Spin Alert! Slate's Matthew Yglesias Gets It All Wrong on Cyprus
Slate’s Matthew Yglesias writes columns about economics and finance. Yglesias has been writing about Cyprus, and my critiques of the policies he has been proposing are the subject of this column.
Here's the short background on Cyprus: The country is in a crisis and the EU is willing to bail out its collapsing banks only if Cyprus raises revenues. The EU is unwilling to make the banks’ sophisticated creditors – the bondholders – take any losses. The EU wanted the banks’ least sophisticated creditors – the depositors – to take losses, even if their deposits were small enough to be within the deposit insurance limit. The reality, which the EU wishes to obscure by calling its proposal a tax, is that that the EU was insisting that depositors no longer be fully protected from loss by government deposit insurance. The EU demand was made shortly after the EU and Cyprus’ government pledged that depositors under the insurance limit would suffer no losses.
Cyprus’ government’s duplicity was prompted by its close ties to Russian oligarchs who deposit the funds they loot from Russia in the failing Cypriot banks. Cyprus’ plan, therefore, imposed a hefty (6.6%) loss on (smaller) insured depositors in order to keep the percentage loss on huge depositors well in excess of the 100,000 euro insurance limit under 10 percent.
The plan was terrible for Cyprus, terrible for insured depositors, and very dangerous to banks in the European periphery (because it could spark large withdrawals of insured and non-insured deposits from such banks). The plan was also a political failure that enraged most Cypriots into opposing the deal. Yglesias’ response to the plan was a March 18, 2013 column praising it: “Two Cheers for the Cyprus Bailout.”
The part that Yglesias liked best about the plan was causing depositors – including the fully insured smaller depositors – losses. The single worst aspect of a terrible plan is what Yglesias cheered. In fairness to Yglesias, he wrote that the losses imposed on the largest depositors should have been larger and the losses on the insured depositors smaller. He did not, however, call for Cyprus and the EU not to breach their promises not to force losses on the insured depositors. His position was that the magnitude of the betrayal of insured depositors be reduced (“It’s perhaps not possible to entirely spare middle-class savers, but they can be cut a much better deal than this.”) Yglesias’ one sentence summary of his position reads: “The plan to punish Cypriot bank depositors is hideously unfair, but it contains the germ of a great idea.”
Yglesias unintentionally reveals that this conclusion rests on a mistake of fact in this paragraph:
“Ever since the spectacular collapse of Lehman Brothers in 2008 and the ensuing financial crisis, regulators and politicians have lived by a single rule: No losses for bank creditors. The common thread of every bailout has been that banks pay off their debts in full.”
I agree that too many of the bailouts have bailed out too many creditors, but Yglesias’ statement is incorrect because it is overbroad. Depositors have not previously suffered losses, but banks have creditors other than depositors and some of them have suffered losses in bailouts.
Yglesias missed the obvious problem that having to put a “hideously unfair” plan to a vote in parliament is likely to lead to a rejection of the plan. (At this juncture, the MPs that voted unanimously voted to reject the plan.) How unfair and self-destructive (because of its terrible impact on depositors and banks in the periphery) a plan was the deal that Yglesias claimed contained “the germ of a great idea?” It was such an unprincipled betrayal that the German government denounced it.
“German Finance Minister Wolfgang Schaeuble, who blamed the idea of a confiscatory tax — and by implication, the market fallout — on the unelected technocrats at the European Commission and the European Central Bank.
‘We of course would have respected the deposit insurance that guarantees accounts up to 100,000 but those who opposed a bail-in — the Cypriot government, also the European Commission and the ECB — they decided on this solution and now they have to explain it to the Cypriot people,’ Schaeuble said.”
The Germans are the Ã¼ber falken on making bank creditors take losses in bank bailouts, so SchÃ¤uble’s denunciation of the deal demonstrates conclusively that it is indefensible. (Caveat: SchÃ¤uble was speaking for public consumption. There are indications that he proposed during the negotiations to inflict a far higher percentage loss on the uninsured depositors.)
The Bloomberg reporters explained the broader concern about the deal.
“Europe’s drive to rescue Cyprus risks undermining a region-wide deposit guarantee plan, a key tenet in the battle to contain the debt crisis, and casts doubt on the ability of the weakest lenders to retain deposits.
‘This will be the death knell for an EU Common Deposit Guarantee scheme,’ Roberto Henriques, an analyst at JPMorgan Chase & Co. in London, wrote in a report to clients. ‘With this action, one of the stabilizing instruments will have been completely undermined in the current process and, in the future, we may see a very strong reaction in deposit flows in the event that a banking sector may experience stress.’
‘It is very clear in the [European] commission text that savers who are covered by deposit guarantee schemes, because they have deposited less that 100,000 euros, should be excluded from the scope of any bail-in,’ said Vicky Ford, a U.K. Conservative member of the European Parliament who is working on the law.”
These are the same concerns I expressed in my March 18, 2013 article criticizing the cynical and self-destructive Cyprus deal. Yglesias and I wrote our articles with the same facts available to us.
Yglesias, however, thinks the Cyprus “reverse toaster” plan is “well-organized” and is essential to create desirable incentives.
