The Banks of Cyprus and their Road to Bankruptcy
The largest banks in Cyprus have been effectively bankrupt ever since Greece's sovereign debt received its second 'haircut'. Readers may recall that neither Greek haircut number one, nor haircut number two were ever supposed to happen.
"Default is not an issue for Greece", ECB governor Trichet trumpeted in May of 2009. On December 11, 2009 we heard that "Policymakers lined up at an EU summit in Brussels on Friday to say Greece will not go bankrupt and they trusted it to take the tough fiscal consolidation measures required to get its public finances in order".
Former monetary affairs commissioner Joaquin Almunia told Bloomberg on January 29, 2010: "No, Greece will not default. Please. In the euro area, the default does not exist because with a single currency the possibility to get funding in your own currency is much bigger." Alumnia even considered a bailout a preposterous idea; a Bloomberg report from the 2010 Davos pow-wow noted: "Almunia dismissed as "sensationalist" newspaper reports that the euro region was discussing options to bail out Greece."
One day earlier, both the French and the German government assured everyone that there was not the slightest chance that Greece would require a bailout. Spain's then finance minister Elena Salgado declared herself 'not worried' by the possibility of a Greek debt default. And of course, the Greek government itself frequently insisted that it wouldn't default on its debt under any circumstances.
We could go on, but you get the drift. Greece then defaulted anyway. This was disguised as a so-called 'private sector initiative', the eurocratic euphemism for a Greek debt default that would only hit private sector creditors, but not the ECB or other public sector creditors. These lenders had to stomach a loss of more than 70% on their holdings of Greek government bonds. And then Greece defaulted a second time, by means of the expedient of buying back its existing 'new' debt at a steep discount. Apart from a few hedge funds that had bought the debt cheaply ahead of the buyback in expectation of such a deal, private creditors were 'persuaded' to agree to being robbed a second time.
This second de facto default occurred after the eurocracy had insisted that the first haircut was an 'absolutely unique event', never to be repeated again anywhere in the euro area.
At this point it should be made clear that there is, of course, nothing wrong in principle with a debtor going bankrupt and his creditors losing money once he becomes unable to pay. Granted, Greece had lied for almost a decade about its true financial situation, but that lie was not a big secret. There were people in the EU bureaucracy who prior to Greece's accession to the euro pointed out to their colleagues and the EU parliament that Greece was playing fast and loose with its debt statistics. In fact, even the Goldman Sachs derivatives deal that allowed Greece to hide a good part of its debt was not a secret. It wasn't 'suddenly discovered' in 2010 or 2011 as the public has been led to believe. The eurocrats knew about it all along. Critics within the eurocracy who complained about these things simply lost their jobs.
Any creditor who did his homework would have been able to find all of this out; it is part of the public record. Lenders to Greece took the risk anyway, so they deserved to take losses. However, from 2009 onward, and that is the point we wish to make here, every single official in the eurocracy assured creditors that they were safe, up until the very point in time when they weren't anymore. Euro-group head Jean-Clause Juncker at one point even openly admitted that he regarded telling lies as part of his job description.
The Republic of Cyprus is officially regarded as a single country; in practice Cyprus is partitioned, into a Greek and a Turkish half. The Greek half of the island in the South is de facto the part of it that is a member of the EU and the euro area. Given its Greek roots, it is no surprise that its banks held large chunks of Greece's sovereign debt. Recall that this debt was once considered perfectly 'risk free', while offering a small yield premium over that of euro area 'core' countries. Banks were not required to hold any capital in reserve against their sovereign debt holdings.
The result of this was that the banks of Cyprus got knee-capped twice in a row. Since these are fractionally reserved banks, they are insolvent at all times anyway. It would be different if they could actually pay all demand deposits immediately on demand; since fractionally reserved banks cannot possibly do that, they cannot be regarded as truly solvent. Their solvency depends entirely on the percentage of depositors trying to withdraw money remaining below their effective reserve threshold. In the euro area, 'required reserves' are nowadays set at a laughable 1% by the central bank, although the percentage of 'covered' money substitutes has temporarily increased in the euro area as a whole due to the ECB's LTROs. Of course, the lowering of the reserve requirement to 1% was specifically designed to help those banks that are in the absolute worst condition, thereby exposing their depositors to even more risk than they would normally bear. It is probably safe to assume that Cypriot banks firmly belong in this category.
