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The Cyprus confiscation becomes the model for bank insolvency

I am still sifting through the documents from the recent G20 Summit in Brisbane to see what our esteemed leaders (not!) have planned as their next brilliant move to reinforce neo-liberal principles. One of the least talked about outcomes from the recently concluded G20 Summit in Brisbane were the agreed changes to the banking systems operating in the G20 nations. The dialogue started in the G20 Finance Ministers’ and Central Bank Governors’ Meeting in Washington in April 2014. Clause 8 in the official Communiqué covered the aim of the G20 “to end the problem of too-big-to-fail” and signalled the “development of proposals by the Brisbane Summit on the adequacy of gone-concern loss absorbing capacity of global systemically important banks (G-SIBs) if they fail.” The Brisbane Summit would consider these proposals. The aim was to “give homeand host authorities and markets confidence that an orderly resolution of a G-SIB without exposing taxpayers to loss can be implemented”. You won’t believe what they came up with.

Unfortunately, all the G20 documents for 2014 are currently unavailable as the leadership transfers to Turkey for 2015 (the new WWW site seems to have eliminated the history of the G20 and its documents). But you can find the documents for the April 2014 meeting – HERE although the relevant appendix to the official Communiqué, prepared by the Financial Stability Board, can be found at the – FSB Chair’s Letter to G20 Ministers and Governors on financial reforms – Update on Progress.

The official Communiqué contained several appendices and the one covering the proposed solution to the ‘too-big-to-fail’ problem was prepared by the so-called – Financial Stability Board, which is “is an international body that monitors and makes recommendations about the global financial system”.

The Governor of the Bank of England, Mark Carney is the Chair of the FSB, which was created in April 2009 to replace the so-called inancial Stability Forum (FSF), which, in turn, had been “founded in 1999 by the G7 Finance Ministers and Central Bank Governors following recommendations by Hans Tietmeyer, President of the Deutsche Bundesbank”.

There was a call to expand the group in 2008 and the G20 Leaders Summit in April 2009 created the FSB. Its members include Heads of Finance and Economics or Treasury Departments of the G20 nations, Central bank governors, European Commission, IMF, World Bank, OECD, BIS and ECB officials and other related elites.

It is the mafia of neo-liberal economics.

Like most of these organisations, the FSB is dominated by suited men! Here is the current group:


Carney’s Appendix said that:

As the G20 Leaders directed, it is essential that systemically important institutions can be resolved in the event of failure without the need for taxpayer support, while at the same time avoiding disruption to the wider financial system. The expectation that systemic institutions can privatise gains and socialise losses encourages private sector risk-taking and can be ruinous for public finances.

This was in the context of the blanket acceptance of fiscal austerity by all G20 Leaders as the only way for the future conduct of government.

They no longer wanted responsibility for their banking systems but were ideologically opposed to nationalising them despite banking being heavily ‘public’ in the sense that, ultimately, the maintenance of financial stability, a public good, means that governments cannot allow them to become insolvent

The FSB was preparing the agenda for the G20 Brisbane Summit and called on the Leaders for support:

… to ensure that national authorities are empowered to co-operate fully with their counterparts in other countries, including by recognising foreign resolution actions and ensuring that debt issued under foreign law includes contractual recognition provisions so that bail-in is effective in a cross-border context.

The terminology – bail-in – enters the discourse to replace bail-out. It first appeared in 2013 when the European Commission, the ECB and the IMF conspired on Moarch 25, 2013 to defraud the Cypriot depositors as their banks failed.

The Commission wanted to avoid any further general bail-out funds being provided to the basket case economies in the Eurozone having previously providing emergency funds to Greece and Portugal.

In the case of Cyprus, they decided that the creditors of the two prominent banks in Cyprus would bear the brunt of the bank failure. It turned out they included deposits of more than €100,000 among the creditors alongside the debt holders and the owners.

So it was an advance on the so-called PSI (private sector involvement) that saw Greek government bond holders take serious losses as part of the rescue packages for that nation. Not only were bond holders who had bought debt in good faith being punished but now simple depositors who had simply lodged funds in these banks as part of their saving portfolio were seeing their funds stolen by the Troika.