“Thus far, a well-organized haircut plan—in contrast to the chaotic Lehman bankruptcy—does not seem to be provoking any dangerous financial contagion around the world. But if similar plans are to be workable in countries less weak and tiny than Cyprus, they have to be done in way that are less punitive to small depositors and put the risk where it belongs—on wealthier, presumably more sophisticated, investors who have the capacity to assess the soundness of different banks. As problematic as the initial Cyprus proposal was, it is an important step back to post-crisis normalcy.”
Yglesias is not being ironic when he calls the Cyprus deal “well-organized.” He actually thinks it is well-organized, which is an idiosyncratic view from a journalist. Commentators with experience and expertise have the opposite view.
“‘It looks like a botched and improvised job, and unprofessional – groping in the dark without much consideration of what sort of signal it sends,’ said Alessandro Leipold, a former International Monetary Fund official who is now chief economist at the Lisbon Council research group in Brussels.
‘That’s no way to really run a crisis.’”
Note that Yglesias does not want to pay depositors in full even when their accounts are below the insurance limit and, by law and policy, are supposed to be paid in full. Yglesias simply wants the loss inflicted in the future on insured depositors to be “less punitive” (than 6.6% losses). He wants to inflict losses on “small depositors” even though he (implicitly) acknowledges that they lack “the capacity to assess the soundness of different banks.”
We need to consider the negative implications of Yglesias’ desired policy of inflicting losses on small depositors for financial stability. Yglesias simply assumes that his policy would improve bank safety by creating private market discipline that would return banking to “normalcy.” Yglesias’ policy would create a strong incentive for small depositors in EU periphery banks to move their money to systemically dangerous institutions (SDIs) (the non-euphemism for “too-big-to-fail” banks), particularly U.S. and U.K. SDIs. That general incentive will be compounded greatly whenever there is a report or a rumor that a Nation or a particular bank is troubled. In the EU periphery, such reports or rumors are common. These incentives can generate massive runs. Not all runs are classic rapid runs. Banks can lose billions of dollars in deposits over the course of months. Bank runs are a regulatory and economic nightmare.
Yglesias is also far too confident about the benefits of requiring large depositors to suffer losses in the event of a bank failure. He believes that this will create sophisticated private market discipline based on his assumption that large depositors “have the capacity to assess the soundness of different banks.” This has never proven true. There are studies that find that riskier banks pay higher interest rates on both insured and uninsured deposits, but that does not provide effective discipline. Banks that are accounting control frauds typically pay higher deposit interest rates, but they are never closed by “sophisticated” depositors. The broader truth is that no private sector institution has shown the ability to exercise effective private market discipline over fraudulent banksters.
All theoclassical finance theory predicts that subordinated debt holders will exercise the most effective private market discipline. The theory is that their subordinated position means that they will frequently be wiped out if a bank fails, that only sophisticated creditors purchase sub debt, and that sub debt holders often buy such large amounts of bonds that it is highly worthwhile for them to bear the investigative expenses essential to effective private market discipline. The reality is that sub debt holders have never effectively disciplined a fraudulent bank. If sub debt holders consistently fail, then there is no reason to believe that uninsured depositors will succeed. The record shows that they routinely fail to prevent “control fraud.” The reality is that private market discipline of financial control frauds is an oxymoron – the creditors fund the frauds rather than disciplining them. The failure is easy to understand. Banks that follow the fraud “recipe” experience a “sure thing” – they are mathematically guaranteed to report record profits in the near term (Akerlof & Romer 1993: “Looting: The Economic Underworld of Bankruptcy for Profit”). Creditors break down the walls of the bank CFO’s office in their eagerness to lend to banks reporting record profits.
When Yglesias pines for the return of pre-2008 banking “normalcy” he betrays his devotion to theoclassical dogma and his inability to learn from the crisis. The pre-2008 “normalcy” was one that even conservative finance scholars now concede was beset by “pervasive” control fraud at our “most reputable banks.”
“Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market” by Tomasz Piskorski, et al. (February 2013)
“Normalcy” was faux private market discipline funding the rapid growth of fraudulently originated mortgages. Those mortgages were then fraudulently sold to the secondary market where the fraudulent mortgages provided the faux backing to fraudulently sold toxic mortgage derivatives. The frauds were so massive and grew so rapidly that they hyper-inflated the financial bubbles in many countries and drove the financial crisis and the Great Recession. Yglesias promises that his policy proposals will return us to that criminogenic “normalcy.”
The only evidence of effective discipline against financial control frauds came during the 1980s and 1990s. That discipline was exercised by federal S&L and banking regulators.
Yglesias’ take on Cyprus as of the morning of March 19, 2013
By Tuesday morning, Yglesias realized that the “well-organized” Cyprus plan was dead on arrival.
Yglesias’ plan to sell Cyprus to the Turks
By Tuesday afternoon, Yglesias had come up with his plan to save Cyprus by selling large portions of it to the Turks. Yglesias called his plan the “Desperation Option.”
Here’s Yglesias’ explanation of his “too sensible” plan: “here’s a plan that’s much too sensible to be considered – sell diplomatic recognition of Northern Cyprus’ secession to Turkey for the 5.8 billion euros that Cyprus needs.” If we are very lucky, Slate will have no Cypriot readers.
What Yglesias’ proposal really proves is that Nations that give up their sovereign currencies give up a vital aspect of their sovereignty that can lead to humiliating losses of the most fundamental attribute of sovereignty – our Nation is not for sale at any price to anyone.