Best of the Week
Most Popular
1.Gold Price Trend Forecast, Where are the Gold Traders? - Bob_Loukas
2.Stocks Bear Market of 2017 Begins? Shorting the Dow At its Peak! - Nadeem_Walayat
3.Betting on President Trump Leaving Office Early, Presidency End Date - Betfair Market - Nadeem_Walayat
4.Why Stock Market Analysts Will be Wrong About 2017 - Clif_Droke
5.Is This The Best Way For Investors To Play The Electric Car Boom - OilPrice_Com
6.Silver Price 2017 Trend Forecast Update - Video - Nadeem_Walayat
7.Gold Price Set For Very Bullish 2017, Trend Forecast - Austin_Galt
8.10 Things I learned From Meetings With Trump’s Transition Team - - John_Mauldin
9.How Investors Can Profit From Trumps Military Ambitions - OilPrice_Com
10.Channel 4 War on 'Fake News', Forgets Own Alt Reality Propaganda Broadcasting - Nadeem_Walayat
Last 7 days
Underperformance in Gold Stocks Argues for Interim Peak - 25th Feb 17
Watch What Happens When Silver Price Hits $26...  - 25th Feb 17
Gold Futures Buying Yet to Start - 25th Feb 17
When the Stock Market Flying Pig Tops - 24th Feb 17
Gold, Second Fed Hike and Interest Rates - 24th Feb 17
Bitcoin Price Hits Record High! - 24th Feb 17
Another Stock Market Bubble? Bring it On! - 24th Feb 17
What Investors Need To Know About U.S. Money Market Funds? - 24th Feb 17
When Was America’s Peak Wealth? - 24th Feb 17
The Oscars – Worth Their Weight in Gold? - 24th Feb 17
The Best Reasons to Buy Gold in the Age of Trump - 22nd Feb 17
Silver, The Return of Stagflation - 22nd Feb 17
Why EU BrExit Single Market Access Hard line is European Union Committing Suicide - 22nd Feb 17
Gold: Short End US Rates Matter More Than Long End Real Yields - 22nd Feb 17
CONTINENTAL RESOURCES: Example Of What Is Horribly Wrong With The U.S. Shale Oil Industry - 22nd Feb 17
Here’s Proof Rising Rates Are Good for Gold - 21st Feb 17
Gold and Silver Weekly Update - 21st Feb 17
US Dollar and Gold Battle of the Cycles - 21st Feb 17
NSA and CIA is the Enemy of the People - 21st Feb 17
Big Moves in the World Stock Markets - Big Bases - 21st Feb 17
Stock Market Uptrend Continues - 21st Feb 17
Brent Crude Oil Price Technical Update: Low Volatility Leads to High Volatility - 20th Feb 17
Trump’s Tax System Could Spark The Wave Of Self-Employment - 20th Feb 17
Here’s How to Stay Ahead of Machines and AI - 20th Feb 17
Warning Signs Of Instability In Russia - 20th Feb 17
Warning: This Energy Investment Could Wreak Havoc On Your Portfolio - 20th Feb 17
The Mother of All Financial Bubbles will be Unimaginably Destructive when it Bursts - 19th Feb 17
Gold’s Fundamentals Strengthen - 18th Feb 17
The Flynn Fiascom, the Trump Revolution Ends in a Whimper - 18th Feb 17
Not Nearly Enough Economic Growth To Keep Growing - 18th Feb 17
SPX Stocks Bull Market Continues to make New Highs - 18th Feb 17
China Disaster to Trigger Gold Run, Trump to Appoint 5 of 7 Fed Governors - 18th Feb 17
Gold Stock Volume Divergence - 17th Feb 17
Gold, Silver, US Dollar Cycles - 17th Feb 17
Inflation Spikes in 2017, Supporting Gold Prices Despite Increased Odds of March Rate Hike - 17th Feb 17
Roses Are Red... and So's Been EURUSD's Trend - 17th Feb 17
Gold Trade Note Sighted - 17th Feb 17
Gold Is Undervalued Say Leading Fund Managers - 17th Feb 17
NSA, CIA, FBI, Media Establishment 'Deep State' War Against Emerging 'Trump State' - 16th Feb 17
Silver, Gold Stocks and Remembering the Genius of Hunter S. Thompson - 16th Feb 17
Maps That Show The US’ Strategy In Asia-Pacific - 15th Feb 17
The Trump Stock Market Rally Is Just Getting Started! - 15th Feb 17
Tesco Crisis - Fake Prices, Brexit Inflation Tsunami to Send Food Prices Soaring 10% 2017 - 15th Feb 17
Stock Market Indexes Appear Ready to Roll Over - 15th Feb 17
Gold Bull Market? Or was 2016 Just a Gold Bug Mirage? - 15th Feb 17
Here’s How Germany Buys Time From China - 15th Feb 17
The Stock Trader’s Actionable Guide to Trump - 15th Feb 17
Trump A New Jacksonian Era? The Fourth Turning (2) - 14th Feb 17
Stock Market Yet Another Wall Street 'Witch's Brew' - 14th Feb 17
This Is Why You Don’t Own A Lot Of Stocks - 14th Feb 17
Proposed Tax Reforms Face Enormous Headwinds - 14th Feb 17

Market Oracle FREE Newsletter

State of Global Markets 2017 - Report

Why the Cyprus Depositors Savings Theft Could Set Banking Back 300 Years

Stock-Markets / Credit Crisis 2013 Mar 19, 2013 - 11:25 AM GMT

By: Money_Morning

Stock-Markets

Martin Hutchinson writes: Even by the standards of the EU bureaucracy, raiding the private deposits of Cyprus' banks is spectacularly foolish.