At the time, it was claimed many of those who lost deposits were Russian money launderers. That was just a way of making us less concerned about what was taking place.

The elites thought they had found the magic rescue formula. On March 25, 2013, the President of the Eurogroup (Dutch finance minister Jeroen Dijsselbloem) issued a very terse statement – Statement by the Eurogroup President on Cyprus:

Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.

Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.

He was forced to make this qualification (“specific case”) after earlier in the day claiming that “Cyprus would be used as the model for future bailouts” which of course was an “open invitation to any investor with more than €100,000 in a eurozone bank to remove it without delay, which some then did”. (Source).

It was a typical European Commision/Council exercise in bungling. The sharemarkets started to frash, the euro depreciated and the cost of insuring European banks rose during the day, which then forced Dijsselbloem to issue the qualification.

But, of course, the plot was to use the Cyprus bail-in as a model for the future to further distance government from taking responsibility.

Bank deposits would now be confiscated any time the bank would face capital losses.

On October 15, 2014, the FSB issued a paper – Key Attributes of Effective Resolution Regimes for Financial Institutions – designed to inform the agenda at the Brisbane Summit.

Bail-in is described as the process to “achieve continuity of essential functions” of a bank, either:

(i) by recapitalising the entity hitherto providing these functions that is no longer viable, or, alternatively, (ii) by capitalising a newly established entity or bridge institution to which these functions have been transferred following closure of the non-viable firm …

It would involve:

1. Confiscation of creditor claims according “the hierarchy of claims in liquidation” to “absorb the losses”.

2. Use these funds to “convert into equity or other instruments of ownership of the firm under resolution”.

The hierarchy? There would be “flexibility to depart from the general principle of equal (pari passu) treatment of creditors of the same class”.

But it was noted that “equity should absorb losses first, and no loss should be imposed on senior debt holders until subordinated debt (including all regulatory capital instruments) has been written-off entirely”.

Senior debt is usually borrowing that has to be repaid first and is usually backed by collateral that can be sold if liquidation is required.

In the Cyprus case, the ECB was declared a senior debt holder!

None of the directors or senior officers of the bank would be liable – they would be “be protected in law (for example, from law suits by shareholders or creditors)”

By the time they got to Brisbane in November 2014 this plan had become the official narrative and it was clear who was going to be considered a creditor for the purposes of the bail-in resolutions.

The Too Big To Fail (TBTF) plan was outlined in the FSB’s document issued on November 10, 2014 – Adequacy of loss-absorbing capacity of global systemically important banks in resolution. It built on the Key Attributes document discussed above, which had described “the powers and tools that authorities should have to achieve this objective”.

The powers included:

… the bail-in power, i.e., the power to write down and convert into equity all or parts of the firm’s unsecured and uninsured liabilities of the firm under resolution or any successor in a manner that respects the creditor hierarchy and to the extent necessary to absorb the losses. Hence, the resolution strategies that are being developed for G-SIBs provide for a recapitalisation by a way of a bail-in

The FSB discussed what they called the need to set a “new minimum requirement” for the “total loss-absorbing capacity (TLAC)” for financial institutions.

In other words, to ensure banks have enough capital available in times of stress, which sounds reasonable before you delve into the detail.

You might familiarise yourselves with the new – International regulatory framework for banks (Basel III) – administered by the Bank of International Settlements, which replaced the Basel II guidelines.

I discussed the new guidelines in these blogs – Bond markets require larger budget deficits and Counter-cyclical capital buffers

The Carney plan wanted banks to have a minimum amount of so-called ‘junior’ liabilities (LAC) that would be ‘bailed-in’ ahead of senior creditors.

The process for resolution of a stressed bank would be that:

1. The minimum TLAC would see equity and Tier 1 capital written off. This would include all of the “existing Basel 3 minimum capital requirements” plus more. Tier 1 capital (or core capital) includes shares, retained earnings, and other assets (preferred shares etc).

2. Tier 2 capital would be converted into equity or written off next. Tier 2 (supplementary) capital includes undisclosed reserves, revaluation reserves, general provisions, and other assets).

3. If still not sufficient, the more senior creditors would be hit.

But the relevant distinction is between secured and unsecured creditors, given that the scale of bank losses in 2008 and after were so large that the Tier 1 capital and equity holdings would have been quickly lost.

