It doesn’t create a lot of confidence in Europe that tiny little Cyprus, with a GDP less than Vermont, is now causing immense turmoil.
Though to be more accurate, events in Cyprus aren’t causing turmoil as much as they’re causing people to examine both government finances and bank soundness in other nations. And that’s causing anxiety because folks have taken their heads out of the sand and looked at the reality of poor balance sheets.
Looking closer at the specific mess in Cyprus, an insolvent financial sector is the cause of the current crisis, though the problem is exacerbated by the fact that the government has dramatically increased the burden of government spending in recent years and therefore isn’t in a position to finance a bailout.
But that then raises the question of why Cyprus is bailing out its banks? Why not just let the banks fail?
Well, here’s where things get messy, particularly since we don’t have a lot of details. There are basically three options for dealing with financial sector insolvency.
- In a free market, it’s easy to understand what happens when a financial institution becomes insolvent. It goes into bankruptcy, wiping out shareholders. The institution is then liquidated and the recovered money is used to partially pay of depositors, bondholders, and other creditors based on the underlying contracts and laws.
- In a system with government-imposed deposit insurance, taxpayers (or bank consumers via insurance premiums) are on the hook to compensate depositors when the liquidation occurs. This is what is called the “FDIC resolution” approach in the United States.
- And in a system of cronyism, the government gives taxpayer money directly to the banks, which protects depositors but also bails out the shareholders and bondholders and allows the institutions to continue operating.
As far as I can determine, Cyprus wants to pick the third option, sort of akin to the corrupt TARP regime in the United States. But that approach can only work if the government has the ability to come up with the cash when banks go under.
I’m assuming, based on less-than-thorough news reports, that this is the real issue for Cyprus. It needs taxpayers elsewhere to pick up the tab so it can bail out not only depositors, but also to keep zombie banks operating and thus give some degree of aid to shareholders and bondholders as well.
But other taxpayers don’t want to give Cyprus a blank check, so they’re insisting that depositors have to take a haircut. In other words, the traditional government-imposed deposit insurance regime is being modified in an ad hoc fashion.
And this is why events in tiny Cyprus are echoing all over Europe. Folks in other nations with dodgy banks and unsound finances are realizing that their bank accounts might be vulnerable to haircuts as well.
So what should be done?
I definitely think the insolvent institution should be liquidated. The big-money people should suffer when they mismanage a bank. Shareholders should lose all their money. Then bondholders should lose their money.
Then, if a bailout is necessary, it should go only to depositors (though I’m not against the concept of giving them a “haircut” to save money for taxpayers).
But Cyprus apparently can’t afford even that option. And the same is probably true of other European nations.
In other words, there isn’t a good solution. The only potential silver lining to this dark cloud is that people are sobering up and acknowledging that the problem is widespread.
Whether that recognition leads to good policies to address the long-run imbalances – such as reductions in the burden of government spending and the implementation of pro-market reforms – remains to be seen.
[…] As the above table indicates, there are several examples of nations getting good results by limiting the growth of government spending. But there are very few examples of long-run success since very few nations have politicians with the fortitude to control outlays if the economy is growing and generating an uptick in tax revenue (which is why states like California periodically get in trouble). […]
[…] the “FDIC-resolution” approach that I’ve mentioned before, and it’s sort of what happened in Cyprus (after the politicians tried every other […]
[…] The final outcome in Cyprus was bad, but probably less bad than other options. The final result surely was better than the corrupt TARP regime in the United […]
[…] The final outcome in Cyprus was bad, but probably less bad than other options. The final result surely was better than the corrupt TARP regime in the United […]
Now that Cyprus voted against a bailout watch the funds dry up .Also watch as this country turns into the next Greece.The people of Cyprus would have had a better chance of surviving if they took this deal.Germany is not going after Russian mobsters they want control over Europe as a whole.Cyprus is an excellent launching pad.
Daniel sorry but how do you explain that Cyprus is the twentieth in the Index of economic freedom 2013 of the Heritage foundation?
That was an interesting comment, wonder why this has not been addressed ? Wink Wink..