For a measly $5.8 billion euros, the EU has now put the entire Eurozone on edge-not to mention the entire global economy.


It revolves around something as simple as trust. And as a former banker, I can tell you that there's no substitute for the belief that your deposits are safe and sound.

It's a thin line and once it's been crossed it's nearly impossible to repair.

Now savers in Spain, Italy and elsewhere in the Eurozone are left to wonder about the safety of their own accounts.

Here's why savers everywhere should be concerned...

The Problem With the Cyprus "Bailout"
Like Ireland and Iceland, Cyprus has a banking sector that's not only shaky but is far bigger than its overall economy, with deposits of around $90 billion, or five times its GDP.

Unlike most banking systems, more than half of those deposits are in large chunks of over 100,000 euros ($128,000), the limit of Cyprus' deposit insurance. Indeed, about $20 billion of Cyprus' deposits are held by the Russian mafia.

Since Cyprus' president Nicos Anastasiades didn't want to shut down the island's attraction as a money haven and playground for the Russian jet-set, he agreed to a deposit tax of 6.7% on deposits up to 100,000 euros and 9.9% on deposits above 100,000 euros, to satisfy the EU's demand of 5.8 billion euros ($7.2 billion) part of the bank bailout.

But like most schemes designed by politicians and EU bureaucrats, this one has huge flaws, including the fact it angered Russian president Vladimir Putin. Even at this level, with much of the money coming from Cyprus' modestly well-off citizens, Putin described it as "unfair, unprofessional and dangerous."

But the main flaw isn't about Putin. It has to do with the idea of deposit insurance itself.

Under a separate scheme introduced by the EU after the 2008 financial crash, deposits under 100,000 euros are insured by the Cyprus government.

Of course, the "tax" on deposits is a supposedly clever way to get around this without the Cyprus government itself defaulting. However, all this little trick does is call into question deposit insurance throughout the EU and, indeed, worldwide.

That's why this tiny country, with a population of only 800,000 and $17 billion in GDP, has roiled the world markets-- it attacked the central principle of deposit insurance.

After all, if governments can just seize deposits by means of a "tax" then deposit insurance is worth absolutely zippo.

Meanwhile in Cyprus, there were a number of alternatives to breaking this underlying bond of trust. The banks have some bond debts outstanding, which certainly should have been written down before the deposits were attacked. In fact, the tax is an attempt to avoid this, and should be resisted on that ground alone.

Instead, because the large deposits are so big, you could raise the required 5.8 million euros simply by a 15% tax on large deposits - but that would make Putin REALLY angry (he personally may or may not have money in Cyprus, but lots of his friends do).

They could also write down Cypriot government bonds, but because the banking system is relatively so huge the write-off would have to be a big one. To get 5.8 billion euros it would take more than a 50% write-down.

In the big picture, Cyprus doesn't matter much, unless EU incompetence and the recalcitrance of its own politicians makes it leave the euro altogether, in which case that currency unit yet again faces the prospect of break-up.

Who Can You Trust?
But in this case, the effect on global deposit insurance systems is much more important.

Deposit insurance was first invented in the United States during the Great Depression as a means to reassure savers about the solvency of banks, a third of which had just gone belly-up. It worked beautifully. Americans trusted the federal government (at least, they did back then), so once deposit insurance was in place savers came to have complete trust in the banking system.

Unfortunately, that same trust had a very bad effect on the banking system itself.

From leverage ratios of $4-5 of assets to $1 of capital in the 1920s, banks leveraged themselves ad infinitum, having leverage ratios of $10-12 of debt to $1 of capital in the 1970s, and up to $30 of assets to $1 of capital in 2008.

Even today, after de-leveraging, J.P. Morgan Chase (NYSE: JPM), in many ways the most solid of the big banks, had assets of $2,359 billion at the end of 2012 and tangible equity of only $146 billion -- or a ratio of 16.2 to 1. As recently as 2010, JPM's leverage was 19.3 to 1.

At those levels you can see the dangers that kind of leverage presents.

In fact, I counseled the National Bank of Croatia to this effect, when they were designing their deposit insurance system in 1996-97, advising them to have insurance covering only 90% of deposits. Unfortunately the politicians in the Croatian parliament overruled us, so Croatia now has the same damaging 100% insurance as everywhere else.

So the depositor today ends up with the worst of both worlds. He can't rely on the banks not to go bust, given their current absurd levels of leverage (which are of course encouraged by Ben Bernanke's money printing). On the other hand, now there's a question of whether he can rely on deposit insurance either.

If these worries become really serious, it will be devastating for the world economy. Small savers will take their money out of banks and resort to household safes and a shotgun.

If savers no longer have a solid place in which to put their money, we will have undone the financial revolution of the last 300 years, and returned to a world in which Samuel Pepys didn't trust the local goldsmith, so buried most of his wealth in the back garden. Needless to say, that won't do much for small business - the entire flow of finance will seize up altogether.

The solution is to do away with deposit insurance, forcing banks that want to attract depositors to hold $1 of capital for every $4-5 of assets, at most.

Eliminating Ben Bernanke and going back to a gold standard will probably be necessary too-even though that's not likely to happen anytime soon.

But if politicians continue behaving as badly as those who designed the Cyprus bailout, the gold standard will be the only economically viable alternative.

With this "bailout" all the EU has done is open up a Pandora's Box.

Source :http://moneymorning.com/2013/03/19/why-the-cyprus-bailout-could-set-banking-back-300-years/

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife