly clear that Europe’s leaders have decided that democracy and the European Project are expendable but that the Euro must be defended at all costs. http://guthman.blog.lemonde.fr/2012/09/30/melenchon-a-raison-au-sujet-de-la-menace-a-la-france-des-institutions-democratiques-de-la-lutte-contre-la-bce/
What we are seeing in Cyprus tonight is quite probably the beginning of the end for the European project.
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Even given everything you say-which I largely agree with-I am still inclined to think that France, not Germany, is the last country that would remain in the Eurozone if others started peeling off. Some peel from the bottom-Greece, Portugal, Italy-because they were always too weak for monetary union. But others peel from the top-Netherlands, Austria-because they don’t want to be pulled down with the rest of the mob. Germany is in the group that peels from the top, which is precisely why the ECB is in effect a second Bundesbank: they have to keep the Germans happy to keep them in.
Deposit insurance creates a moral hazard for banks and their depositors.
1. Can you explain how deposit insurance creates a moral hazard for banks? I can certainly see a case for arguing that the overly generous treatment of bankers during the financial crisis created a moral hazard who suffered no consequences for crashing the world’s economy meant that they didn’t feel the need to change their risky, but extraordinarily profitable, way of doing business. But I don’t see how this applies to the banks themselves because banks are incorporeal; mere legal fictions incapable of gauging incentives except through their agents (bankers) whom we’ve pretty much universally decided shouldn’t be punished because Davos man is different.
2. Can you explain how any sort of moral hazard for depositors makes a difference in their behavior? How exactly would depositors be able to tell a good bank from a risky one?
There is sort of an answer to #2, and it’s called “Iceland”. In 2006 or so, Iceland was offering simply absurd returns on a standard savings account, which I believe you could opt to set up to be denominated in Euros. A lot of Brits in particular put their money there, perhaps not understanding the difference between insured and uninsured bank deposits - and after Iceland collapsed, the British government made loud threatening noises in defense of their citizens’ jeopardized bank accounts.
Now, I’m not sure the Icelandic bank deposits had any governmental deposit insurance (my recollection is not, but it’s not one I’m firm about), but the British depositors just assumed a bank is a bank is a (safe, insured) bank. On the other hand, when a savings bank is offering you something like a 10% return on your money, you should think at least thrice before depositing.
I don’t think that’s a fair answer. Yes, the banks in Iceland paid slightly higher rates but hardly astronomical as you imply and certainly there was no way for an individual depositor to understand that the banks had been imprudently buying highly rated CDO and bonds that would become worthless when the American housing market crashed. Which, by the way, raises another question for you: Do you really consider it realistic for a depositor to judge whether a bank is making a higher return (and so willing to pay higher interest) on loans that are safe or risky? In other words, should a depositor be expected to appraise the loan and securities portfolios in addition to evaluating the general soundness of the bank’s operations?
The question is whether a depositor has a realistic and reliable way to know which, if any, banks are safe. Without a inexpensive and practical method of instantly and continually evaluating the soundness of banks, you are simply spouting bromides. There is a reason why government backed deposit insurance schemes became common after the Great Depression. Without deposit insurance, bank runs and financial crises are very common as depositors are always on a hair-trigger to get their money out of a bank or country where there’s the slightest hint of danger. You might want to keep in mind that the Great Depression was largely triggered by a run on an Austrian bank, the Creditanstalt.
Unless you can suggest a foolproof way for depositors, who have their own businesses to run and lives to live, to evaluate a bank’s safety (and on a daily basis, too)then deposit insurance is a small price to pay for having a safe, reliable banking system.
I’m all in favor of deposit insurance. I’m just pointing out that people who are used to federally insured banks can be caught when they assume all banks are federally insured. Hence, part of what happened in Iceland.
What was Canada doing different from the US during the Great Depression since it had no bank failures?
Charles,
I don’t know about the 1930s, but in the subprime crisis my vague recollection is that Canada’s banks fared quite well, which I think was attributed at least in part to higher reserve requirements (less leverage permitted).
This is a reply to CharlesWT at 10:45,
I have no real expertise on this but I did do some reading on the Canadian banking system last year when I was researching save havens.
