Deposit insurance, bank runs, international currencies, and the inflation tax

Just a short post on one point about the recent Cyprus business. (It looks like Cyprus will impose a "one-time tax" on bank deposits rather than honour its deposit insurance.)

Governments usually provide deposit insurance to prevent bank runs.

If the banking system is too big, and the banks' losses are too big, relative to the government's capacity to pay that insurance claim, that's a problem.

But the problem is very different if the government (unlike Cyprus) can print currency to pay bank deposits that are liabilities in that same currency. If worse comes to worst, the government just prints as much currency as is needed to pay the depositors what they are owed. If that means is has to print "too much" currency, that's a problem, because it means inflation will be "too high". But that inflation will adversely affect the real value of currency and bank deposits equally. So even if people expect it might happen again, this doesn't cause a bank run, where people try to get out of bank deposits into currency.

It's a very different sort of problem in a country like Cyprus where the government cannot print money. If people see a "one-time tax" on bank deposits happen once, they might expect it to happen again. And if they expect it to happen again they will try to get out of bank deposits into currency. Which is a bank run.

The difference is that inflation from printing too much money is a tax on currency too. Cyprus cannot tax currency; it can only tax bank deposits.

If the banking sector is too big, and if bank losses are too big, relative to the country's ability to pay, deposit insurance as a way to prevent bank runs is not credible and won't work in a country that cannot print.

Next week is going to be interesting. And not just in Cyprus. People have seen it has happened once, in Cyprus. Will they expect it to happen again? In other Eurozone countries?

Update; since I can't read Greek, this article and comments in Cyprus Mail is the nearest I could find for judging local reaction. Or maybe this is better.

Comments

[Vladimir]

This is basically a variation on the "euro as a gold standard" argument often heard in recent years. I didn't follow economics much a decade ago when euro was replacing the old European national currencies, so I wonder how many economists back then were pointing out that the standard argument against the gold standard as a catalyst of financial panics would similarly apply to the new common currency? (At least for the smaller European countries, whose governments can't easily get access to the printing press as the lender of last resort.)

[Ben J]

Vladimir,

Before his death, Milton Friedman was predicting that grafting the Eurozone onto one currency would cause problems. Here is one example:

http://mobile.euobserver.com/economic/16030

[Vladimir]

Also, has any mainstream economist ever analyzed government-insured deposits in a fiat money regime by looking at them as a bundle of multiple financial instruments that represent each axis of the depositor-bank-government triangle separately? (I'll fight the urge to put "insured" under scare quotes, as I like to do for any uses of that word that don't refer to an actual insurable, i.e. actuarially quantifiable, risk.)

What I mean is that your deposit insured by CDIC, FDIC, or any other local equivalent backed by the printing press, involves a loan from you to the bank and a loan guarantee by the government. Which means, from your perspective, that your deposit might as well be a government-issued voucher for using the printing press to print the given amount of money -- and the bank as an institution is of no concern to you, except maybe for some marginal frills it might offer, like conveniently located ATMs, free certified cheques, and nice fish tanks in their branch offices. For all you care, its entire management might be staffed by people freshly out of jail for fraud and embezzlement, as long as you know that your deposit is covered by the CDIC guarantee. The banker is just a bureaucrat who issues your printing press voucher, not someone whom you need to trust in any way.

So, the obvious question is: what's the point of the whole pretense? Why not just have a government monopoly over demand deposits? (And any other deposits that are covered by similar guarantees -- including those that are theoretically not covered, but where everyone understands that a bailout would be the only politically viable option if push really came to shove.)

Or to put it differently, what purpose is served by having this money in the hands of institutions that don't have to compete for it on any grounds of prudence and profitability? (They sure have the incentive to maximize profits with what money they have from depositors -- but this profit maximization is completely divorced from the depositors' own incentives, and makes no difference as to how much money they'll get from depositors. Not to mention their own informal and implicit government guarantees in case of trouble...)

[Ralph Musgrave]

Vladimir says “Why not just have a government monopoly over demand deposits?”. Good point. That’s pretty much what the various advocates of full reserve banking propose. E.g. William Hummel advocates full reserve plus he advocates that all transaction accounts should be at the Fed. See under heading “A Single National Depository” here:

http://wfhummel.cnchost.com/monetaryreform.html

An alternative full reserve system is set out here:

http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

Under the latter system, all checking or transaction account money at a commercial bank has to be backed by an equal amount of reserves held by the commercial bank at the central bank.

I don’t see a need for central banks to have a monopoly of actually RUNNING checking accounts. But certainly any money that depositors want to be 100% safe or instant access should be backed by reserves / monetary base.

In contrast to 100% safe money, if a depositor wants their bank to lend on their money under full reserve, they are not guaranteed their money back. For example under Laurence Kotlikoff’s version of full reserve, such depositors get mutual fund units, and those units may lose value if the underlying loans or investments do badly. But unlike our existing system where “doing badly” leads to a run on banks, all that happens under full reserve is that those units lose value – much like a stock market set back.

As Mervyn King said, “we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis”.

As to bank subsidies, they disappear under full reserve. The safe money is safe, so there is no taxpayer exposure there. As to investment money, depositor / investors take a hair cut, not the taxpayer.

[Nick Rowe]

Vladimir: A lot of economists were sceptical of the Euro when it was introduced (yep, Friedman was one). Though mostly it was a concern about asymmetric shocks, with less emphasis on the lender of last resort problem. I wish i had better memory or record of what I was thinking and saying back then. I do distinctly remember worrying about how a country with a currency board could manage the lender of last resort function, which is basically the same problem.

Most of the sceptics were outside Europe though, and were sort of told it was none of their business. While inside Europe I think there was a lot of pressure not to rain on the Euro parade.

I'm not a good source on that subject.

I think you have it roughly right in your second comment. Banks with government deposit insurance are like a government-private partnership, where the government takes on part of the job but farms out the rest of the job to competition in the private sector, but monitors and regulates those partners. An uneasy compromise. But would you want the government to have total control over commercial bank lending and borrowing?

Ralph: yes, 100% reserves are one solution. But think about the capital stock in a country with 100% reserves. And think about where exactly you would draw the dividing line between deposits that were or were not required to have 100% reserves. Remember the fuss over money market mutual funds "breaking the buck"?

[Erik]

I guess we'll see, but my gut says the other European countries aren't going to see bank runs (although we may see a little in Greece).

The Europeans have just taken so much and have basically said OK to everything. Thought the Italian election showed a little grumbling, it still wasn't enough. The fear of the alternative has keep the voting public in check.

It's telling that the people setting the policy feel so confident that the people will continue to be sheep, that they would allow this type of measure to move forward.

It's funny that another article states that the steps they took to head off a problem was to put out a statement saying everyone should take a “calm and a level-headed assessment” of the situation.

[Nick Rowe]

Erik: you may be right. I have been surprised at the absence of bank runs in the last couple of years. (Except for the oxymoronic "slow bank runs".) And the apparent willingness of the populations to stick to the the Euro despite everything. Whether this will be a final straw (in addition to the high and rising unemployment rates) I don't trust myself to say.

[Ralph Musgrave]

Nick,

I don’t see a big problem in drawing “the dividing line between deposits that were or were not required to have 100% reserves”. The basic rule is that depositors have a choice. If they want 100% safety and/or instant access their money is not invested in commerce: it’s backed 100% by reserves and it earns no interest.

Alternatively, if they want their money loaned on to mortgagors or to commerce, they’re on their own, and they sign a piece of paper saying so. That seems a simple clear dividing line to me.