You won’t find mention of ordinary deposits in the FSB document only to note that “insured deposits” are excluded from the TLAC.

But as Ellen Brown notes in an interesting account – New G20 Rules: Cyprus-style Bail-ins to Hit Depositors AND Pensioners – which explains how pension funds will also be absorbed into the risk capital of the banks, that small depositors are insured against loss in the US and Europe “but deposit insurance funds in both the US and Europe are woefully underfunded”. Meaning depositors lose either way. However, in the US, at least, the underfunding claim is not accurate. I am reliably informed that the FDIC is guaranteed by the Treasury Department, which means it has an unlimited supply of US dollars available to it.

On November 11, 2014, Mark Carney (FSB Boss) gave a – Press briefing in Basel ahead of the G20 Summit in Brisbane.

He told the press that:

Senior debt could, for example, count toward a bank operating company’s TLAC if it was issued by the holding company, and the debt of the holding company is effectively subordinated to the debt at the operating company. Another way senior debt could be eligible for TLAC is if it could be subordinated in statutory terms so it could be made clear via statute that senior unsecured creditors could be bailed in before other senior creditors – the most obvious ones are depositors.

So ordinary depositors will become unsecured creditors (the largest group for a deposit-taking institution) under the new laws enacted in the G20 nations. The resolution process (that is, the bankruptcy procedure) would see deposits confiscated and turned into equity or liquidated to pay off secured debtors.

An insolvent bank could thus remain in operation by transferring deposits into capital.

We can no longer consider bank deposits to be secure (guaranteed by government). In the case of an insolvency process, they will be absorbed under these new rules, into the capital structure of the bank and dealt with accordingly.

While it is sensible for banks to have more capital to insulate them against losses, it is outrageous that ordinary depositors would have to pay the costs of a bank going broke, when it is easy for a currency-issuing government to step in, nationalise the institution, sack all the managers and decline to pay bonuses etc, and then restructure the institution with the deposits intact.

Otherwise, why would an ordinary person risk their savings.

The alternative is to boycott these large institutions and develop not-for-profit mutual funds/community banks, which do not risk their depositors’ funds in the global derivatives casino.


The FSB proposed was approved by the G20 Brisbane meeting with little discussion. Cyprus is now the bankruptcy model.

It is unlikely that small depositors will be implicated. But as we learned from the Cyprus scandal, the life savings of people were above the threshold that the Troika confiscated.

Certainly, if you have largish deposits (as part of your life saving, for example), these new rules provide a massive incentive to transfer them into a more protected form of assets. With interest rates very low, holding cash in safe boxes becomes attractive.

Once again the world leaders come up with solutions that are not in the interests of the common folk.

That is enough for today!

(c) Copyright 2014 William Mitchell. All Rights Reserved.

This Post Has 33 Comments

  1. This has nothing to do with “Tax Payer Supprt”. It is about giving the elites a get out of jail free card if they choose black at the roulette table and the ball lands on red or zero.

  2. The local working class paper in my city is awash with articles about valiant efforts on the part of city authorities to make this anti society cashless.
    For a guy depending on cash to supplement his income this will be catastrophic.

    The plan if you have not figured it out yet is to totally destroy old societies and replace them with some empty something or other.
    If and when the common folk hold much of their assets in cash they will surely declare it null and void.
    ‘Investment” decisions are in some senses easier.
    Its not about creating value if it ever was.
    Its about predicting the next move of the insiders wealth concentration experiment.
    A destruction of all local exchange , of the medieval trade fair is at the very top of the agenda as they wish to control all life.

    A situation where cash becomes valuable above all else will also make it extremely vulnerable.
    As we are dealing cards within a game of pure extraction.

  3. I support the G20 / Brisbane solution. I.e. I’m not moved to tears by Bill’s claim that the G20 solution is “not in the interests of the common folk.”

    The inescapable reality, which half the population including half the economics profession can’t face, is that when a large bank fails, someone somewhere loses out. The only question is: WHO?