We have previously written about the wrangling over the bailout of Cyprus. The initial estimate of the size of the bailout has more than tripled since Cyprus officially applied for aid in June last year.
Neither governments nor banks are 'allowed' to officially go bankrupt in the euro area, so it was to be expected that a bailout would be put into place. Prior to the bailout, there was a lot of noise made about 'Russian oligarchs' holding large deposits with Cypriot banks, money that is allegedly somehow tainted, although an IMF investigation has concluded otherwise.
Pressure was also put on Cyprus because of its low tax regime. The 'harmonizers' and 'centralizers' in the EU have used the opportunity to blackmail Cyprus into raising its taxes. They have succeeded, although they probably expected more (Cyprus has now agreed to hike its corporate tax rate from 10% to 12.5%). The fact that the banks of Cyprus are effectively bankrupt was implicitly acknowledged, as the bailout obviously mainly serves to save the banks and their current owners.
Cyprus's new President Nicos Anastasiades (R) and his predecessor – and you thought they were going to keep your savings safe?
(Photo credit: Reuters)
The 'Tax' on Depositors, or Theft by Another Name
"Draghi told Schäuble that he often heard that argument from lawyers, even though the question of whether Cyprus was systemically relevant or not was not one that lawyers could answer. That, said Draghi, was a matter for economists. Schäuble is a trained lawyer. Draghi was backed by the European Economic and Monetary Affairs Commissioner Olli Rehn as well as the head of the European Stability Mechanism, Klaus Regling.
The three pointed out to Schäuble that the two biggest banks in Cyprus had a large network of branches in Greece. If any doubt were cast on the safety of deposits held with those banks, the uncertainty of Greek savers could quickly spread to Greek banks, which would represent a major setback for Greece.
In addition, they argued, a Cypriot bankruptcy would undo the positive news that had recently helped to calm the euro crisis."
These doubts have obviously been cast aside. Bank bondholders are evidently regarded as more important and therefore more bailout-worthy than mere depositors, especially as the biggest depositors are believed to be hailing from Russia. Just as has happened in Argentina in the 2001 crisis, it was decided to impose a confiscatory deflation on the depositors of Cypriot banks, which has been disguised as a 'tax' on deposits (for an excellent overview of Argentina's case, see this article by Joseph Salerno). In reality it means that there is no money, and money that is extended in the course of the bailout is at least partially going to be supplemented by the funds belonging to depositors.
There is nothing wrong in principle with depositors bearing risk. However, the modern-day banking system is based on a fiction of bank solvency: depositors are generally led to believe that they are not exposed to any risk. The fact that the banks do actually not have the money to repay all, or even a significant portion of their demand deposit liabilities, is systematically suppressed (this is to say, it is never once mentioned in the mainstream media). Government 'deposit insurance' schemes and the central bank backstop are widely held to guarantee that deposits are indeed safe. Similar to the 'impossibility of a Greek default', this is only true until it isn't anymore.
When push comes to shove and the choice is between letting a few banks and their shareholders and bondholders bite the dust or letting depositors pound sand, we have just learned that depositors are the ones drawing the short stick. They are not considered to be 'first in line' among creditors. Note here that a depositor deposits his own money with a bank. He is not thinking of himself as a 'creditor' of the bank – he deposits money for safekeeping purposes and payment services. He only finds out differently once the banks are in trouble. As is usual in the euro area (and elsewhere for that matter), lies were told by officials up until the very last moment, so as to lull depositors into a false sense of security and make it easier to steal as much money as possible from them:
"The euro zone agreed on Saturday to hand Cyprus a bailout worth 10 billion euros ($13 billion), but demanded depositors in its banks forfeit some money to stave off bankruptcy despite the risk of a wider run on savings.
The eastern Mediterranean island becomes the fifth country after Greece,Ireland, Portugal and Spain to turn to the euro zone for financial help during the region's debt crisis. In a radical departure from previous aid packages – and one that gave rise to incredulity and anger across the country – euro zone finance ministers forced Cyprus' savers to pay up to 10 percent of their deposits to raise almost 6 billion euros.
