Europe Hits the Self-Destruct Button

In the late summer of 1914, the great monarchies of Europe set out on the road to war.  None of them expected the war to be anything but brief and each of them expected to win.  Practically nobody expected that the majority of European monarchies would cease to exist.  Without knowing it, the crowned heads of Europe had hit the self-destruct button on their dynasties, their way of life, their countries, and in a very real way, their entire world.

Without realizing it, Europe has just decapitated itself again.  The last few years have not exactly been filled with sweetness and light or even prosperity.  The pages of Scragged have dripped with frustration, warning, and from time to time naked fear.  But this latest event is by far the most frightening that we have seen - yes, even more so than Barack Obama's re-election.

What could possibly be so horrifying?  The lords and masters of the EU have triggered a country-wide bank run, in a world where all banks are interconnected, and in a manner calculated to completely bypass all the financial safeguards that have been put in place over the past century for the precise purpose of preventing bank runs and the awe-inspiring economic destruction they cause.

Getting the Runs

Like much of Europe over the past few years, the small island country of Cyprus allowed its banks to rack up debts not only far beyond their own ability to pay, but indeed bigger than the entire economy of the country that was supposed to be regulating and guaranteeing them.  When the financial bubble burst and the banks collapsed, the government of Cyprus was supposed to guarantee the funds of depositors.  As with Ireland and Greece, Cyprus couldn't pay.

Rather than allow depositors to lose all their money as happened regularly in the 1800s, the EU stepped in with loans.  Unfortunately, the loans required were impossibly big.  Ireland could barely pay theirs, Greece is refusing to pay, and Cyprus hasn't a prayer.

What's supposed to happen in this case is for creditors to take a haircut: if you loaned money to a bank that's bankrupt, you don't get your money back.  The problem for the EU is that most of the lending to troubled banks was by other banks in bigger countries.  If those loans default, the big banks in Germany will be in the same situation. Europe's whole banking system could become insolvent and shut down at the speed of a wire transfer.

When America had the problem of overextended banks in 2008, the Treasury and the Fed took extraordinary measures, basically lending banks all the money they needed to tide them over.  This was controversial at the time and we still aren't convinced that it was a totally good idea, since it has created a class of giant bank that's officially "too big to fail" no matter what they do.

Still, shoveling out newly-created money had one great virtue: our banking system didn't collapse.  Depositors didn't lose money, we avoided a systemic banking shutdown like the one at the beginning of the Great Depression, and the government got all its money back from the banks plus interest.  This is unlike the "investment" in General Motors, which lost billions of taxpayer dollars but saved the unions and their corrupting ability to give money to Democrats.

Different Strokes for Different Folks

Europe cannot do the same thing, because though the EU likes to pretend it is a unitary federal state, it is not.  Unlike our Fed, the European Central Bank doesn't have the ability to simply wave the wand and create however much money it happens to want at the moment.  The ECB has to talk the individual national central banks into creating money.  Many banks were unwilling or unable to, partly out of fear of their own voters.  

Since they couldn't just print money, all the rescue loans had to come from somewhere real, namely taxpayer dollars.  That is why Germans are Greeks are furious at each other: Germans are angry at having to pay taxes to support Greeks who work half as hard and half as long, and Greeks are incensed at Germans for not loaning them enough money to support their cushy lifestyles indefinitely.

The voters being already angry, no politicians dared dump money into the hopeless case of Cyprus, at least not without exacting a heavy penalty.  But there is no plausible penalty.  Cyprus has no money, no serious industries, nothing worth taking or privatizing, not even any plausible hope of tax hikes to increase revenues.  What to do?

Theft, Pure and Simple

Turns out, the only place left in Cyprus where there was any money was the bank depositors themselves - i.e. the individual checking, savings, and other bank accounts in the troubled banks.  So that's what the EU hit: 

The terms of the deal mean that Cyprus’s savers will sacrifice up to 10pc of their deposits in a move which will raise as much as €6 billion. 

The move, which is likely to prove unpopular with the country’s 1m citizens - and the Russian non-residents who reportedly account for half of deposits in Cyprus’s banks - will be enacted almost immediately.

Following a bank holiday in the country on Monday, March 18, the levy on bank deposits will come into force on Tuesday, March 19.

The Cypriot government will take steps to prevent electronic money transfers over the weekend, in order to stop depositors attempting to avoid the curbs.

Let's sum up what happened: Over last weekend, the government of Cyprus said, "Hey everybody, you know how you were expecting to do banking on Monday?  Well, you can't - we're closing all the banks.  And we're turning off your ability to transfer money out of your bank accounts, it's stuck there.  And when the banks do reopen Tuesday - or maybe Wednesday or Thursday, we're not sure - you'll have 10% less money because we're taking it.  Have a nice weekend!"

What would you do?  The entire nation of Cyprus dashed madly to the ATMs, hoping that the news was just as much of a surprise to the banks and that they hadn't turned them off yet.  Which they hadn't; the ATMs were cleaned out instantly.  Anybody with online banking tried to transfer money out of the country where it would be safe.  The banks will be a long while cleaning up the mess of transactions that went through and shouldn't, those that didn't and should, those that didn't and are stuck in some sort of limbo somewhere...

That would all be bad enough, but what's ten thousand times worse is the precedent: Any European government can, without warning, snatch money at will from everyone's bank account.

Insanity or Evil?

What is the perfectly obvious result?  Cypriot savers are screwed, of course, but they're far from the only Europeans whose country is bankrupt and whose banks are in trouble.  The only thing that kept everybody in Europe from trying to pull all their money out of their busted banks all at once was the ironclad promise that deposits would be safe no matter what, a promise which the all-wise Euro-elites just gaily dismissed with a wave of the hand.

The Financial Times writes on what will happen next:

With the agreement on a depositor haircut for Cyprus – in all but name – the eurozone has effectively defaulted on a deposit insurance guarantee for bank deposits. That guarantee was given in 2008 after the collapse of Lehman Brothers. It consisted of a series of nationally co-ordinated guarantees. They wanted to make the political point that all savings are safe.

I am using the expressions “in all but name” and “effectively” because legally, Cyprus is not defaulting or imposing losses on depositors. The country is levying a tax of 6.75 per cent on deposits of up to €100,000, and a tax of 9.9 per cent above that threshold. Legally, this is a wealth tax. Economically, it is a haircut...

If one wanted to feed the political mood of insurrection in southern Europe, this was the way to do it. The long-term political damage of this agreement is going to be huge. In the short term, the danger consists of a generalised bank run, not just in Cyprus.

As in the case of Greece, the finance ministers said: “Don’t worry, this is a unique situation”. This is true only in a very narrow legal sense. The bond haircut in Greece is indeed different to the depositor haircut in Cyprus. And when they repeat this elsewhere, it will be unique once more.

Unless there is a last-minute reprieve for small savers, most Cypriot savers would act rationally if they withdrew the rest of their money simply to protect them from further haircuts or taxes. It would be equally rational for savers elsewhere in southern Europe to join them. The experience of Cyprus tells them that the solvency of a deposit insurance scheme is only as good as that of the state. In view of Italy’s public sector debt ratio, or the combined public and private sector indebtedness of Spain and Portugal, there is no way that these governments can insure all banks’ deposits on their own. [emphasis added]

Cyprus is suffering a major bank run the likes of which have not been seen in decades. Within a week or two, a month at the most, anyone sane in Italy, Spain, Portugal, or possibly Ireland will see the handwriting on the wall and withdraw all their money as well.  They will shortly be followed by the savers in the "healthy" countries when they realize just how exposed their banks are to the now-dead ones.  Unless Europeans are total cretins, the EU has succeeded in creating the very continent-wide bank run that all their frenetic financial activity over the last five years was supposed to prevent.

The fundamental nature of banking means that it is not possible for a bank, any bank, to survive a run unless backstopped by unlimited government funds.  Even the very healthiest of banks has only a small fraction of its depositors' money actually in the safe, the rest is loaned out to borrowers.  If every depositor tries to withdraw money all at once, the bank is instant toast.  A bank healthy yesterday can be dead tomorrow.

When a run starts, the logical action for any individual person or business is don't wait, don't contemplate.  Run, don't walk, to your nearest bank - no matter who or what it is - and withdraw all your money in cash on the spot.  You might be lucky and get your cash before the place caves in.

That's what happened in the Great Depression.  Many economists believe bank failure is what caused the Great Depression to be Great.  In America, we have the FDIC to protect us from runs, and unlike practically every other government program, it's actually done a rather good job of it over the years.  It may well save us now.

Thanks to this heartstopping action of pure insanity, Europe's banking system is toast, even though they're valiantly pretending otherwise.  Europe's governments can no longer guarantee depositors' accounts - they'd already made every promise in the world, and Cyprus proves those promises worthless.

The only question is: did Europe's elites know they were hitting the self-destruct button on themselves?  Or did they do it by accident in a moment of madness?