Re money market funds, they just play the same confidence trick that banks play under the current system: promising depositors their money back while investing depositors’ money in a less than 100% safe manner. And taxpayers footed the bill when that went wrong in the recent crisis (both in the case of banks and MMFs).

MMFs would be caught by the above “clear dividing line”. MMFs invest in commercial paper and government debt. So they’re on the commercial side of the dividing line.

There was actually an article in the WSJ recently which although it didn’t specifically argue for full reserve, did argue that MMFs should be forbidden from engaging in the above confidence trick.

[Doctor Why]

As a Cyprus resident, I think that while the whole situation has been badly mismanaged by everyone involved, the deal itself is pretty fair and reasonable.

First of all, deposits at Cyprus banks are a high-yield investment (3-4% p.a.), so nobody should be really surprised that the depositors may at some point lose some of the principal.

Second, if the banks are not recapitalized immediately they will lose access to the ECB lending facilities and go bankrupt. The Cyprus banking system needs to be recapitalized to the tune of 10 bln euros (60% of Cyprus GDP). Given that the government debt is already close to 90% of GDP, depositors and bondholders represent the only practical source of funds.

Third, if the haircut (conversion to equity) was limited to uninsured deposits, that would most likely give control over the banking system to non-residents (some would say money-launderers) - and nobody in the Eurozone would be happy about that.

So, while the Cyprus deal does create a bad precedent for the Eurozone as whole, under the circumstances it was probably one the best options available. Now, if the plan is approved by the House of Representatives (and that's a big IF), the recapitalized banks will immediately gain access to all ECB lending facilities and the inevitable bank run will no longer be a major threat.

[Ron Ronson]

"If worse comes to worst, the government just prints as much currency as is needed to pay the depositors what they are owed. If that means is has to print "too much" currency, that's a problem, because it means inflation will be "too high"'

Why can't countries without their own currency conduct monetary policy via fiscal means ? They target steady NGDP in their region and use (say) a sales tax to make adjustments to hit the target ?

[Simon van Norden]

Nick:

"I do distinctly remember worrying about how a country with a currency board could manage the lender of last resort function, which is basically the same problem." Sounds a lot like the problems we saw a decade ago in Argentina.

Meanwhile, I'm hoping that Orphanides (the former governor of the Bank of Cyprus) will write something explaining his views on the situtation. I expect that the nature of the problem facing the Cypriot parliament today (aside from the various political intrigues) is the choice between (a) taking the deal they were offered by the IMF & EU & ECB, or (b) abandon the euro in the next 48-72 hours (perhaps a bit longer if they declare a banking holiday.)

My understanding is that the Prime Minister was elected 3 weeks ago on a platform of 100% protection of banking deposits. He and his party no doubt will face considerable (and justifiable) wrath for reversing themselves so quickly and completely. However, the announced deal illustrates the danger of keeping deposits in Cypriot banks. Failure to ratify the deal and have solid EU/ECB/IMF support guarantees a bank run the instant banks open for business. Abandoning the Euro (i.e. declaring this weekend that all deposits have been converted into Cypriot "Rubles" or whatnot) is a politically and economically better option.

The only other out that I can think of is that Putin announces a special deal with Cyprus to save their banks. (No idea how realistic this is.)

[EU citizen]

given the choice: a 6-10% tax on your euros, or a 50(?)% devaluation of your money, turned into local currency, I don't think the deal is that bad

[Nick Rowe]

Simon: yep, the Euro problem is a lot like Argentina. And the Euro was introduced around the same time as the Argentinian crisis.

Like you, I think a better option would be to abandon the Euro. And I still think it's going to happen somewhere in the next couple of years. But I've been thinking that for the last couple of years, and it still hasn't happened!

I've just heard that Cyprus will have a bank holiday Tuesday as well. (It used to be the "Cyprus Pound" I think, before the Euro.)

Ron: that's what some of the Euro countries might like to do, if they could only borrow enough Euros to do it! Unfortunately, the very same time you most want to borrow Euros is exactly the time nobody wants to lend to you.

Doctor Why: A resident of Cyprus! Welcome! (And commiserations.)

If they want to remain part of the Euro, I don't see any obvious easy alternative either.

"Third, if the haircut (conversion to equity) was limited to uninsured deposits, that would most likely give control over the banking system to non-residents (some would say money-launderers) - and nobody in the Eurozone would be happy about that."

That is a really good point, that I hadn't thought of, and which I hadn't seen mentioned anywhere else.

Ralph: so if I understand you, you are not requiring 100% reserves by law. You are just removing government deposit insurance, and leaving it up to the market to decide if depositors want to deposit their money in a bank with 100% reserves, or not?

I can understand that as a libertarian response to the problem. It does mean turning the clock back, to how we used to do things. But sometimes, when you have taken a wrong turn and found yourself in an even worse place, turning the clock back is the right thing to do?

[Nick Rowe]

EU citizen: but the 6% to 10% tax on Euro deposits is only *part of* the cost. The Cyprus government is paying the rest of the cost, through increased taxes and borrowing. Replacing Euro deposits with New Cyprus Pounds, and the ensuing devaluation, would be 100% of the cost. (Plus, I don't know what the unemployment rate is in Cyprus, but if it's anything like Greece, a devaluation and easier monetary policy might be a benefit, not a cost.)

[Andrew F]

Yes, but, it will certainly increase the flow of Greeks, Italians, Portuguese, Spaniards, etc. moving their Euro deposits to USD, gold etc. held offshore. This moves seems hand-crafted to trigger a Euro-wide bank run.

[Nick Rowe]

Andrew: It might. There are two possibilities:
1. People run from Euro bank deposits into Euro notes (or out of Club Med deposits into Club Baltic deposits).
2. People run from all Euro deposits and notes into foreign deposits and notes and into real assets.
(Or maybe a mix of both, of course).
Ironically, 2 might be a good thing, for the Eurozone!

[Simon van Norden]

Andrew F: "This moves seems hand-crafted to trigger a Euro-wide bank run."

Don't forget that policy is endogenous. There are strong forces that will move ECB/IMF/EU policy to avoid Euro-wide bank runs (e.g. by reversing course and simply making whole all deposits in Cyprus.)

I think it is more realistic to see the Cyprus deal as an attempt to minimize the cost of bailing out a very small member state whose situation, for a variety of reasons, evokes very little sympathy from the lenders. As such, it is a trial balloon that will be quickly hauled in if things go badly awry.

[Ron Ronson]

'Unfortunately, the very same time you most want to borrow Euros is exactly the time nobody wants to lend to you."

But is NGDPO works the way its supposed to (largely via expectations) - then they may not actually have to borrow the money, right ?

[Ron Ronson]

Though I suppose if there is doubt about the viability of borrowing then the fiscal authorities commitment to NGDPT might not be credible.

[Doctor Why]

Simon van Norden:
"There are strong forces that will move ECB/IMF/EU policy to avoid Euro-wide bank runs (e.g. by reversing course and simply making whole all deposits in Cyprus.)"

As long as banks are well-capitalized, the ECB can easily deal with a bank run - even relaxing collateral requirements, if necessary.

However, the problem with Cyprus banks is that:

1) their capital is close to zero, and so the ECB cannot lend to them.
2) The capital requirements are too large compared to Cyprus GDP (about 60% of GDP), and so the government cannot recapitalize them.

From this perspective Cyprus is a truly unique case which cannot be extrapolated to other eurozone members.

[W. Peden]

Ralph Musgrave,

"If they want 100% safety and/or instant access their money is not invested in commerce: it’s backed 100% by reserves and it earns no interest."

