Cyprus President Nicos Anastasiades just addressed the nation in a dramatic Sunday night speech regarding the bailout of Cyprus, which will see a one-time tax on everyone with cash in Cypriot banks.

The basic gist:

• Cyprus is in a huge crisis, and the country was given two choices, blackmail style.
• Either the government could get no help, and see a complete collapse of the economy and the financial system.
• Or take the "bailout" deal, which involves the painful deposit tax.
• This is the country's worst crisis since 1974, and the choice was to take the lesser of two evil

IT IS not a fudge, but it is still a failure. The euro zone’s bail-out of Cyprus, which was sealed in the early hours of Saturday, did get the bill for creditor countries down from €17 billion to €10 billion, as had been rumoured. But the way it did so was somewhat unexpected.

Almost €6 billion of the savings for taxpayers in euro-zone countries came from losses imposed on depositors in Cyprus’s outsize banks. A one-off 9.9% levy will be imposed on all deposits over the insurance threshold of €100,000 before banks reopen after a bank holiday on Monday. That idea had been in the air for a while, not least because a lot of those uninsured deposits came from outside Cyprus, and from Russia in particular. The politics of saving wealthy Russians with money loaned by thrifty Germans were always going to be tricky.

What had not been anticipated was a 6.75% loss for savers with deposits in Cypriot banks below the insurance ceiling. Cypriots woke up this morning to find bank branches closed to them. By the time they will be able to get at their money, it will be too late. The offer of equity in banks to replace the value of their savings is meant to be a balm but it’s not a choice they would have made. Why this decision was taken is not yet clear. The most plausible explanation is that

the Cypriot government itself preferred to spread the pain rather than wipe out non-resident depositors and jeopardise its long-term prospects as an offshore financial centre for Russian and other money.

Whatever the rationale, it is a mistake for three reasons.

1. REWAKEN CONTAGION RISK: The first error is to reawaken contagion risk elsewhere in the euro zone. Depositors have come through the financial crisis largely unscathed. Now they have been bailed in, some of them in breach of an explicit promise that they can be sure of getting their money back even if a bank goes belly-up. Euro-zone leaders will spin the deal as reflecting the unique circumstances surrounding Cyprus, just as they did the Greek debt restructuring last year. But if you were a depositor in a peripheral country that looked like it needed more money from the euro zone, what would your calculation be? That you would never be treated like the people in Cyprus, or that a precedent had been set which reflected the consistent demands of creditor countries for burden-sharing? The chances of big, destabilising movements of money (into cash, if not into other banks) have just shot up.
2. EQUITY: The second error is one of equity. There is an argument to be made over the principles of bailing in uninsured depositors. And there is a case for hitting everyone in Cypriot banks before any taxpayer in another country. But there is no moral imperative for whacking Cypriot widows and leaving senior bank bondholders untouched, as appears to be the case here; or not imposing any losses on sovereign-debt investors in Cyprus; or protecting depositors in the Greek operations of Cypriot banks, as has also happened. The euro zone may cloak this bail-out in the language of fairness but it is a highly selective treatment. Indeed, the euro zone’s insistence that this is a one-off makes that perfectly plain: with enough foreigners at risk and a small enough country to push around, you get an outcome like Cyprus. (That is one reason why people are now wondering about the implications of this deal for little Latvia, also home to lots of Russian money and itself due to join the euro zone in 2014.)
3. STRATEGIC: The final error is strategic. The Cypriot deal has no coherence in the larger context. The euro crisis has been in abeyance for a few months, thanks largely to the readiness of the European Central Bank to intervene to help struggling countries. The ECB’s price for helping countries is to insist they go into a bail-out programme. The political price of going into a programme has just gone up, so the ECB’s safety net looks a little thinner.

The bail-out appears to move Europe further away from the institutional reforms that are needed to resolve the crisis once and for all. Rather than using the European Stability Mechanism to recapitalise banks, and thereby weaken the link between banks and their governments, the euro zone continues to equate bank bail-outs with sovereign bail-outs. As for debt mutualisation, after imposing losses on local depositors, the price of support from the rest of Europe is arguably costlier now than it ever has been.

It is also hard to square this outcome with the ongoing overhaul of finance. The direction of efforts to improve banks’ liquidity position is to encourage them to hold more deposits; the aim of bail-in legislation planned to come into force by 2018 is to make senior debt absorb losses in the event of a bank failure. The logic behind both of these reform initiatives is that bank deposits have two, contradictory properties. They are both sticky, because they are insured; and they are flighty, because they can be pulled instantly. So deposits are a good source of funding provided they never run. The Cyprus bail-out makes this confidence trick harder to pull off.

Other than that, it is a really good deal.

MOHAMED EL-ERIAN: The EU Had Four Valid Reasons To Force Cypriot Depositors To Pay Up 03-17-13 BI

According to El-Erian, the EU actually had four valid reasons to make such an unprecedented move.

1. First, El-Erian says, given the problem – which stems partly from the enormous size of the Cypriot banking system relative to GDP – depositors are partly to blame. "In entrusting funds to Cypriot institutions, depositors (and especially foreign depositors) inadvertently funded the over-extension of the banking system, both domestically and abroad," writes El-Erian.
2. Second, much has been made about the "Russia angle" in the Cyprus deal. Because Cyprus is viewed as an off-shore tax haven for Russian oligarchs mafia types, many worry that the move could anger those depositors. El-Erian thinks that is a good thing, though: "By killing once and for all the notion that Cyprus is a safe and lax offshore haven, the levy serves to limit such intermediation [of funds from dubious origins] in future."
3. The third valid reason for a deposit haircut, according to El-Erian, is that the alternatives seemed worse. Someone was going to lose out in this deal. For the two reasons outlined above, it might as well be the depositors.
4. Finally, this will serve as a "wake-up call" for investors who thought the ECB had fixed everything with its "whatever it takes to save the euro" speech back in July. This, too, is a good thing, says El-Eria

 

What You Need to Know About Cyprus El-Erian
Cyprus: The next blunder VOX
Cyprus Can't Put 'Genie Back in the Bottle': O'Neill CNBC
Chaos as banks empty cashpoints and ban online transfers DMail
After Cyprus, Depositors Race to Withdraw Their Cash. Is the Rest of Europe Next? DBeast
Cyprus works on tax levy deal to get bailout approved Reuters
Cyprus Bailout 'Disaster' Risks New Euro Crisis CNBC
Barclays Says Cyprus Bank Crisis Won't Spread To Southern Europe Forbes
TIME: The $13 billion bailout package may seem like chump change, but in fact it represents about 50% of Cyprus’s total economy
Russian Oligarchs Lose Friend In Cyprus Banks Forbes
Moody’s Sees Defaults as PBOC Warns on Local Risks BL

Trillions In Subsidies to the Giant Banks Are Continuing to This Day

Preface: Bloomberg’s recent estimate that the big banks are subsidized to the tune of $83 billion dollars per year created tremendous controversy.  But – as shown below – the real number is many times larger.

Chris Whalen is one of America’s top banking analysts.

Well-known economist Nouriel Roubini notes:

Chris Whalen is one of the leading independent analysts of the US banking and financial system.

Whalen notes today that the big American banks get a subsidy in excess of $780 billion dollars per year.

Specifically, Whalen estimates the following types of subsidies to the giant banks:

• $360 billion in Federal Reserve subsidies, by creating an artificial “spread” in interest rates (Bloomberg, Business Insider, Huffington Post, and many other publications have documented that the government is subsidizing big banks with artificial and guaranteed “spreads”, where the banks borrow cheaper than any consumer can, and then lend the money back to the government at much higher interest rates.)

• $120 billion in federal deposit insurance (through the FDIC, backed by the Treasury)

• At least $100 billion in government-guaranteed loans, especially mortgages

• At least $100 billion in monopolistic advantages in the secondary market for home mortgages. Specifically, the government subsidies the big banks to steal away fees earned from smaller banks, gain on sale into the TBA market and servicing. Whalen quotes a veteran banker explaining:

The smaller players lived on the bleeding edge of the mortgage market, but they were also far more efficient lenders than the large banks. Now, care of the Fed, we have a highly inefficient oligopoly in the US mortgage market that is built around the largest banks.

• More than $100 billion in fees in the over-the-counter (OTC) derivative market. Whalen explains

The lack of capital required in these transactions and other special dispensations from the Fed provide the zombie banks with unlimited leverage and almost no public scrutiny. The fact that OTC contracts are exempt from the automatic stay in bankruptcy is a huge subsidy. The bilateral market structure is another.

That totals $780 billion per year.

But Whalen notes that there are many other subsidies as well:

The above points are only a partial list of the subsidies and other flows that allow the members of the banking industry to pretend to be profitable, risk-taking organizations in a free market economy.

The bailouts of the big banks amount to trillions of dollars, are never-ending … and continue to this day. (Indeed, the government is arguably paying trillions of dollars more in unnecessary interest payments just to have the banks “create” money, instead of creating it itself … as the Founding Fathers may have envisioned.)

Whalen notes that the big banks are not really profitable:

[These are] structural subsidies blessed by Congress and the Fed that make large banks look more profitable than they truly are. In fact, the TBTF banks are not really profitable at all.

***

The reality, sad to say, is that banks in 21st Century America are government sponsored enterprises ….

Indeed, they are government sponsored enterprises where all of the profits are privatized, and all of the losses socialized.

And the big banks are not helping – but are rather destroying – the economy. Indeed, failing to break up the big banks – and the malignant, symbiotic relationship between D.C. politicians and the banking giants – is destroying our country.