My understanding is that at the time of the Great Depression, Canada had a smaller number of banks but they were much larger than those permitted in the United States, with national branch banking (meaning access to a much larger and diversified base of deposits). The risk of banks being “to big to fail” turned out to be quite minimal because Canadian banking was and continues to be intensely regulated. Risk taking was strictly limited and controlled. Canadian bankers received good but not outlandish compensation and the government expected bankers who screwed-up to be gone in disgrace and without “golden parachutes,” so Canadian bankers tended and still have a tendency to be on the prudent side.
Canada also had and still has a very deep and longstanding commitment to protecting its banking systems and depositors. Before the crash of 1929, there were several important government interventions to stop banking crises and prevent bank runs by, inter alia, providing reserves and lender of last resort facilities. Also, starting with the financial crisis of 1907 and throughout the Great Depression, both Liberal and Conservative governments made it clear that they would do whatever was necessary to protect depositors. Consequently, depositors were confident that their money would be safe and because of these implicit guarantees there were few (possibly no) runs on Canadian banks, hence no bank failures.
Mitch, that matches with what I know (and what a certain Ben Bernanke wrote in a 1983 paper, so it can’t be too outlandish
).
US banks tended to be small and thus vulnerable during the Great Depression; they didn’t have the capital buffer to absorb losses, and even purely regional effects of recessions could seriously hurt them. Canadian banks, due to their larger size and decentralized structure, turned out to be much more robust.
I assumed the statement was tongue-in-cheek,
therefore,
I could see where deposit insurance would be a moral hazard for Banks, that is, assuming they actually took their contractual obligation seriously.
But, I have to admit, the customer part has me stumped.
Because, after 2008, believing anything a Bank promises
betrays the promisee as a naïve sucker? No? O.k. I give up, what’s the joke?
I don’t see how it’s a joke. I could be wrong, but I seem to recall that in the US, around 07 or 08, we actually decided to insured deposits over the FDIC limit, which I think was then raised.
So, not only did we make whole rich people who were too silly to remember where they left their large piles of money, but we then said, hey! Let’s do it more!
So, who’s the naive fool, wonders the taxpayer?
Sorry, I meant to say, we covered *uninsured* deposits, those which were over whatever the limit was, maybe $100K? Just to be nice, apparently.
The FDIC or RFC of whoever it was asserted that maintaining a bank as a going concern while it was cleaned up was cheaper than closing it (which we be required if any deposit was not paid in full) so in MANY (perhaps most) cases they guaranteed deposits of any size. But not in all cases. The Freedom Bank in Harlem, for example.
Well, I’m not saying it was the crime of the century to do it. Even though it seems careless for people to not remember how much they have, and where it is, I agree that money ought to more or less remain where you left it, bank-wise. I mean, not literally there. ; > But in that banking sense. The FDIC limit should be printed in nice big letters somewhere, just to remind people.
The other day I watched “American Madness” on the telly, which is thematically similar to It’s a Wonderful Life vis-a-vis banking. It is unquestionably good to avoid panic. I guess this moral hazard idea bothers me more when the DOJ says certain institutions are so ginormous, we can’t even police them, much less try to protect our economy from them.
I’m sure there’s some reason to violate some people’s contractual rights in order to give other (richer) people more than they’re contractually due, but I can’t figure out what it is.
The bailout keeps those banks alive as the state-owned entities they already were. That’s what Cyprus wanted. The EU insisted on haircuts, and there are no haircuts to be had except on the depositors. So they settled on the idea of a little pain for everyone.
The key thing is that the Cypriot PM don’t want to liquidate the banks. If they did that, they could confiscate some or all of the uninsured money but then rich Russians (and rich Cypriots!) wouldn’t put their money into Cypriot banks, quite understandably. The failure here is the unwillingness to accept that the Cypriots won’t be outlaw hero bankers no more either way. Anybody putting large sums of cash into Cypriot banks, even if they were 100% bailed out, is basically clueless.
If they paid off the insured deposits, inflicted the 16% haircut on the over 100k crowd and liquidated those and called it a day, then it would be over, except Cyprus would have no banks then. (And they also might get sued a lot.)
max
['When you become an offshore banking haven, bank creditors own *you*.']
I can certainly see how the overseas money launderers might withdraw their business given a 16% confiscation - but I rather doubt they’ll take a 10% confiscation with any greater level of equanimity. Surely, any meaningful confiscation means all the oligarch’s dirty money goes to other tax havens; even no confiscation probably leaves the money launderers heading for the exits, as the specter could return at any time.