To clarify your 2nd option bail-out, don’t banks have to pay for FDIC insurance? Theoretically, if a bank is bailed out through deposit insurance, the bailout should cost tax payers nothing because the bailout money should be covered through collected premiums–just like any other insurance.
A fascinating article that fails to mention that the present financial sword of damocles hanging over europe has “Made in the USA” carved on it. The mortgage debacle there caused the world’s banking system to implode. An ideal scenario for the euro to come under attack from speculator’s in Wall Street. While America screams for europeans to “tighten their belts” to attain national solvency Washington continues to ramp up its own national debt. It truly is time for americans to burn their credit cards and begin to pay more taxes! More taxes? Do the 1% of americans who own 40% of that nations wealth contribute to national exchequer – I doubt it. What stink tank in the american bank, the IMF, thought up the solution in Cyprus. Who knows but for the tax shy folk in america watch out because that solution, like a hollywwod blockbuster, could be “comingt soon” to all your banks !!
[…] were unsurprisingly shaken by the latest developments in Cyprus, a country that (as Cato’s Dan Mitchell has pointed out) has a GDP smaller than […]
Reblogged this on Right From Yaad and commented:
Cyprus’ reality may give Peter Phillips & Co. ideas to confiscate Jamaicans’ deposits in our banks.
The US Fed is essentially doing the same thing in slow motion: By keeping interest rates on deposits at a distorted and artificial near-zero, US depositors are given a de-facto inflationary haircut of 2% a year — compounding annually.
For those who have not figured it out yet, this finances (or at least attempts to, in part) the big government of HopNChange : The futile attempt to maintain standard of living without a competitiveness increase to match the rise of the emerging world — actually under a competitiveness DEcrease, as effort reward curves are being flattened by a copy Europe transition to a welfare state.
The writing is on the wall. Sooner or later another correction is in the cards. There is no perpetual motion machine of prosperity. Whether by stepwise crises, one big dip, or slow wretched decline, America is going down. Aspirations to French policies are essentially aspirations to decline.
May you live in interesting times…
The Germans were going after Russian mobsters,caught the average innocent , and shook the world’s confidence in euro bank investments? Almost makes me think the 85 billion of inflationary printing monthly by the current administration makes some sense. Same looting of the common person. Less noticable. LOL
[…] were unsurprisingly shaken by the latest developments in Cyprus, a country that (as Cato’s Dan Mitchell has pointed out) has a GDP smaller than […]
Control over a society of people they can use for slave labor by controling the food supply and power grid.The people in charge of this government, in front and behind the scene ,have been working at this a long time.They have included very minute details in their planning.It will surprise many when this happens.
Excellent analysis. My faith in the wisdom of the European Union is deeply shaken.
Total control of what? A society that cannot work or pay their bills? What is the objective of having control over a mess?
[…] individual dos bancos sem condições de sustentabilidade é um sistema bancário insustentável: Lessons from Cyprus. Por Dan […]
On your article on Lessons from Cyprys, we in the U.S.A. are facing another financial crisis.We already bailed out the banks and shareholders now we will contribute more of our tax money to our own demise.The government will first confiscate any and all retirement accounts on grounds that individuals are not educated enough to control them as safely as the government can.Most of these funds will be used to create a police force equipped just as good or better than our military.Soon the banks will close and you won’t have access to your money.Food supplies will be in demand and riots will break out. Don’t expect local police to help.Society will fall apart and the government will have exactly what they want.Total control.
I would raise two general questions:
What guarantee is there that this was a one-time intervention?
What happens if this ‘strategy’ is imposed in France or Germany?
Business Insider wrote about this in an article entitled “This Crazy Cyprus Deal Could Screw Up A Lot More Than Cyprus…”
Think it can’t happen here? It already did.
http://www.wcvarones.com/2013/03/think-cyprus-cant-happen-here-it.html
The real reason ,is Cyprus ,launders Russian money,,as half of all accounts in Cyprus are Russian and the Government is taxing this off shore nest and the Natives are just caught in middle..
Reblogged this on This Got My Attention and commented:
More trouble in Europe