If people really wanted this, wouldn't it emerge anyway under a deposit-insuranceless system? I.e. people don't want 100% safe deposits that pay no interest (and are effectively cash that's easily carried) because under deposit insurance they can get 100% safe deposits that DO pay interest.

Take away deposit insurance and any genuine demand for 100% reserve banking will offer profits to investors. Of course, considerable regulation would be required to ensure that banks offering such services didn't do anything fraudulent.

[Simon van Norden]

Doctor Why:

Interesting point.
I'm assuming that if a bank run in the rest of the euro-zone is at stake, then the EC/ECB/IMF will *rapidly* reverse the haircut. I'd thought that a take-it-or-leave-it offer to the Cypriot govt. of a "Spanish solution" would do the trick.
(i.e. The Cypriot president is told that if he wishes to recapitalize Cypriot banks with Cypriot govt. EUR bonds, those bonds will be accepted as collateral by the ECB.)

Of course, the President (or the Cypriot Parliament) might refuse the offer and prefer to do an Iceland (i.e. abandon the euro in the next 72 hours.) But either way, the members of the Troika would probably judge that to be enough to kill off the incentive to run on the banks.

[Simon van Norden]

If I were to look for early signs of a bank run elsewhere in the Euro zone, I would want to look for a country
- with a big banking sector relative to GDP
- bad banks (or potentially shaky ones)
- on the Euro (i.e. NOT Switzerland)

Anyone know how Austria has been doing?
I'd heard a few years ago that they met all these conditions (lots of bad loans to Eastern Europe.)

[Patrick]

Doesn't that describe Germany and France?

[Nick Rowe]

W Peden: "Take away deposit insurance and any genuine demand for 100% reserve banking will offer profits to investors. Of course, considerable regulation would be required to ensure that banks offering such services didn't do anything fraudulent."

I agree with the rest of what you say, except the word "considerable" in that last sentence. The government regulators would have a much easier job than at present. They presumably wouldn't even need to count the dollar bills in reserve, since nearly all would just be electronic liabilities of the central bank.

[Max]

"Though mostly it was a concern about asymmetric shocks, with less emphasis on the lender of last resort problem."

I've been thinking lately that the biggest failure was not understanding that for a currency union to be a union of equals, with everyone playing by the same rules, the countries have to all be the same size.

Otherwise, the large countries determine monetary policy and this enables them to issue safe debt, while the small countries lack that privilege.

If Germany were smaller, then either it wouldn't be the undisputed safe haven of the euro zone, or else the ECB wouldn't worry as much about overheating since it would contribute less to average euro zone inflation.

[genauer]

@ Simon

Ten years yields as of closing this friday

German bunds (as THE triple AAA benchmark): 1.46%
Austria (stellar, unquestioned AAA, http://www.bloomberg.com/quote/GAGB10YR%3AIND) 1.73
Canada (http://www.bloomberg.com/quote/GCAN10YR:IND) 1.90
UK (AA) 1.94
US (AA) 1.99

Our Austrian "Schluchtenscheisser" Brothers and Sisters are doing very well, being only half the credit risk, compared to CAN, UK, US : - )

Our brothers and sisters in Switzerland run an explicit half sided peg to the deutschmark / Euro ( >= 1.2 ), since 1.5 years with the explicit "unlimited" firepower of their central bank.

I have them with 1.35 as "fair value" in my books. I believe that, as in 1978, they could count on our financial artillery support, if they would ever run out of ammo, what I doubt very much.

[Simon van Norden]

Genauer: Thanks for the update! But I was wondering more about stress-test results on Austrian banks (or private rather than govt. debt comparisons) as well as their deposits/GDP ratio.

(BTW, Could you please help me with my German....Google translates "Scluchtenscheisser" as "gorge asses" which I suspect might not be correct....)

[genauer]

Simon,

LOL, you should replace asses with "shitters". And we have those cozy names for each other, "Piefke", "Saupreiss" from the other side, within close family : - ).

Max,

Austria is the perfect example running an implicit peg of 7 Shillings to 1 Deutschmark, ever since WWII, without any formal ties.

You dont need any OCA or other ivory tower theories for that, just the political will.

[Simon van Norden]

Ah....the OENB to the rescue!

The Austrian central bank's homepage has a nifty report from January 2013 "Facts on Austria and Its Banks" (http://oenb.at/en/img/facts_on_austria_e_jaenner_2013_screen_tcm16-235433.pdf)

In a nutshell, it seems to say
- the Austrian economy is in great shape, thank-you very much.
- Austrian banks continue to be in bad shape due to large loan in CESEE (Central, Eastern and South-Eastern Europe.)

Some quotes from their executive summary:
Austrian Banks Face Crisis-Induced Challenges
• ...the operating performance has been weak, reflecting the continued adverse conditions that result from the ongoing sovereign debt problems.
• The capital positions of domestic banks, while having improved further in the past year,
remain below international averages ...
• The exposure of the majority-Austrian-owned domestic banks to Central, Eastern and
Southeastern Europe (CESEE1) came to EUR 215.5 billion in June 2012. This exposure,
while still comparatively high, is broadly diversified across the region.
• Compared with Austrian banks’ domestic banking business, the operations of their CESEE
subsidiaries are fraught with higher risks, as is reflected above all by high loan loss provisions.
At the same time, the CESEE-related operations have also been generating higher profits
than the domestic banking operations and thus remain a key profit driver for the Austrian
banking system.
• Foreign currency lending by Austrian banks has been curbed sharply in Austria and has also
gone down in the CESEE area. This notwithstanding, Austrian banks continue to have high
amounts of outstanding foreign currency loans in their books.

From their statistical summary, Austrian banks' exposure to CESEE is about 2.5x the total capital of the banking sector and about 2/3 of Austrian GDP. (Austria has about a 75% Govt. debt/GDP ratio.)

Not great, but could be worse.

How's Ireland doing?

[genauer]

Simon, I take issue with your "in bad shape"

they are in some riskier business, with higher profit ratios, but because it is "broadly diversified" across a region including excellent countries like Czech, Poland,

I am pretty sure that their risk premium, as reflected in their yield, reflects the risk.

I will pull some BIS data for you, tomorrow.

The last time, somebody tried to scare me with my German alleged risk, we came up with some more reasonable number 6 times lower. 10% of their GDP is certainly not being sneezed at, but as a one time off, it would not hurt their AAA rating.

[Simon van Norden]

Genauer; This is not "my "in bad shape"". This is "my saying that the OENB says "in bad shape"".

I am certainly not suggesting that I know more about the state of Austrian banks than their regulator! That regulator's public position is

"the operating performance has been weak, reflecting the continued adverse conditions that result from the ongoing sovereign debt problems."
"the operations of their CESEE subsidiaries are fraught with higher risks, as is reflected above all by high loan loss provisions."

I roughly translate that as "bad shape"....but feel free to read the report and disagree.

Either way, I'd be happy to see some BIS data.

[Min]

W. Peden: "If people really wanted this, wouldn't it emerge anyway under a deposit-insuranceless system?"

Well, it didn't emerge during the wildcat banking era in the U. S.

I guess the equivalent was putting money under the mattress. ;)

[Doctor Why]

Simon van Norden

"i.e. The Cypriot president is told that if he wishes to recapitalize Cypriot banks with Cypriot govt. EUR bonds, those bonds will be accepted as collateral by the ECB."

The ECB can accept (illiquid) Cyprus bonds only if Cyprus reaches an agreement with the ESM/Troika. The ESM, in its turn, has to make sure that the government debt is sustainable, and it currently believes that adding extra 60% of GDP to the existing stock of debt (about 90% of GDP) will make the level of debt unsustainable.