    Under the existing system, it’s largely TAXPAYERS who pay, given failure of a large bank and in particular a SERIES of large banks. And in the case of Dork of Cork’s Ireland, the average taxpayer was plundered good and proper in order to make sure that those with tens of thousands in sundry Irish banks didn’t lose out. That’s not my idea of “in the interests of the common folk”.

    A far better system is one under which those who want total safety lodge their money at the central bank or with government – something they can already do in some countries: e.g. in the UK anyone can open an account at the nationalised savings bank, National Savings and Investments. In contrast, those who want to have their money invested or loaned on with a view to earning interest, i.e. making a profit, sodding well carry the relevant risks. Why should anyone else carry the risks?

    If you lend to a corporation via the stock exchange, i.e. buy bonds in a corporation, or buy shares via the stock exchange YOU CARRY the risks. Quite right. Why should the taxpayer protect you when lend to a corporation or mortgagor via a bank?

  4. Ralph, why do you even post here when you make such patently wrong comments about taxpayers “paying”… you aren’t even responding to Bill’s proposed solution, which is made in the MMT framework, and proposes nationalising the banks, saving the deposits, and declining to funnel money to profits/rents through executive bonuses. You may be right about what HAS happened, but what has happened only occurred because the relevant decision makers are idiots (at best).

  5. Um….just hang on a minute!!!!

    FDIC insured deposits are backed by the full faith and credit of the US govt.

    If FDIC reserves go bust, the US Treasury is still liable. The FDIC is an agent of the Treasury.

  6. Anthony,

    The fact of nationalising an insolvent bank does not alter the fact that the money needed to prevent depositors losing out has to come from somewhere. Take a simple example: $Xmillion has been deposited at a bank, and the bank has lost the lot. If the bank is nationalised and depositors are to be protected, then government has to get $Xmillion from somewhere: the money won’t grow on trees. In short, the money comes from taxpayers, i.e. the “common folk” to quote Bill.

    Next, you refer to MMT. And Bill says “it is easy for a currency-issuing government to step in, nationalise the institution…”. Bill seems to be implying that governments can just print money willy nilly and pay for ANYTHING. Either that, or that’s what you’re implying. Well that won’t wash.

    Assuming the economy is at capacity (what Bill calls the “inflation barrier”) then government just can’t print and spend more: if it does, inflation becomes excessive. Alternatively, if the economy is operating at BELOW CAPACITY, then obviously government can “print and spend”. But if the bank hadn’t gone insolvent, then government would have spent the money on something else: health, education, roads, tax cuts or whatever. I.e. the fact of rescuing the bank still amounts to a cost for the “common folk”: they get less spent on their health care, education, roads, tax cuts etc.

  7. Dear Ralph Musgrave (at 2014/12/04 at 14:34)

    Bank insolvencies of the type we have witnessed plus the zombies that have been propped up do not occur at full employment.

    Further, the act of nationalisation and deposit protection involves, in the first instance, no net public spending increase. The owners lose, the other debtors lose and the depositors shift their savings from one legal entity to a new publicly-owned entity. The bank is then recapitalised at the stroke of a computer keyboard and business recommences under new prudential guidelines.

    Where is the issue?

    best wishes

  8. I think you’ve missed the point Ralph. Printed money is not endless and needs to be balanced by inflationary pressures. Hence printed money used to nationalise banks would not necessarily be available for infrastructure projects, especially if spending would produce excessive inflation.

  9. In the US one should be careful about keeping cash anywhere because the local police force can confiscate it. The police don’t even have to prove that the owner of the cash is involved in anything illegal. They bring changes against the cash, not the owner. It might help to watch this you tube video about civil forfeiture. It won’t take long and will be well worth your time.

    Last Week Tonight with John Oliver: Civil Forfeiture (HBO)

  10. “Under the existing system, it’s largely TAXPAYERS who pay,”

    No it isn’t and you know damn well it isn’t. Please stop repeating rubbish.

    No ‘taxpayers’ pay a penny more for anything. Under the existing system the fiat money is simply issued *after* a systemic event rather than before.

    That’s what an insured system does. It has a smaller initial balance sheet and holds everything in contingency rather than on the face. The insurance pays out on an event. I’ve already explained the one-to-one between an insured system and an in-specie system in detail – including pictures!

