You Have Been Warned
The crisis in Cyprus has supposedly been resolved and the resolution eventually decided upon is being implemented. There is therefore a powerful temptation to say that whatever the fuss was about, it’s behind us now and we can forget about it and get back to normal. That is an understandable sentiment, but one that is woefully wrong in every respect, from its assumptions to its conclusions.
Take, for example, that last point – ‘let’s get back to normal’. It is not merely a distortion, it is actually a total inversion of the truth. ‘Normal’, since 2007 globally and since 2009 in Europe, is a state of crisis. The causes of the European and global crises (which overlap, but are by no means identical have never been properly addressed by policy-makers, ergo they have never been resolved. The European crisis, in particular, must be seen for the chronic illness that it is, with the only variables relating to it being the degree of intensity that it displays at any given time, and its geographic/ national focus. The ‘treatment’ that has been given to this chronic crisis has been, for the most part, symptomatic and aimed at providing immediate relief, not lasting recovery.
Worse, when a genuine form of treatment has been agreed upon, it has usually not been implemented — and even when it is begun, it is discontinued or diluted to the point of ineffectiveness. The result is that things are thereby made worse than would have been, even in the absence of any treatment. Cyprus offers examples of all of these phenomena, but perhaps the most dramatic relates to the critical issue of rescuing failed banks. If, as has been the case almost everywhere, bankrupt banks are ‘bailed out’ by the state using taxpayers money, whilst the ‘stakeholders’ in the bank are allowed to walk away without punishment, the result is increased ‘moral hazard’. That means, in simple terms, that the management of banks everywhere are encouraged to take greater risks than they normally would with the money — other people’s money — under their control. If they are successful, the profits will accrue disproportionately to them – but if they are spectacularly unsuccessful, they will lose little or nothing.
Who are the stakeholders? They include the shareholders who invested in the bank’s equity, the bondholders – junior and senior – who lent to it via bond issues and the depositors who lent it money in return for safe-keeping and interest. The accepted approach to saving banks, in text-books at least, was that the bank’s losses should be borne, at least in part, by these stakeholders – and in the order noted. Equity investors should be first in line, for losses as for profits and, if the loss is so great that wiping them out completely is insufficient, then junior and then senior bond holders must bear the brunt. Only then – meaning in very extreme cases – should depositors be tapped. Even then, small depositors – by definition, comprising mostly households — should be protected by the state-provided guarantees that exist in most developed countries (for sums of up to 100,000 euros in EU countries).
That approach has been thrown overboard almost everywhere since 2007. Banks in the US, UK, Ireland, Greece, Portugal, Spain, Holland, Belgium and many other countries have been saved by the state, using taxpayers’ money. In most cases, shareholders have suffered losses, but in few have they been wiped out (ie the bank has been totally nationalized). Bondholders have generally been left whole. The idea that depositors would be ‘impaired’ (the new buzz-word for not getting back all the money they deposited) was considered unthinkable – until Friday night two weeks ago, when the initial proposed framework for saving Cyprus was announced. That proposal included ‘impairing’ even state-guaranteed deposits, but it was rejected by the Cypriot parliament – although the mere proposal itself marks a major milestone in banking history, and in the ongoing collapse of the euro, the EU and the global financial system as it has developed for the last century.
A tremendous debate is raging across the world with regard to the belated revival of the basic concept of moral hazard — as it relates to investors in bank equity and in bank bonds (a very common investment and a supposedly very safe one), and above all, as it includes depositors in bank accounts. Is it right and desirable? Is it insane, to the point of being financially suicidal – because it will trigger runs by bank depositors?
You might have an opinion – indeed, if you are intelligent person, or even merely a depositor in a bank, or a tax payer in any developed country, you should have one. But be aware of one thing above all. Whatever your opinion, you should separate it firmly from the cold recognition of the fact that the world is a different, and for most people, far more dangerous place than it was two weeks ago. Your money, which you supposed to be ‘as safe as money in the bank’, is no longer safe, let alone guaranteed. How unsafe it is varies by country and by bank but, for the first time in several generations, the starting point is now reversed: all banks and all bank deposits carry risk, with some more at risk than others.