Theoretically, the ESM may change its views on debt sustainability, or it may recapitalize the banks directly, but both options look at this point rather improbable.

[W. Peden]

Nick Rowe,

Good point. I hadn't really thought through the practicalities of it.

Min,

That tells us a lot about the revealed preferences of 19th century American savers.

Whether the same preferences would be manifested in a largely post-cash economy is another question. Rothbardians, IIRC, think that without widespread financial fraud and deposit insurance and other government interventions, 100% banking would dominate in a deregulated financial system. We won't know until it happens, especially given that it's impossible to reliably predict future innovations regarding cash and deposits, and their effects on the demand to use cash.

[genauer]

Simon,

I actually do not see a need to pull the BIS data, because the relevant numbers are pretty much and in detail spelled out in your link. I could not do that any better.

They stayed clear of the GIPSI countries, the Loan to Deposit ratio of their
their CESEE business is 105.8%. So nobody has any interest to do stupid things.
(105.8% - 100)x 216 /308 = 4.1% GDP maximal potential risk exposure from CESEE.

"At the same time, the CESEE-related operations have also been generating higher profits than the domestic banking operations and thus remain a key profit driver for the Austrian banking system."

The "Macroeconomic Imbalance Procedure Scoreboard" is excellent, keeping in mind that given a "Average current account balance in % of GDP over the past 3 years" of + 2%, a slight reduction in "Percentage change of export market shares" is actually a good thing, "Private sector debt in % of GDP" is just 1% above the 160% threshold, and a national debt of 72% is something most other countries have some years to work to (Chart 13).

Since they have some state assets, their national net interest payment after inflation is ZERO (Chart 14).

Your Canadian situation with sizable pension funds is internationally pretty unique. http://www.nbc.ca/bnc/files/bncpdf/en/2/WEEKLYECONOLETTER_20120206.pdf for a good discussion of those various numbers in an international context.

They correct since 2 years some anomalies like subprime and that weird thing of Romanian mortgages from local subsidiaries of Austrian banks made in Swiss Franc and don’t extend the business in the moment.

So, in summary I think the Austrian banks are in good shape, you have to go some risk, if you want return, and long term growth in new markets.

Getting back to Cyprus, they now also learned, that the mainland Europe taxpayers do not pay their bills.

The credit they get is not so large, that they could get any stupid ideas, about not paying it, and how they divvy up the internal composition is their problem.

My guess is, that they will reduce the operating fee for lower deposits, and stiff the larger, Russian ones, a little more.

Once again, people learned that throwing tantrums doesn’t pay, and that slandering Germany and Merkel does not get them one single cent.

Let them sleep one more night about it, and everybody will find that he got a very good deal.

[genauer]

I forgot:

http://ftalphaville.ft.com/2013/03/18/1426252/teaching-a-lesson-lesson-learned/

[Mandos]

Southern depositors will now be crazy not to ASSUME that something like this will happen to them at some point, considering that there is no improvement of immediate conditions on the horizon.

The Eurozone is not a classroom. It is not there to give der deutsche Besserwisser an ego-boost of having played tough love and lifted the shiftless Southerners out of their bad habits. It is playing with dangerous forces. Taxes are difficult to collect in the EuroSouth for a *reason*, and this Cyprus gong-show is yet another episode in hitting the least responsible. Just because German workers were feckless enough to allow their leaders to enact Agenda 2010 doesn't mean everyone has to be that way.

[Patrick]

How did Cypriot banks get into so much trouble while the German, uh, I mean the European regulators did nothing? Was there no oversight at all?

[genauer]

Patrick,

Banking and Financial supervision and regulation is still national in Europe.

They are now still hackling about the final form for a future ECB supervision.

Mandos,
at http://economistsview.typepad.com/economistsview/2013/03/financial-markets-havent-freaked-out-over-cyprus-yet.html#comment-6a00d83451b33869e2017d420e5b53970c

I calculated, and Mark A Sadowski checked, that similar cash positions would be 6-13% of GDP in the US, I assume similar numbers for most "normal" countries, my rough guess for Cyprus was 350% GDP, refined by Mark to 389%.

Taking 10% of just that makes a solid contribution and is much easier to collect in this statelet.

Taking 10% of only the cash is irrelevant in the other countries and will therefore not be done.

[Mandos]

I calculated, and Mark A Sadowski checked, that similar cash positions would be 6-13% of GDP in the US, I assume similar numbers for most "normal" countries, my rough guess for Cyprus was 350% GDP, refined by Mark to 389%.

That is because it is a major industry for this island. I fail to see how this is even a relevant fact. Taking 10% of deposits in Cypriot banks not only cheats the ordinary Cypriot in a sudden and indiscriminate manner, it destroys one of the islands "comparative advantages".

I am not a huge booster of banks, to put it mildly. But this is where we are. Respecting, at minimum, the spirit of the deposit insurance is essential to the vaunted "confidence" that everyone keeps talking about that. If Europe wanted to avoid bailing out Russian investors, it should have come up with a common fiscal and industrial policy before instituting the Eurozone.

[Shining Raven]

Nick writes:

"If worse comes to worst, the government just prints as much currency as is needed to pay the depositors what they are owed. If that means is has to print "too much" currency, that's a problem, because it means inflation will be "too high"."

I don't think "printing money" in order to guarantee deposits that already exist can lead to higher inflation. After all, the banks have already created all that money, and people have used their deposit balances in actual transactions. Making sure that banks remain solvent and that the "money" (balance) in a savings account is actually available to make payments with cannot lead to additional inflation - the money is already there, and until yesterday people did not have any second thoughts about using it to pay for something. The only thing that happens is that a giant destruction of "money" balances is averted, so the overall effect seems to be more to prevent a deflation than to induce any additional inflation.

[genauer]

Mandos,

please just follow the discussion link at the economist view. There is no point in repeating this here.

What I see is, that people I had significant disagreement with in the past are now converging with my point of view, which, I think has not changed much, but I claim to be a learning person.

Even the French guy does now the same calculations as a German Green politician, resulting in calling Merkel to be "too soft", but I always tell them, please don't say anything, which could be misinterpreted as infringing on their sovereignity.
Whatever we think about there legal attitudes.

Even a loose mouth Claudia Roth does that most of the times.

[Mandos]

I read the discussion and I didn't interpret it as people agreeing with you, but I suppose it is subjective.

Let's be clear: I too am also in fact opposed to direct bank bailoutry, much in the manner of Sahra Wagenknecht! I'd be much happer if something like Wagenknecht's proposal were adopted, more or less, but there is no way it would ever happen like that.

What is instead happening is a one-sided punishment of people on the periphery for failing to meet some peculiar standard of rectitude, an attempt "uninstall" their societies and replace them with German Ordnungspolitik, instead of Germany partially accomodating its German "Ordnung", which is a very self-flattering term anyway, to the wider European context. This is socially very dangerous and is imposing huge suffering on societies that had other ways of settling accounts, for better or for worse. I always find it strange why people wonder why Berlusconi managed to restore his popularity: to me it is very obvious, a sector of Italian society is giving the world the finger.

[Mandos]

German politicians have drifted away from Eurobonds because there is an election approaching in October, and the German public is convinced that this is all about lazy Southerners looting German Bausparpläne. The looting had already been accomplished by the exploitation of the obvious weakness in the Maastricht Treaty, financial globalization, and yes, Agenda 2010. This is the part that is difficult to explain and is not helped by people like Dr. Sinn, who are only now just coming to the astonishing realization that this all may have something to do with demand.