    The insurance is necessary to get the price of loans down low enough to sustain the *required* level of lending into the economy.

    Your proposals simply add unnecessary risk and make lending too expensive. That does nothing other than encourages ponzi schemes – particularly in a capitalist system which inevitably returns a lower level of profit to valuable projects over time simply due to economic maturity.

    Price will not and does not sort everything out by magic.

    That leads to even more extensive government intervention in the economy – which would then have to duplicate the bank structure to work out which projects should be funded and which shouldn’t. At which point why bother having private banks at all?

    Proposing excessive centralisation leads to rigidity and inflexibility, just as excessive distribution leads to inconsistency and lack of control. An efficient system needs a balance of the two.

    We need to narrow the banks by banning activities that are incompatible with the goals of a monetary system and start treating the regulated banks more like franchise holders – if we are to have private banks at all. Their job is to capitalise future income streams.

    The state *is* the investor in the banks however indirectly. Bank failures are a failure of state regulation. Therefore it is always a public loss regardless of how you dress it up – just like a failed infrastructure project.

    Pushing public losses onto specific private individuals is just wrong and won’t work.

  11. It’s important to remember that we’re talking here about an event that exhausts the deposit protection insurance system in the particular country as well as all the capital buffers the banks are supposed to have.

    That’s a fairly major source of loan defaults – which likely means a systemic crisis that is going to cause a reduction in economic activity.

    So if you then bail-in depositors aren’t you then going to make them and everybody else feel very insecure and they are just going to stop spending – in addition to any other banks’ cost of funding going through the roof.

    It all sounds terribly pro-cyclical.

  12. Bill,

    Re your claim that “bank insolvencies . . . do not occur at full employment”, why ever not? A bank can make silly loans when unemployment is at 4% just as much as it can at 6%, 8% or any other percentage. In fact at the onset of the recent crisis we had more or less full employment (certainly higher employment than has obtained for the last 4 years or so) and banks toppled like nine pins.

    Re your “no net public spending increase” point, I assume you’re envisaging nationalisation only when a bank becomes insolvent. Let’s assume a bank is funded 5% by shareholders and 95% by depositors. To keep things simple I’ll assume no bonds, but in any case bond-holders are effectively just a form of long term depositor. If the bank’s assets decline by anything up to 5%, it isn’t insolvent so no nationalisation takes place. More than 5% and IT IS technically insolvent. Let’s assume assets deline by 10% and that actual insolvency takes place. In that case, and to ensure that depositors don’t lose out, government will have to find money to the tune of 5% of the bank’s assets (10%-5%).

    To summarise, if a bank is nationalised on insolvency and depositors are to be protected, then government is forced to put SOME public money into the bank: maybe a very small amount, or in the worst possible scenario (highly unlikely), a sum equal to total deposits at the bank.

    Re your question “Where is the issue”, I think the basic issue is: “Who stumps up money when a bank goes insolvent?” My answer is that it should be the people who stand to profit when the bank does well, i.e. shareholders, bond-holders and depositors, all of who earn some sort of interest or dividend when all goes well. It should never be the taxpayer who stumps up. As the UK’s Independent Commission on Banking put it, “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.”


    I’m not entirely sure what you’re saying, but you seem to suggest that if public money is not put into an insolvent bank, that that money is not necessarily available for infrastructure etc. My answer is that it is certainly over-simple to say that if $Y is not put into an insolvent bank that therefor $Y will be available for infrastructure etc. That’s because the stimulatory / inflationary effect of the two options (per dollar) are almost certainly different.

    However, putting money into depositors’ pockets is bound to have SOME SORT OF stimulatory effect. I.e. a proportion of that money is GUARANTEED to be spent. So assuming constant aggregate demand, then devoting public money to rescuing depositors must mean less money spent elsewhere.


    Re the “insured” banks to which you refer, in the UK as I understand it, no bank pays any sort of insurance premium, thus taxpayers foot the bill when any bank fails. In the US, FDIC only covers small banks. That was why I referred to “large banks” in my original comment above.

    Where banks ARE fully and properly insured, I’m sure the G20 Brisbane lot have no objections. After all, that achieves the objectives the G20 (and Vickers) want: not having taxpayers on the hook.

