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Cyprus Fallout: Is Your Money Safer in a Mattress?

As long as banking activities are allowed to run against the public good, deposits will always be at risk.
 
 
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So it now looks as though Cyprus, a bucolic island of some 860,000 people in the heart of the Mediterranean, really does matter. 

Here’s how things stand: Bullied by the the European Union, the ECB and the IMF (the unholy trinity of neo-liberalism), Cyprus has now agreed to impose a levy of 20 to 25 percent on large bank accounts as it seeks to overcome final obstacles to a financial rescue and avoid a chaotic bankruptcy. The levy would be applied to deposits exceeding €100,000 at the country’s largest bank, Bank of Cyprus. In exchange, account holders would receive shares in a restructured bank, although government officials have acknowledged that this would imply sharp losses.

The principle of deposit insurance, at least up to 100,000 euros, appears to be upheld. It looks like only the uninsured deposits above that threshold will be taxed. So can we now go to sleep comfortably, knowing that we don’t have to stick our hard-earned savings into what the Financial Times’ John Dizard termed “ Banco de Mattress”?

Almost certainly not.

Regardless of the ultimate form this bailout takes, it is increasingly hard to view Cyprus as a “one-off,” which has no implications for us here in the US. What Cyprus has demonstrated is that even with deposit insurance, your deposits are not in fact a risk-free guaranteed asset, but actually simply another branch in the creditor tree in relation to your bank if it fails. That was made abundantly clear by no less than the Bank for International Settlements (BIS), the central bankers’ bank back in the heart of the financial crisis. The BIS noted that bank failures had become increasingly expensive for governments and taxpayers and therefore recommended an “Open Bank Resolution,” which would ensure that, as far as possible , “any future losses are ultimately borne by the bank’s shareholders and creditors." (See primer on the Open Market Resolution concept by the Reserve Bank of New Zealand.)

Why does this matter? Because, you, as a depositor are legally considered a “creditor” of your bank, not simply a customer who may have entrusted your entire life savings with the very same institution.  As Wikipedia notes:

In most legal systems ... the funds deposited are no longer the property of the customer. The funds become the property of the bank, and the customer in turn receives an asset called a deposit account (a checking or savings account). That deposit account is a liability of the bank on the bank’s books and on its balance sheet. Because the bank is authorized by law to make loans up to a multiple of its reserves, the bank’s reserves on hand to satisfy payment of deposit liabilities amounts to only a fraction of the total which the bank is obligated to pay in satisfaction of its demand deposits.

What banks do with your money is far more germane than you might have thought. They not only can blow up the institution through the creative use of toxic derivatives, but could well get you standing in the queue waiting to get paid out if the range of their activities are not strongly circumscribed. 

True, it looks like the small depositors in Cyprus now will in fact receive their deposit insurance guarantees. But how credible is a guarantee coming from a country that doesn’t create its own currency? That, by the way, is the problem afflicting all of the countries in the Eurozone. At least in the US, Canada or the UK, such deposit insurance guarantees can be made credible because they are ultimately backstopped by the issuer of the currency. Not so in Cyprus, Spain, Portugal, even France or Germany, because they gave up their currencies for the euro, which is now issued solely by the European Central Bank (ECB). A European-wide system of deposit insurance which does not have the explicit backing of the ECB is as problematic as, say, New York state seeking to backstop all of the deposits of the American banking system without the US Treasury behind it.