[Bob Smith]

The obvious question is why the bailout of Cypriot banks didn't just ding uninsured deposits (i.e., amounts over E100K)? At least that would have honoured the deposit insurance committment both in letter and spirt (technically it is still be honoured, it's just being partly financed with a tax on the insured parties), while giving uninsured depositors the treatment they bargained for (note to investors, when Cypriot banks are paying 5% interest when everyone else is paying 0.5%, you're buying into risk. Why does nobody get that?).

Sure, that would have meant a bigger haircut for investors over the E100K threshold, but let's be honest, when you're talking about a 10% haircut or a 15% haircut (which is what it would have taken), Cyprus' reputation as a banking jurisdiction is pretty much hooped. It likely would have hit foreign investors harder than Cypriot investors (assuming they aren't the ones with hefty deposit), which at least makes the bailout politically feasible (more so if some of those foreign investors are generally unsympathetic persons - money lauderers and tax dodgers). It would have reassured Joe Q. Public in Cyprus, but more importantly in Italy, Spain, etc. that at least his deposits were protected. Is it me, or is the EU inclined to do everything in the most counter-productive way possible?

[Mandos]

How do you arrive at the 15% number? Foreign/nonresident deposits are only a third of what is in Cypriot banks. AND not all the Russian accounts are oligarchs, or even large accounts. It is the same way with German old people driving with cash to Switzerland, a practice that is now only coming to an end by German tax investigators literally stealing data from the Swiss. (Not that I have much sympathy for the Swiss here.)

Those accounts that are Russian business, as I understand it, probably realize that 5% is a big risk, and the feeling is, I think, that 10% is an acceptable cost of doing business. Especially relative to the benefits of doing business outside Russia. More than that and we're getting into "is this worth it?" territory.

[Bob Smith]

The 15% figure came up in a news article I read yesterday, whichwas presented as the figure that would have been required to insulate deposits under E100k from any hit while still generating the same level of revenue.

And I'd bet a good chunk of what was in Cypriot banks was held by Cyprus companies which, if you could dig through their shareholdings, are wholly-onwed by foreigners. Not sure why you're ranting about Russians, I sure didn't mention them, but Cyprus is a favourite holding company jurisdiction for Russian investors (along with Mauritius).

In any event, the question still stands, why didn't they pursue this approach?

[Nick Rowe]

Bob: two hypotheses:
1. What Doctor Why says in comments above: "Third, if the haircut (conversion to equity) was limited to uninsured deposits, that would most likely give control over the banking system to non-residents (some would say money-launderers) - and nobody in the Eurozone would be happy about that."
2. Cyprus needs a loan from Putin, and doesn't want to piss him off too much.

But I don't know.

[Mandos]

*shrug* Everyone in Europe is obsessed with Russians (it's very 80s), I assumed you were too :) In German media, it is always about that "German taxpayers should not bear the cost of bailing out Russian investors", because all the money in Cyprus obviously belongs to Russian tax evaders.

The story from the Cyprus Mail is that the Cypriot president *desperately* wanted to keep the tax on large accounts smaller than 10%, because he believed that 10% is a magic number that would retain Cyprus' attractiveness as a banking destination. The other EU ministers decided that they wanted 5 gigaeuros, and in the end told him to go get it somehow. That meant entailing the rest of Cypriotic deposits. I have a feeling that this story is rather self-serving, because the Cyprus Mail (I used to read it regularly as Cyprus was a hobby of mine) chronically loathes whoever is in government in Cyprus at the moment, though not without reason.

Whether you think 10% is a magic number is another matter. *Someone* did. Cyprus, for one, desperately wants to think that it will still be viable in banking.

[genauer]

Mandos, Nick,

these „Bausparpläne“ trying to boost home ownership from some 40ties to the more common 60ties in the western world, are all dead by now, given the ridiculously low interest rates.

What people also realized is that distorting the real estate market with special incentives to special groups, with all the best intentions, and significant argument going for them, after a World War, 60 years ago, did in deed keep people like away from buying. We corrected that now.

Communist Wagenknecht’s proposal, as soon as you boil it down to practical, is not far away, from what we were doing in the fifties, appealing to Erhardts “social market economy” founding father themes, and much longer ago, like Iron Chancellor Bismarck’s 1885 universal health care and retirement plan, and back again in the 1990ties. We have built a lot of “social capital” over hundreds of years.

She writes in the German equivalent of the Wall Street Journal, the “Handelsblatt”, and we are listening to each other, and look carefully what folks like Bebbe Grillo really want. Greek Syriza Tsipras had an audience with Schäuble in this January 2013, too.

Where specifically do you see your “no way it would ever happen like that” , I , as a German conservative, might miss there?

Why do these discussions, like here, so often end up in discussing details of Germany? It is a Canadian blog, and Nick Rowe has very good, valid reasons to keep it this way.

Searching for what I might have done wrong here, where, I only defended the credit quality of our Austrian brothers and sisters, with precise numbers and references, not “lots of bad loans”.

My original statement, that 10-year rates are a very robust, simple indicator, is very valid.

That I am not in a bind to pay one single cent for the follies of other nations, too.

Last minute add-on, see economist view links again:

The “magic” 10% limit on haircuts comes from the old , hard bind of
http://economistsview.typepad.com/economistsview/2013/03/financial-markets-havent-freaked-out-over-cyprus-yet.html#comment-6a00d83451b33869e2017ee98b958e970d

the 15.6% comes from the IMF target of 120% GDP at 2020, if the new, but not really yet punishable hard 100% 100k deposit insurance is calculated, as simple as that.

We are not obsessed with the Russians. In the moment they gave up conquering us, and actually gave us a pretty reasonable deal on eastern Germany, we welcome them here, have 2 dozen city employees taking care of their visitors, have the menus in kyrillic, Merkel, Putin talk in Russian, Putin gives a speech in German at the Sovereign, the Bundestag, and I think I mentioned before, one of my ancestors sold a submarine to Russia. For some time the Polands worried too much, that we could becomes friends too much, too quickly : - )

[Mandos]

Why do these discussions, like here, so often end up in discussing details of Germany? It is a Canadian blog, and Nick Rowe has very good, valid reasons to keep it this way.

The reason why is that the Eurocrisis is about imbalances within the Eurozone and who has the power to change them. Unfortunately the discussion boils down to some Northern European economies, the weightiest of which is ______?

Where specifically do you see your “no way it would ever happen like that” , I , as a German conservative, might miss there?

As yet, there is no talk of such a large debt haircut as she seems to be proposing. Could be that I am not understanding the German well enough.

[K]

Nick:

"But think about the capital stock in a country with 100% reserves."

You are implying - I assume - that it would be too small. I don't agree. If we look at just the US, there must be a good $50-60Tn of public equity, public debt and housing stock alone, all which is way more risky than the $9Tn of senior deposit funding for bank balance sheets. Reasonable estimates I've seen is that the deposit insurance subsidy is worth about 80 bps, ie. equivalent to BBB corporate bond credit spreads right now. 80 bps on $10Tn is a joke compared to the total risk of the capital stock, the vast majority of which is public and private equity and housing/land. The argument that the public is just to wimpy to bear the risk without government stepping in just doesn't add up because we are already bearing 90% of it directly. As we've discussed in the (distant) past, you could easily create $10Tn of bomb-proof money by just repoing the capital stock at the central bank with an *80%* haircut. It just doesn't get any more safe than that. Deposit insurance is totally unnecessary.

"when you have taken a wrong turn and found yourself in an even worse place, turning the clock back is the right thing to do?"