    However, I don’t agree with your claim that “insurance is necessary to get the price of loans down..” or that my proposal would make “lending too expense”. The reason is simple, and as follows.

    Say the chance of depositors losing everything in any one year is one in 50 and that that’s the only risk. The logical insurance premium to charge is one fiftieth of total deposits, and that gets passed on to lenders. On the other hand if there is no insurance, then depositors will necessarily “self insure”, i.e. they’ll demand enough interest to cover the risk they’re running. And the logical “insurance premium” is again one fiftieth of total deposits which gets passed on to lenders.

    And even if insurance does cut costs a bit, I don’t accept that interest rates have much effect on investment. As Jamie Galbraith put it, “Firms invest when they can make money, not when interest rates are low”.

  13. Carney: “The expectation that systemic institutions can privatise gains and socialise losses encourages private sector risk-taking and can be ruinous for public finances”

    The privatisation of gains and socialisation of losses is the essence of modern capitalism. It’s a bit much to believe that the banking sector is suddenly overwhelmed with concern over this issue. This is pure B.S – a smokescreen for a policy that will do nothing to address the issue, and will instead hurt the host of depositors (a significant subset of taxpayers) so that the parasite can survive.

  14. Hurrah!
    I was going to comment yesterday about this issue, having read Ellen Browns piece which you reference. Im pleased you were on the same page! Its good to have my suspicions confirmed, and that I hadnt missed anything here.

    One thing which I dont think you have explored fully here is that which E.B goes into in some depth, regarding the stealing of pension funds which I feel will occur as a result of these rules. Having already withdrawn from Santander bank (and I advise anyone else here to do the same, given their quality of service and their inherent eurozone spanish liability) and diversifying my (small) capital out of risky commercial banks over time, the only thing I cant protect is any pension stocks.

    I hope you and E.B are in contact and can be a united voice on more issues going forward as we challenge elite groupthing (/evil schemes !)

  15. “Bill seems to be implying that governments can just print money willy nilly and pay for ANYTHING.”
    Well either that or he was quoting Bernanke when he said they were QE’ing the balance sheets of banks ‘willy nilly’ as you put it.
    *Commercial bank accounts at the federal reserve had deposits created at stoke of keyboard.
    *Bad assets were bought off the commercial banks balance sheets using stroke of the keyboard transactions.

    “In fact at the onset of the recent crisis we had more or less full employment (certainly higher employment than has obtained for the last 4 years or so) and banks toppled like nine pins.”
    Employment in this period was not ‘full employment’ There is NO data to represent this claim. (Sorry phillips curve/NAIRU rubbish is not empirical if it was in any other field science, mathematics etc it would be dismissed as rubbish).
    Instead look at the private sector debt to disposable income ratios in US/Europe/Australia. The size of the liabilities in the banks deposit sheets leading up to the crisis.

    “If the bank’s assets decline by anything up to 5%, it isn’t insolvent so no nationalisation takes place. More than 5% and IT IS technically insolvent. Let’s assume assets deline by 10% and that actual insolvency takes place.”
    If a bank is insolvent it implies not only negative capital (and for whatever reason a refusal by the central bank to provide liquidity on overnight banking window, other banks wont lend on the intermarket). Then it logically follows that the market has to believe percieve a significant percentage of the liabilities on the banks balance sheet to be bad and not profitable. Banks must go insolvent temporarily every day. Certainly if 5% negative liabilities rubbish is to be believed.

    “My answer is that it should be the people who stand to profit when the bank does well, i.e. shareholders, bond-holders and depositors, all of who earn some sort of interest or dividend when all goes well. It should never be the taxpayer who stumps up.”

    This is quite A FLIGHT OF THE IMAGINATION tax has to be rationalised againt liquidity of banks during a bailout?

  16. As much as I am loathe to agree with Ralph, he inadvertedly raises a larger point about centralisation v decentralisation and whether we should have private banks at all. If its the case that we can just print money to plug holes in bank balance sheets, why don’t we do what Adair Turner proposes and just print money for fiscal spending? Better yet, why don’t we print money and hand it directly to people with high marginal propensity to consume (the poor) etc instead of this mawkish business with QE? These are interesting philosophical questions.