Meanwhile, there are an awful lot of innocents with household savings who put their money in an insured account. And note that there was no safe amount in the scheme. According to the plan, if you had 16 euros in your account, you lost one of them. You’d think the bank regulators would at least immunize the first couple of tens of thousands, even if they hadn’t guaranteed 100,000.
“Surely, any meaningful confiscation means all the oligarch’s dirty money goes to other tax havens;”
I would think any meaningful level of confiscation means that the clean money goes bye bye, too. At current interest rates, about the only advantage banks have over pickle jars is a certain degree of convenience, and 10% of your savings is a darned high fee to pay for checking.
Not just foreign investors, but Cypriots, too, are now on notice that any money they keep in a bank may be confiscated at any moment. If there’s not a bank run, it will only be because of withdrawal limits, and those can’t stop people from ceasing to deposit. Cyprus has just taken a great step towards becoming a bank ANTI-haven.
Plus one to that-there’s no difference in practical terms between 10% expropriation and 16%. This was a bleary-eyed blunder, the kind of thing that just happens at 3 AM around the negotiating table. Even floating the idea was the worst kind of precedent for everyone involved.
Kleiman: “I’m sure there’s some reason to violate some people’s contractual rights in order to give other (richer) people more than they’re contractually due, but I can’t figure out what it is.”
max: “The bailout keeps those banks alive as the state-owned entities they already were. That’s what Cyprus wanted. The EU insisted on haircuts, and there are no haircuts to be had except on the depositors. So they settled on the idea of a little pain for everyone.”
Max, you’re really skipping right past the key point there. “So they settled on…a little pain for everyone” is simply begging the question. What Kleiman’s asking here is WHY they “settled on…a little pain for everyone” rather than haircuts for the uninsured deposits and no pain at all for the insured, since that’s what insured means.
I might agree, if there is a big, obvious, oft-repeated warning to people that they aren’t insured. It is important to protect the unsophisticated, distracted, and otherwise less-sharp amongst us.
You mean to tell me that when banks compete, we don’t actually win?
All the focus on monetary policy is well and good-but it misses the big issue of political stability and prevention of European wars.
The reason the European Coal and Steel Community, the precursor to the EC, was started basically was to fight communism and to prevent future inter-European wars. http://en.wikipedia.org/wiki/European_Coal_and_Steel_Community
The EU’s rationale for existence remains pretty much the same-but it gets lost in the Euro problems.
Another European war would be a lot more expensive than bailing out the Euro debtors-who may or may not be morally worthy.
“Yes, I like the idea of selling the whole island to Turkey for enough money to save the banks.”
You don’t know much about the history of the region, do you? I’d suggest you meditate on the events of 1974 and think again.
Yes, I am happy to see your comment as that also struck me as a really stupid idea given what I know about Cyprus and Cypriots. In addition, the idea of just handing a group of people (who live on that land) over to a different government because Mark Kleiman thinks it would be an elegant solution is just obscene.
Susan, I suspect you and Nick might want to turn up the gain on your sarcasm detectors.
As the Financial Times reports:
This is not to distract from Angela Merkel’s and Wolfgang Schäuble’s sins, who have much to answer for themselves, but the idea of taxing insured deposits appears to have been that of Nicos Anastasiades and his government, likely to either protect the status of the Cyprus banking system as a tax haven or in the service of moneyed interests.
Normal political considerations aside, what legislator in his right mind would vote to take money from Russian mobsters?
WSJ suggests these issues.
1. Because the Cyprus banking sector is so large relative to its economy, the available deposit insurance will only cover ~60% of total deposits under €100k. Without EU support, the government can’t make good on the remaining ~40%.
2. Cyprus banks have relatively little senior debt (bonds). Once problems wipe out the stockholders, the depositors are essentially the next layer of capital. [However, the EU plan calls for bailing out those few bondholders ahead of the depositors. The reason is unclear to me.]
3. Cyprus has $2-3B loan from Russia that comes due in a few weeks. Cyprus needs Russia to roll it over.
If so, small depositers may do better taking the haircut.
for 2. the answer is pretty clearly in who holds those bonds. I bet it’s people the ECB likes better than either cypriots or russians.
(oops, that was me, fwiw)