The important thing is to have a public deposit option. I.e. everybody should be able to keep money at the CB at the policy rate, just like the clearing banks. (No brick and mortar - just an online account plus a debit card.) And like Ralph says, require the banks to disclose that they do not keep your cash in a vault and no government guarantees it. That doesn't sound to me like turning the clock back. Was there ever a viable public deposit/payment system?

[Nick Rowe]

It seems the Cyprus Parliament has rejected the plan.

Now what? Will Cyprus be able to reopen the banks? If they do, without some other plan, then there will be a very big bank run.

And if the banks stay closed, well, I wonder what that effectively does to the money supply, and the ability of people to buy and sell things? Recessions are always and everywhere a monetary phenomenon.

[Doctor Why]

Nick,

This is how things are done in Cyprus (everything takes at least a week).

Banks will probably stay closed for a few more days, but ATMs are working, so the local economy is going to be OK.

As for the long-term solution, there are so many crazy ideas that nobody can predict what's going to happen.

We'll have to wait and see.

[genauer]

My take is ,

that after that the IMF will insist on a substantially higher hair cut, based on the inferior quality of the credit

[Nick Rowe]

K: "As we've discussed in the (distant) past, you could easily create $10Tn of bomb-proof money by just repoing the capital stock at the central bank with an *80%* haircut."

But (if we change "80%" to (say) 10%) isn't that precisely (in effect) what happens with deposit insurance and commercial banks with 10% capital reserves? And it all worked fine, until the Cyprus banks went and bought a load of Greek bonds, and then the 10% haircut wasn't enough?

I remember our old "Blue Sky" discussions.

I'm also remembering my very old post on Anglo Saxon finance.

[Bob Smith]

Nick: "Third, if the haircut (conversion to equity) was limited to uninsured deposits, that would most likely give control over the banking system to non-residents (some would say money-launderers) - and nobody in the Eurozone would be happy about that."

I could see that, although if your're legislating willy-nilly over people anyhow, you could mandate the conversion into non-voting equity (and there was some hairbrained to give depositors a stake in future Cypriot natural gas field).

It occured to me that the other possibility is that depositors rank equally with other unsecured creditors. If you give depositors a haircut (even if the insured depositors don't lose anything ) does that trigger all sorts of nasty covenants in in the banks' bonds (which are, I gather, governed by UK law, so are outside of the reach of the Cypriot government)? I don't know, but maybe (although, I'd be shocked if that ship hadn't sailed already, surely there must be a solvency covenant in those bond indentures). That might explain why they took the "special tax" rather than "haircut" route (since I can't see a "special tax" on depositors being a trigger for default for the banks' bonds). That doesn't explain why you couldn't have a 15% tax on deposits over E100k, though.

With respect to the 10% (rather than 15%) tax, one colleague floated the idea that the Russians might be able to claim some kind of foreign tax credit up to 10%, meaning that a 10% tax would be a real cost to the Russian fisc., but maybe not to tax-paying Russians (who, no doubt, are abundant in Cyprus), whereas 15% tax would hit the Russian taxpayer. If that were the case, it would be an impressively subtle ploy by the Cypriots. My colleague thought that was far fetched, though, (at least under our foreign tax credit rules) but Russians do things differently.

Nick: "Cyprus needs a loan from Putin, and doesn't want to piss him off too much."

Well, if that was the thinking, it didn't work (and really, would you be less pissed if someone told you they were only stealing 10% of your money?). On the other hand, does that go both ways? Surely they could have put it to Putin "give us a loan or we're going to hit uninsured depositors with a 50% tax!". What's the line, lend a guy a buck and you've got a debtor, lend a guy a billion bucks and you've got a partner?

Very strange. All moot at this point.

[Patrick]

Sorry if this is a stupid question, but I haven't been able to figure out why nobody is suggesting the obvious remedy i.e. wipe out bank equity, big haircut for bondholders, nothing insured above the limit, nationalize/'euroize' what's left, clean it up, sell it in a few years, likely at a profit? If the rumors about shady Russians is true, then perhaps the EU authorities can make good use of the financial information they'd get access too by taking over the Cypriot banking system. They might be able to recover a few billion in laundered money, tax evasion, and generally ill gotten gains.

[Bob Smith]

I can't speak for the rest, but I think the problem with the bondholders is that the bonds are probably governed by UK (or some other foreign) law. Cyprus can do whatever it wants, but it can't re-write those contracts, because on their own terms they're outside of Cyprus' jurisdiction.

I believe a similar issue has bedevilled Argentina over the last decade. At one time it issued bonds governed by US law (because no right-thinking foreign creditor puts faith in the goodwill of the Argentine judiciary, at least not without a hefty risk premium. Ditto, I'm sure, for Cyprus). When Argentina went bankrupt, and settled with creditors for pennies on the dollar, a handful of creditors refused to accept the offer and have spent the last decade chasing Argentine assets around the world on the basis that they still have good debts at face value (on which point they appear to have won a number of US cases) . Case in point, a few years ago they managed to seize an Argentine Navy training ship in Ghana. (see http://en.wikipedia.org/wiki/Argentine_debt_restructuring)

Now, Argentina is entitled to the protection of sovereign immunity, making seizing its assets tricky. A Cypriot bank probably wouldn't be so protected and, in any event, no bank is commercially viable if bondholders are chasing it around the world looking for assets.

One might wonder if Cyprus could play some sort of silly game whereby the repay the bondholders in full, but impose a hefty withholding tax. But I suspect that that would either be prohibited under EU law or some applicable tax treaty. In any event, even if not, I would be shocked if the bond indenture didn't have a provision requiring the bank to gross-up any payments to account for domestic tax, which would just compound the problem.

[Simon van Norden]

Genauer: "Let them sleep one more night about it, and everybody will find that he got a very good deal."

Not so much.

[Simon van Norden]

Patrick: "How did Cypriot banks get into so much trouble ...?"

Bloomberg TV had a good interview with the former Governor of the Central Bank of Cyprus earlier today where he noted that the main cause of the banking crisis was the Troika's decision to "solve" the Greek debt crisis by imposing a haircut on the holders of Greek Govt. bonds....which had a prominent place on the balance sheets of Cyprus's banks. Add to that the strong trading links with Greece, the fact that most of the main banks have important operations in Greece and the cratering of the Greek economy.....and you don't really need much more to understand why their banks are trouble.

(I'm not saying that there were no domestic problems with the way some banks were run....but I'm saying that even Canadian-style bank regulation and management would probably not be up to the challenge faced by Cyprus' banks over the past three years.)

[Simon van Norden]

There's been quite a few people head-scratching about why the Troika decided to go after depositors. The math seems to be as follows.

- there's little or no equity left in any of the banks
- there's almost no bondholders left to wipe out
- the govt's Debt/GDP ratio already is so high that they've been shut out of international capital markets and only Russia is willing to finance them (perhaps because, at the time, Cyprus had a democratically-elect "communist" government....which has just been kicked out of office.)
- yet the Troika has made clear that Cyprus must been seen to make a substantial (less than 50%) financial contribution to bailing out its banks.
- I'm guessing the IMF (or someone else) put its foot down and said that pretending to put more debt on the Cypriot Govt. would effectively be a farce in that few think they will be able to pay the existing debt load.

So when you look at a house that you've fully mortgaged *and* sold the furniture *and* you're told you have to come up woth *more* money.....you rip out the plumbing.

[Nick Rowe]

Simon: that's roughly my take on it. Given the Euro, there aren't many good options. I blame the Euro. And as a way to promote political unity, it currently seems to be very counterproductive. They are all blaming each other, rather than the Euro itself. Like cats in a bag.

