A great many people in Cyprus and beyond are suddenly realising that there is no such thing as money in the bank. Although it should be glaringly obviously untrue to everyone it still seems to be the case in popular perception that bank balances are made up of wads of cash sitting in a safe.
So let me be unambiguous: they're not.
In fact, there's no such thing as 'money in the bank'. That's just a myth.
When you deposit funds in a bank what they give you in exchange is an IOU. That entry in your bank statement saying you're in credit means just that - the bank owes you money. It does not mean they have the money to pay.
And so it came to pass that Cypriot banks did not have the means to pay. And as there are almost no bondholders to take a haircut in Cypriot banks and bank capital is, as ever, too small, those banks can't make good on their IOUs. And people are enraged.
Of course, rational economists in state ministries wonder why they should be. Cypriot people (and others) lent money without security to a commercial operation undertaking an inherently risky business (especially so in tax haven Cyprus) and demanded a risk free return. Welcome to the market folks. This is the free enterprise you all so believe in. And when the IOU's proved worth less than full value what those depositors demand is that someone literally pick up the IOU and pay them even though they don't have obligation to do so. What's more, if no one does agree to pay the depositors threaten, by undertaking a run on the bank, to commit an act of collective economic suicide to undermine any remaining value in the IOU they have. Such is the rationality of economic agents.
What the EU tried to impose on Cyprus looks rational. Except rationality in the face of irrational agents called frightened small depositors, and powerful agents, called Russians with big bank balances, did not work.
And in that case what the EU should have done is permit the issue of new debt - yes, another IOU - to resolve the situation because that would have worked and at almost no cost. QE would have immediately cancelled the new issue if that was desired. But rationality got in the way in a wholly irrational situation and so the right course of action - the one that reflected the fact that those in the know always knew there was no money in the bank - did not happen.
And now Cyprus will pay the price for this confusion on just what money and banking really is.
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“Welcome to the market folks. This is the free enterprise you all so passionately believe in.” And thus you joyously class all the depositors together, rich and poor, inured and uninsuredd. Becasue let’s state the actual facts here: small deposits (those held by ordinary hard working folk who don’t believe in all that much except working and saving) were insured by the Cypriot government. As of Friday evening they were being assured by that government that it would honour its obligation; it deceived them. Large deposits are held by richer people, those with plenty of other investments; they’ll be alright. So the poor have been hit; the rich are OK. And why? So that the banks can honour its debts to other creditors, large institutions. And then you express such sympathy.
I reiterate: I think small depositors should have been protected
Cypriot gov’t failed them
And then didn’t vote for it
Don’t blame me for that
“Cypriot people (and others) lent money without security to a commercial operation undertaking an inherently risky business (especially so in tax haven Cyprus) and demanded a risk free return.”
And they were told they had a risk free return up to 100,000 euros by the State, EU policy and the regulations in place. If everyone lost above 100,000 then there would have been no lies.
I thought you were in favour of the State upholding its promises?…..The issue here is not the banks, or the EU, or even the market but the 100,000 deposit guarantee they have just broken….
That’s a different issue – and I have made clear I think small depositors should have been protected
The banking system is exposed,possibly intentionally, for the second hand car racket that it is, by events in Cyprus .If as seems likely much of the “money” deposited in banks in Cyprus has been spirited out of Russia simply because Cyprus is a tax haven then depositors round the world of tax havens might get the message that their deposits are IOU’s held by bigger rogues than themselves.Visions of headless chickens come to mind if this epidemic spreads
Yes – but there or not, whether it is an IOU or not, when they demand it back, it will be 6.75% or 9.9% lighter than when it went in.
It is straightforward robbery, pure and simple. Yes, the bank does indeed do what it likes with its “deposits”, which are in reality IOU’s. However, if you demand them back, they should be the same amount, plus interest, you put in!
It has thankfully ben rejected for the moment but I have the feeling we haven’t seen the last of this.
And nor should we for funds over €100,000
For 100,000 euros worth of investments, yes. People know they take a risk with investments and if things go wrong – will, tough cheese. I do agree up to a point in not protecting savings over and above 100,000 euros as this helps to create moral hazard, that is, the state obliged to bail out the banks regardless of the stupidity and greed of their actions.
I do feel that savings in ordinary deposit accounts should be largely protected, though.
What if it was your entire life savings and the government decided to take £9,900 out of it just because the ECB said so?
I shall hot foot it down to the bank immediately, withdraw all our savings in cash, hide it at various locations, under the floorboards, mattress etc. and then sit back. Heaven forbid that anyone should then call me irrational.
In fact, there’s no such thing as ‘money in the bank’. That’s just a myth.
Quite. Jimmy Stewart covered this back in 1946:
http://en.wikipedia.org/wiki/It's_a_Wonderful_Life
Thanks for the reminder.
of course there is money in the bank – but unfortunately at the moment its in the gift of the ECB and the IMF. Not to mention the political problems of the Merkel. Its that pesky thing called democracy getting in the way of the EU project again.
One of the points that is really not appreciated in much of the commentary here is why there comes to be so much Russian money deposited in Cypriot banks and the sources of the money. Much of money is deposited as a result of the Russian Cypriot tax duty which exempts any profits remitted to companies, branches and representative offices of Cypriot profits from any Russian withholding taxes – and given that the Russian tax man can be remarkably helpful when they want to be with regrard to transfer pricing – it comes as no surprise that the Russian mafia and oligarchs have make extensive use of the tax treaty in order to transfer the rpofits of their businesses to Cyprus where it is taxed at a generously low rate. I should add that Western companies operating in Russia have not been above using this ruse – including at least one of the Big 4 whose Russian operations were actually a branch of a Cypriot company.
Cyprus also had the added attraction in that it didn’t ask particularly hard questions regarding the source of money with dubious legality and because the Cypriot authorities had no visa requirements it was rather nice place for the Russian mafia and their molls to visit and be reunited with their illgotten gains. Given all this it is perhaps not too surprising that the Godfather of the Russian Mafia is not a little annoyed by the current state of affairs – and will now be looking to extract his pound of flesh by using one of his companies to buy up Cypriot gas reserves on the cheap. And I have a horrible feeling that Merkel/Hollande/Cameron will go along with this little game because the Corporate Sector is still keen on doing deals with Russia.
It is worth noting that much of Iceland’s problems can be attributed to a similar bubble of Russian mafia money flowing into its banks. If Cypriots wish to see their future unless they do something about the problem – perhaps they should look at how the public sector in Southern Italy/Sicilly in effect had its revenue base bled dry and its structures throughly infiltrated by a similar Italian operation.
A moral tale as to what happens when tax havens chose to avoid the real nature of those with whom they are doing business I’m afraid.