    If we don’t print money to bail out banks, and simply use public money like in Spain, Ireland and other countries, I think the net welfare for the common man is reduced by using public funds (remember, we have to borrow from international bond markets to fund these bailouts which means paying interest on top of the bailout, and also opportunity costs of bailing out banks v spending on the unemployed etc). The aggregate interest of taxpayers probably is more in line with the hypothetical “common man” than the interests of a specific bank’s depositors, however many there may be.

    This is further ‘made better’ by the fact that subordinated and junior bond holders will now be burned first (a welcome development), as well as equity holders. If you think about a ‘pyramid of hurt’, large depositors only come before senior secured bond holders which isn’t the worst outcome I can think of. Although I’d rather it the other way around, the legal implications are quite difficult here.

    The second thing we have to remember is deposit insurance which protects small depositors in most countries, even in bail in circumstances. The EU has been talking about a European wide deposit insurance scheme. One commenter mentioned the UK doesn’t have one which is incorrect – we have the FSCS. Small depositors would be protected. To the other concerns that these schemes are underfunded, then that simply means we will have to raise levies on financial services firms!

    I do think depositors should bear some kind of risk ultimately, if we are to keep the banking system private. They receive interest on deposits and there is a section of the population that would prefer to have higher interest on these but can’t because deposit gurantees dont incentivise banks to reward depositors. This calls into question behaviorial economics concerns however about whether the average man on the street is best placed to judge a banks viability, particularly over the long run.

    A ‘free market’ solution that I’ve thought about that would greatly ameliorate the problem would be for banks to have some sort of special insurance scheme or fund that would bail out banks that all of them would contribute to. There is a lot of problem with this as private insurers may not be large enough in many countries. This would come into effect in an insolvency situation, not a liquidity situation which central banks already cater for. An alternative would be a quasi government run insurance scheme of some sort, with part subsidy in the instance the pool of funds isn’t large enough (which could be replenished or paid back in the expansion years once the banks are back to health)

    The socialist solution would be to go chinese on this and just nationalise the deposit taking banks as we already spend so much on regulation, bailouts, guarantees, lobbying etc it doesn’t make sense to let private participants take rents from what is essentially a public utility like a highway or a lake.

    I will leave these issues for better minds to think about, but I just hope that the people in the FSB, ECB will act in the public interest and not in the interests of the rich and the powerful! (Ha-Ha).

  17. “As Jamie Galbraith put it, “Firms invest when they can make money, not when interest rates are low”.”

    Which was precisely my point. The stagnation that happens in a capitalist economy as it matures lowers the achievable rate of profit for normal projects. The only schemes that can then make profits high enough to pay the interest rate are ponzi schemes.

    The Bank of England instigated a Funding for Lending scheme to widen the discount window when the bank’s funding costs increased by *1%*. They expected it to hit loan quantities so much they threw the kitchen sink at it at a time when loan rates are at their lowest for generations.

    You’re talking about removing the entire deposit insurance system which will stick the funding costs up an awful lot more than that.

    So you will get a massive quantity impact and on precisely the sort of loans that we actually need – capital development for real investment.

    Which is why relying on price to sort out type of loans is a very silly idea. You need to restrict the type of loans and restrict what banks can do. More of a franchise model.

  18. The FSCS covers deposit insurance in the UK via a hypothecated levy:

    “The FSCS is funded by the financial services industry on a pay-as-you-go basis. We levy firms each year on the basis of our estimates of the compensation we are likely to have to pay out in a financial year. If our estimates ever turned out to be too low, or we were required to make additional payments, we are able to borrow additional funds during the course of the year and/or make additional levies.”

  19. Sam,

    Taking your points in turn, re your point that that central banks can create money with “keystrokes”. I didn’t suggest otherwise. What I said was that it’s desirable to create and spend keystroke money if the economy has spare capacity, but not if it hasn’t.

    Next, in reference to full employment you state with huge conviction that we didn’t have full employment (in Bill’s “inflation barrier” sense) just prior to the crisis, and then state that determining exactly where the barrier is is impossible. Bit of a contradiction there. However, you do have a point of sorts: that is, while the inflation barrier or NAIRU or whatever you call it is a valid and indispensible THEORETICAL idea, it’s near impossible to actually measure.