[Bob Smith]

Is there going to be a WCI pool on the next Euro-zone jurisdiction to implode? You could justify it as an experiment in the predictive power of markets.

[Simon van Norden]

Bob Smith: "The obvious question is why the bailout of Cypriot banks didn't just ding uninsured deposits (i.e., amounts over E100K)? "

I've now read two news reports (Reuters and NYTimes) that give accounts of the last-minute negotiations prior to the deal announced Saturday night. Both accounts say that the President of Cyprus insisted that the rate on large deposits (over 100K) could not be in "double-digits." At which point, the EU negotiators apparently took the position that the total amount Cyprus had to contribute to the deal was fixed, but they had the leeway to change the mix to make it more acceptable. (Which it seems is still the EU position tonight.) The President then decided to raise the haircut on small deposits.

As I said, that's two often-reliable news sources that have said so. The EU position it describes seems consistent with their position throughout. I'm not aware that the Cypriot President has directly denied that he proposed higher rates on the poor to shelter the rich (anyone know otherwise?)

[Simon van Norden]

Nick: it's a *great* way to promote political unity! All Cypriots* are now united against the Germans....and the Germans against the Cypriots!

*We're ignoring the Turkish Cypriot state right? 'coz no one has mentioned them yet.

[Simon van Norden]

A pool is a good idea (you've just offered to run it, right?)

I'll put my money on small countries....EU rules seem to differ depending on your size (remember the Stability and Growth Pact?)

[Bob Smith]

Simon,

That's consistent with what I had read. If that's the thinking it's just mind-boggling. The Cypriot banking sector is toast for global investors with any material level of haircut (or frankly, even with the threat of a haircut - if they came back tommorrow and said "no worries, we got a huge equity injection from the Russians, we're all good", it would be about 15 seconds before everyone pulled out every last dime). Arguing 15 vs 10 is like bald men fighting over a comb while reorganizing deck chairs on the Titanic (to badly mix my metaphors).

Not that it isn't totally believable.

[Bob Smith]

I guess the tricky part is defining what constitutes an implosion. It kinda has a "we know it when we see it quality to it".

I suppose we could also predict the number of months before a EU member drops out of the Eurozone or the number of months before the ECB says "screw it" and starts churning out acres of Euros. (8 for either)

We could also start taking bets on which Euro zone country elects the first fascist government. (I might take a long-shot on France. Sure Greece and Italy are the early favourites, but I like a dark horse.)

[Determinant]

I nominate Hungary as the candidate for the first fascist government. The neo-fascist Jobbik Party (Movement for a Better Hungary) is already third with 47 seats out of 363.

Spain apparently has an unhuman ability to withstand punishment, so the next implosion will be Malta with a banking/insurance sector worth 800% of GDP.

I give the ECB ten months before they start the printing presses.

[K]

Nick,

I just read that old post on Anglo-Saxon finance. I don't remember reading it before, but it's really good. I especially like this comment of yours, which is basically the same as my proposal for a "bomb-proof" financial system.

"isn't that precisely (in effect) what happens with deposit insurance and commercial banks with 10% capital reserves"

It's the free deposit insurance that causes the huge quantity of deposits, not some kind of intrinsic money demand. Nobody would ever leverage up to that extent except to maximize the value of the government subsidy. So I think it's not the same at all, in fact.

I'm not sure if you are still making the case that there would be less capital if banks didn't fund from deposits? I don't really see very much relationship between availability of risk capital and deposit funding.

[Bob Smith]

Interesting, this Bloomberg piece (http://mobile.bloomberg.com/news/2013-03-19/yes-cyprus-is-different.html) suggests that at least part of the cypriot concern with protecting foreign investor relates to a desire to maintain good relations with a useful ally (Russia) in Cyprus' ongoing conflict with Turkey.

That's a dimension i hadn't seen discussed yet.

[Bob Smith]

New idea. Declare a bank holiday until March 25th. 2053. No haircuts, no collapse, every thing is safe and sound until the banks open. In 40 years.

[Doctor Why]

Simon van Norden:

"I'm not aware that the Cypriot President has directly denied that he proposed higher rates on the poor to shelter the rich (anyone know otherwise?)"

It's possible that he is trying to use small depositors as a shield, or he may have given some commitments to Russian clients. For depositors the practical difference between 9,9 and 15,6% is relatively small, but for a shell company this difference can be huge (e.g. not being able to pay kickbacks on time is very bad for your business).

Bob Smith:

"Interesting, this Bloomberg piece (http://mobile.bloomberg.com/news/2013-03-19/yes-cyprus-is-different.html) suggests that at least part of the cypriot concern with protecting foreign investor relates to a desire to maintain good relations with a useful ally (Russia) in Cyprus' ongoing conflict with Turkey."

I agree, it is a very important factor.

[Doctor Why]

Today the new idea is to open the banks, but impose limits on withdrawals and transfers.

[genauer]

Simon,

you are right, never underestimate the potential of people under the former ottoman rule to do interesting things. Or how should I call this, stupid, crazy?

From my perspective, the entity which is now called Cyprus, killed their business model, yesterday. Every modicum of stability, legality, sanity is gone by now.

If my explorative interpretation is correct, they just killed some 25% of their GDP, possibly 50%, resulting in, according to IMF 120 % GDP debt numbers rules, to wipe out 30 – 100 % of the cash assets there, roughly. And not just some 10% fee.

Since there was repeated talk of “Russian ally” here and in other blogs too, my guess is that here is the only chance to talk this through without emotional explosions.

During the fatal parliament vote, the Cyprus Finance minister was already in Moscow to get new instructions from his owners.

There is plenty UK and Turkish NATO military on this island, covering every hamlet within 50 km (please see Google maps), and I am sure they have now all men on station to eavesdrop on everything somebody says.

All Cyprus ports shippable (http://www.worldportsource.com/ports/CYP.php) are either on NATO territory or within walking distance to them.

Some wording might now get a little dicey, so please be patient with me, and tell me, where I overstep some lines, because I will intentionally explore these lines here.

Would a Canadian “subject of the Crown” call the English “brothers and sisters”?
What do you say, what would the ruler of Akrotiri_and_Dhekelia, the UK Air Vice Marshal Graham Stacey do, if a Russian war ship (as part of a military invasion in response to a Cyprus Sovereign call for brotherly solidarity, like Afghanistan 1979), would come within Torpedo distance (10 km, half the 12 mile zone) to a UK “Sovereign Base Area”, from which the UK is staging in the moment military action in Syria?

There are actually reports that Russian leather jackets are filling all flights from Moscow to Cyprus.

Now, if you would be Putin, how far would you go with the brinkmanship?

And, as a Angela Merkel, what would you do, having elections this summer, besides sitting tight and doing precisely nothing?

[Doctor Why]

genauer,

Cyprus, with its close ties to Russia and potentially huge natural gas reserves, objectively has more room for maneuver than any other periphery country.

The offer it got from the Eurogroup may be reasonable, but it was delivered in a very counterproductive way, given that the new president was elected just a few weeks ago.

Now both sides need to calm down and maybe renegotiate, rather to continue the brinkmanship.

As for the military implications of the current crisis, lets not get silly.

[Bob Smith]

Genauer, let's be honest, Cyprus' business model (at least in the banking sector) blew up the minute people started talking about depositors (insured or otherwise) needing to take a haircut. Rejecting or accepting the proposed bailout plan wouldn't make a different on that account. In terms of Cyprus as a holding company jurisdiction, that might have survived had depositors just taken a haircut, but when the government does it by way of confiscatory taxation, yeah, that's not going to help.

