Best of the Week
Most Popular
1.Stock Market Continues Defying Gravity, Dow New All Time High - Nadeem_Walayat
2.America Superpower 2016 - Ian Bremmer
3.The US Dollar and the Precious Metals Complex - Rambus_Chartology
4.UK Immigration Crisis Could Prompt BREXIT, Propelling Britain Out of EU Despite German Factor - Nadeem_Walayat
5.The “Real Flash Crash” Will Scare You to Death - Shah Gilani
6.Gold Price Trend Forecast - Bob_Louka
7.UK Deflation Warning - Bank of England Economic Propaganda to Print and Inflate Debt - Nadeem_Walayat
8.Gold Lifeboat to Global Economies “Titanic Problem” Warn HSBC - GoldCore
9.Will Interest Rates Ever Rise? - BATR
10.Who’s Killing the Stock Market? - Shah Gilani
Last 5 days
This New Currency Could Wipe Out the Euro - 28th May 15
US Housing Market - Something Smells Fishy - 28th May 15
US Economy – Semi b2b Amps Up its Trend - 28th May 15
U.S. Fed Exported QE Travesty: Meet The BLICS Nations - 28th May 15
World War D—Deflation - Secular Bear Markets Analysis - 28th May 15
George Soros Warns of “Third World War” - 28th May 15
Why You Shouldn't Try to Invest Like Warren Buffett - 28th May 15
Stock Markets Buy and Hold is Back! - 28th May 15
We're Now Frighteningly Vulnerable to a Bond Market Crash - 28th May 15
Austerity, Economics and Religion - 28th May 15
National Holidays London and the Magic of Legoland UK Review - 27th May 15
Imminent Stocks Bear Market Signaled by Dow Theory ... - 27th May 15
Gold Price Has Bottomed – More Evidence - 27th May 15
Three Reasons You Shouldn’t Try to Invest Like Warren Buffett - 27th May 15
Gold Is “100% Guarantee from Legal and Political Risks” States Russian Central Bank - 27th May 15
Don't Drown in the Sea of Global Debt - 27th May 15
Three Reasons Why Carl Icahn Is Wrong About Apple Stock - 27th May 15
Crude Oil Price Stochastic Signals - 26th May 15
Why the Stock Market Will Crash - 26th May 15
GDP, Inflation, Employment Economic Statistics: It’s All a Lie - 26th May 15
Introduction to Peak Food - 26th May 15
Should We Dump the Euro? - 26th May 15
A Geopolitical Net Assessment of Europe - 26th May 15
Stock Market Top in Place? - 26th May 15
Best Cash ISA SBI 2.3% - 2.8 Year Fix, UK Interest Rates 2016 - 26th May 15
China Sets Up Gold Bullion Fund For Central Banks - 25th May 15
Is The Silver Trade Getting Crowded? - 25th May 15
Money Murder Mystery: Who Killed the Stock Market? - 25th May 15
Why Do We Celebrate Rising U.S. House Prices? - 24th May 15
Mario Draghi’s Slippery Downward Slope - 24th May 15
Gold : Truth is Stranger than Fiction - 24th May 15
Facebook Stock Price Forecast - 24th May 15
Make a Killing on the Coming Energy "Debt Bubble" - 24th May 15
Stock Market SPX Uptrend Inflection Point - 23rd May 15
What You Know for Certain - Huge Demand for Gold And Silver - 23rd May 15
Are We in Another Credit Bubble? And Is It Different than Before? - 23rd May 15
The “Real Flash Crash” Will Scare You to Death - 23rd May 15
Venezuela: No Rule of Law, Bad Money - 23rd May 15
Robots That Can Beat the Market by 100% - 23rd May 15
Why Shake Shack Stock Is a Bad Investment - 23rd May 15
Gold Price Primary Driver Bullish - 23rd May 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Biggest Debt Bomb in History

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

© 2005-2015 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

Biggest Debt Bomb in History