Parliament was due to meet on Sunday to vote on the measure, and approval was far from assured. The decision prompted a run on cashpoints, most of which were depleted by mid afternoon, and co-operative credit societies closed to prevent angry savers withdrawing deposits. Almost half Cyprus's bank depositors are believed to be non-resident Russians, but most queuing on Saturday at automatic teller machines appeared to be Cypriots.
President Nicos Anastasiades, elected three weeks ago with a pledge to negotiate a swift bailout, said refusal to agree to terms would have led to the collapse of the two largest banks. "On Tuesday … We would either choose the catastrophic scenario of disorderly bankruptcy or the scenario of a painful but controlled management of the crisis," Anastasiades said in written statement. In several statements since his election, he had previously categorically ruled out a deposit haircut.
"My initial reaction is one of shock," said Nicholas Papadopoulos, head of parliament's financial affairs committee. "This decision is much worse than what we expected and contrary to what the government was assuring us, right up until last night," he told Reuters, without saying whether he would back the measure or whether he thought it would pass.
Of course the measure will pass; if for some reason it doesn't pass, voting will be repeated until it does – this is how dissent is routinely dealt with in the EU. Depositors have correctly interpreted what is happening, and fresh lies have immediately issued forth from the eurocracy:
"The deposit levy – set at 9.9 percent on bank deposits exceeding 100,000 euros and 6.7 percent on anything below that – will take place on Tuesday after a bank holiday on Monday. To guard against capital flight, Cyprus took immediate steps to prevent electronic money transfers over the weekend.
At one cashpoint in the capital Nicosia, a pensioner couple said they had visited several automatic teller machines without success. "We are trying to pull as much as we can," one told Reuters, reaching for a wallet containing four debit cards.
"I'm extremely angry. I worked years and years to get it together and now I am losing it on the say-so of the Dutch and the Germans," said British-Cypriot Andy Georgiou, 54, who returned to Cyprus in mid-2012 with his savings. "They call Sicily the island of the mafia. It's not Sicily, it's Cyprus. This is theft, pure and simple," said a pensioner.
The levy breaks a euro zone taboo by hitting depositors. It prompted Spain, considered the next most likely state to seek a sovereign rescue though supported recently by a European Central Bank promise to buy government debt if necessary, to deny savers in other countries risked being similarly penalized.
The bailout was specific to Cyprus and its bloated banking sector and "could not be extrapolated to any other country," an economy ministry source in Madrid said."
The lie is in the last sentence above – of course these developments can be 'extrapolated' to other countries. Every depositor in a euro area country with a wobbly banking system should take heed. They will steal your money in an eye-blink, while telling you they would never do that up until the day it actually happens.
It should be mentioned that the plan apparently includes the idea that depositors in Cyprus will be 'compensated' with 'equity' in their bankrupt banks. So if you're a pensioner with €2,000 in savings, they will steal €134 from you, and give you completely worthless shares in a bankrupt bank in return. Any widows and orphans with more than € 100,000 in their accounts will see almost 10% of their money disappear.
Schäuble is a Ganymedian Slime Mold
"Cheers," the slime mold said. "This calls for a celebration." (P.K. Dick, Clans of the Alphane Moon)
The hypocritical comments by German finance minister Schäuble on the situation in Cyprus can hardly be surpassed in their unctuous sliminess. Although German politicians are in many cases fairly decent compared to the shameless highway robbers in charge of several other European countries, their establishment 'credentials' cannot be doubted. Members of the political and bureaucratic classes in Europe, secure in their fat salaries and pensions and protected by old boys networks, should at least have the decorum to occasionally shut up instead of pouring salt on people's wounds with their sanctimonious declarations. Mr. Schäuble clearly missed an excellent opportunity to shut up over the weekend and revealed himself as a fervent supporter of EU style statism. Let us not forget, here speaks one of the men who for months on end played along with the lies about Greece and its eventual default, i.e., the proximate cause for the downfall of the Cypriot banks:
"It was the position of the German government and the International Monetary Fund that we must get a considerable part of the funds that are necessary for restructuring the banks from the banks owners and creditors – that means the investors," German Finance Minister Wolfgang Schaeuble told public broadcaster ARD in an interview.
"But we would obviously have respected the deposit guarantee for accounts up to 100,000," he said. "But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people."
Schaeuble said the Cypriot business model, of attracting capital with low taxes and favorable legal regulation, had proven to be unsustainable. But it had been "imperative in the interest of defending our common currency" to offer Cyprus aid."
Even if we have to steal some of that aid from bank depositors! Had Schäuble stopped before his comment on the 'economic model' of Cyprus, then we would have to merely state that it seems rather odd that poor old Germany was so completely unable to insist on a 'bail-in' of investors en lieu of simply robbing depositors. It is interesting though that Schäuble admits quite openly that bondholders were preferred over depositors – in other words, those who have taken risk voluntarily were preferred over those who wrongly believed, and were encouraged to believe so by politicians, that they had taken no risk at all.
However, his comment about the 'unsustainable business model' of low taxes and favorable regulations in Cyprus really takes the cake. There is absolutely nothing 'unsustainable' about keeping the State small and giving the market free reign. One might as well complain about the 'unsustainable business models' of Switzerland or Hong Kong, if not for the obvious and embarrassing fact that they are among the wealthiest places on the planet. There is only one reason for the problems in Cyprus and it has absolutely nothing to do with its market-friendly 'business model'.
We keep being told by people like Schäuble and his fellow European politicians and bureaucrats (the two classes are essentially interchangeable in most parts of Europe, as career politicians in the main emerge from the ranks of the bureaucracy – which is why we usually tend to speak of 'eurocrats' in the broader sense, including both) that the world would go under if a few big banks bit the dust and their bondholders were to take losses. However, this assertion is patently nonsensical. What happens in bankruptcies are two things: first, assets are repriced to their actual market value; second, a change of ownership takes place. Not a single building, factory, or piece of infrastructure would disappear if a few big banks were to go bankrupt. Their current creditors and owners would be replaced by new owners, who very likely would prove better stewards of capital than the old ones.
Admittedly the giant credit bubble and the vast expansion of money substitutes which the fiat money era has enabled have complicated things; but if anyone deserves to be 'bailed out' in the event that a bank's capital proves insufficient to cover its losses, it is surely depositors, not bondholders. Thereafter, one should as quickly as possible introduce wide-ranging, in-depth reforms of the monetary and banking systems along free market lines.
What is ultimately unsustainable is the very monetary system governments have been complicit in creating. Moreover, Schäuble errs when he thinks that that it is going to prove possible to maintain the so-called 'third way' of the 'mixed economy', a.k.a. the 'social market economy', so highly prized in Germany and elsewhere in Europe. The Ponzi scheme of government spending customary in the modern-day welfare/warfare states could not possibly exist without the inflationary fiat money system and its fractionally reserved banks. The State would be far smaller without it. However, this system is on a path to certain self-destruction. The fact that even a severely hampered market economy continually creates wealth has extended its life span, but the constant reiteration of boom-bust sequences of ever greater amplitude consumes more and more scarce capital. At some point a tipping point will be reached, just as has happened in the command economies of the former Eastern Bloc. Then the system will collapse. As Ludwig von Mises stated in "Planning for Freedom":
"The Welfare State is merely a method for transforming the market economy step by step into socialism."
In "The Anti-Capitalistic Mentality" he notes:
"Capitalism and socialism are two distinct patterns of social organization. Private control of the means of production and public control are contradictory notions and not merely contrary notions. There is no such thing as a mixed economy, a system that would stand midway between capitalism and socialism."
And in "On the Manipulation of Money and Credit", he links all of this up with inflationism:
"Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard advocates went hand in hand with liberalism, free trade, capitalism and peace, so is inflationism part and parcel of imperialism, militarism, protectionism, statism and socialism."
We will take Ludwig von Mises' pithy assessment of the so-called 'third way' and the inflationist system over Mr. Schäuble's any day.
Addendum: Bank of Cyprus to Extend 'Bank Holiday' if 'Necessary'
As we finished writing the above, we heard over TV that the National Bank of Cyprus has not only stopped all money transfers that were already in progress, but will, in the event that the vote in parliament has a 'negative' outcome (i.e., if the deposit grab is miraculously not approved), 'extend the bank holiday until Tuesday' – and presumably for as long as it takes.