Whether that has sunk in in Cyprus yet remains to be seen. I received an email in my inbox this morning from one the companies that helps organize and manage investments through Cyprus for foreign investors. It was tauting the virtues of Cyprus' tax treaty network without even mentioning the fact that its financial sector was imploding or trying to cook up some story about why everything will be hunky-dory going forward. The timing of the email was unfortunate if nothing else.

[Jacques René Giguère]

If there is no cash withdrawal but you can transfer deposits from account to account, the payment system would still work. It would have been better to impose such a corralito. You would have a pure fiat currency run by the banks. Of course, after the tax , there is no fiat anymore.
The Cyprus foreign policy show how a union must be either complete or nonexistant. Youcan't have the same curreency without fiscal union and common bank supervision,then common foreign policy and full political union ( local jurisdiction must be administrative only). Of course policies must be near-unanimous ( or at least the majorities must be shifting so that everyone has a veto sometimes). Run it like Switzerland.
In a way, NATO is a good model, it almost never went to war as NATO because you coud not get enough people on board. The only one were either solidarity no-brainer Afghanistan ( ok it turned out a no-brainer in the real sense...) or one where you could barter support. In the Kosovo war, Greece was allowed not to bomb Serbia but was told that using their ports was the price to pay for NATO forbidding Turkey to misbehave. (NATO may be the only alliance where two members joined to get protection from each other...) And Turkey was forbidden to bomb ( they could fly escort).

There should have been no Euro without comon foreigh policy.

[Simon van Norden]

Genauer: "my guess is that here is the only chance to talk this through without emotional explosions."

Give your head a shake! The emotional explosions have been in the streets (and the voting booths) for all to see in several countries now. Reuters today is reporting demonstrations in Athens to pressure the govt. to "do a Cyprus."

...and let's not forget the emotions that would be unleashed by Merkel's political opponents arguing that she is sending German money south to bail out lazy mediterraneans and russian oligarchs.

[genauer]

Simon,

maybe I should have said this differently.

I meant, that a Canadian blog, with most of the people here having no skin in the game, is pretty much the only place to discuss, without emotional explosions:

"If my explorative interpretation is correct, they just killed some 25% of their GDP, possibly 50%, resulting in, according to IMF 120 % GDP debt numbers rules, to wipe out 30 – 100 % of the cash assets there, roughly. And not just some 10% fee.

Since there was repeated talk of “Russian ally” here and in other blogs too"

What I tried to say, that

a) there is no such thing as a "Russian card" within shooting distance of NATO territory, and
b) that this has now already triggered a disorderly default of Cyprus

[genauer]

I should have written "NATO military bases" instead of "NATO territory". A significant difference.

[Doctor Why]

genauer,

Russia is a permanent member of the UN Security Council, and this fact alone makes it a valuable ally. There is no need to come up with crazy scenarios of Russian military intervention, for which Russia lacks the necessary capabilities anyway.

[genauer]

Doctor Why,

hmmm, that looks like more misunderstanding here.

How would the UN Security Council be related to any of the problems of Cyprus?

[Doctor Why]

genauer,

Resolutions, sanction against Turkey?

Anyway, the main flash point now is the offshore gas fields, and Russia also can send a few ships there, if necessary, to protect joint commercial interests.

[Doctor Why]

Are you aware that Turkey does not recognize the right of Cyprus to drill in Cyprus's exclusive economic zone and that Cyprus has to build quasi-military alliances in order to be able to develop its offshore gas fields (containing reserves worth tens of billions of euros)?

[genauer]

What Cyprus needs today is 5.8 b Euro cash, and not as a loan, to be counted against the IMF 120% criteria.

Doctor Why, may I ask you a question : how close have you ever lived to a real military base, with signs every 20 meters, that anybody going across the fence could be shot without warning, or a "real" border with barbed wire, anti-personal mines, and lots of guns of all kind stacked on each side?

[Doctor Why]

genauer,

1) "What Cyprus needs today is 5.8 b Euro cash, and not as a loan, to be counted against the IMF 120% criteria."

One plan was to sell shares in Laiki bank to Russia in order to reduce the recapitalization requirements, so we are not talking about a loan.

2) I'm sorry, I'd rather not tell. If you are implying that I have no experience in this area - well, you are wrong.

[genauer]

" one plan was". Exactly. Who buys shares of an outfit which loses 1% of revenue per quarter, has non-performing loans of 18.9% at home , and 47% abroad? Rapidly approaching 1? How do you define the NPV of something like this, to minus 5 billion, or ... ?

When mainland Europe looks at Greece and Cyprus, we see people and Governments living in some parallel phantasy universe.

The mob in the street can demand as much as it wants that 2+2 = pi, and their parliaments can decide on this, it still doesn't make it so.

[Doctor Why]

genauer,

AFAIK, the deal is supposed to work something like this - a Russian bank (Gazprombank?) buys 4bln euros worth of newly issued shares of Laiki in return for natural gas development rights for GAZPROM.

So it is not a fantasy deal, but a real quid pro quo.

[genauer]

Well,

if Cyprus sells drilling rights, not loans, for 5.8b cash to show up in the ECB this weekend, they could have done this a little earlier, and without damaging their reputation.

[Doctor Why]

They could have done a lot of things differently if they hadn't had a crazy communist government until Feb 28.

[genauer]

And can somebody explain to me, why these drilling rights should be more worthful for Gazprom than for BP, Exxon, or any other western corporation.

Why a turkish soldier would have more respect for a russian 100-foot boat, they let through the bosporus, then for 2 US carrier fleets?

[Doctor Why]

Cyprus chose to have good relations with Russia and less good relations with the US (I guess corruption has as much to do with this as traditional cultural ties). They may gradually change their alliances, but that's going to be a painful process.

For example, Russia has already threatened that it may renounce their double taxation treaty with Cyprus if they (Russia) does not like the eventual shape of the bailout deal.

[Bob Smith]

"For example, Russia has already threatened that it may renounce their double taxation treaty with Cyprus if they (Russia) does not like the eventual shape of the bailout deal"

Not sure that's a winning strategy. Sure it would hoop Cyprus' holding company business. On the other hand, Cyprus could turn around and tax the bejesus out of the existing Russian holding companies (typically tax treaties contain a non-discrimination clause). Cyprus would lose its existing business, but pay off its debts with formerly Russian money ("Hey look, we now own all Gazprom's offshore assets" - anyone think any of their offshore investments might be run through Cyprus?).

[genauer]

Cyprus can have as good ties with Russia as it wants, it doesn't help them one bit with Turkey or the ECB.

It just raises more suspicion, about their criminality and sanity, when they endlessly wriggle around, trying to play a card they just don't have.

[Doctor Why]

In most cases Russian officials (in this case it was Medvedev, I think) don't know what they are talking about, so it's hard to tell whether they understand the consequences of such a decision.

[Doctor Why]

genauer,

It helps with Turkey to some extent.

As for the rest - yes, this may end badly.

They tried to do a similar balancing act with confiscated arms a couple of years ago and ended up destroying their main power station.

[Simon van Norden]

genauer: "Doctor Why, may I ask you a question : how close have you ever lived to a real military base, with signs every 20 meters, ..."

You're asking that question....of a Cypriot?!?!

Have you ever tried to fly into Nicosia? There's an airport....but no flights since the early 70s....it is too close to the cease-fire line for aircraft to fly without possibly attracting AA fire. Instead, you fly into an airport an hour away.

I think civilians have been able to pass from one side of the capital to the other for only the past few years ("Checkpoint Charlie" style.) I asked an official what it was like on the other (Turkish) side...but he said that as an official it would not be considered proper for him to cross.