    But that’s not a big weakness in the idea: science is full of variables, concepts etc which cannot be measured but which are nevertheless indispensable. E.g. what’s the square root of minus one? Darned if I know, but I gather from mathematicians that the concept “square root of minus one” is indispensable.

    Next, you say “Banks must go insolvent temporarily every day.” You could well be right. That was why I made a distinction above between TECHNICAL insolvency and ACTUAL insolvency. Technical insolvency is where liabilities exceed assets but no one is too bothered because the bank’s creditors think the problem is temporary or recoverable. Actual insolvency is where creditors lose faith and depositors withdraw their money en masse.

    According to the opening pages of Robert Peston’s book “How do we fix this mess”, several large UK banks were technically insolvent for extended periods in the 1970s, 80s and 90s.


    I quite agree that QE is “mawkish”. I’d go further and suggest that the whole distinction between monetary and fiscal policy is mawkish, or put another way, economists love the distinction and the complexity there because it keeps thousands of them employed writing useless articles and papers. I.e. I support the Adair Turner suggestion. Actually Keynes made that suggestion in the 1930s, so its not original.

    Re your concern about “whether the average man on the street is best placed to judge a banks viability..” full reserve banking solves that problem by giving depositors a range of choices. They can, 1, have their money lodged at the central bank, and government guarantees that money, but the money is kept in a totally safe manner: i.e. it is not loaned on to businesses or mortgagors. 2, they can have their money fund conservative mortgages (bit like traditional British building societies). There is no government guarantee there, but the money would be 99.9% safe. And 3, if they really want they can fund NINJA mortgages or some other risky stuff. The average woman, and even possibly the average man ought to be able to deal with that range of choices.

    Re your insurance proposal, I’ve got a better idea: just forbid any one or any entity from taking the risk that is inherent to all banking. The risk I’m referring to is essentially fraudulent. It consists of accepting $X from depositors, lending on the money, while at the same time promising depositors they’re guaranteed their money back. That’s no different from taking money off a friend for safekeeping, and putting the money on a horse. It’s just a nonsense. It’s dishonest.

    Full reserve banking forbids that activity, and in fact that activity is being banned in the case of money market mutual funds in the US. I.e. under full reserve, where people want money loaned on they buy SHARES in the lender. That means the lender does not have any specific liability so it can’t possibly go insolvent. As George Selgin said in his book, The Theory of Free Banking, “for a balance sheet without debt liabilities, insolvency is ruled out”.

  20. When we print money to nationalize insolvent banks, we are creating money the economy already thought existed but didn’t with money that actually does exist. Since the amount of money people thought they had before the insolvency is identical to the amount of money they actually have after it, the newly created money will not be inflationary.

  21. Thanks for the reply Ralph Musgrave

    “But that’s not a big weakness in the idea: science is full of variables, concepts etc which cannot be measured but which are nevertheless indispensable.”

    This is not the situation of unsolvability in economics, the signicant variables are there and known. Its the field that is stuck in primitive groupthink of ideas and obsolete concepts.
    Where we should be today if economics was even remotely a scientific for example:

    Take a Stock Flow Consistency Model which (uses dynamic equations), scrape macro data in real time from bank account balances and run a regressive algotithm over the whole dataset simulating known/likely breakpoint conditions and chaos (The Big-Oh time complexity would not be prohibitive this would be like a medium term weather forecast). At least then we’d have a rough minsky style chance of spotting the problems… There is only the one place doing it with real world data to my knowledge: Levy SFCM you’d think if the profession had any integrity this stuff would be running forecasts for every banking system in every nation. It would have been one of the lessons learned. STILL i read papers on central bank eg: RBA website that have an ‘agent’ consuming ‘infinite’ quantity X interacting with another identical agent doing the same thing rubbish.

    “Actual insolvency is where creditors lose faith and depositors withdraw their money en masse.”
    Where did this happen? Is this in GFC?

    @Icarus Green
    “A ‘free market’ solution that I’ve thought about that would greatly ameliorate the problem would be for banks to have some sort of special insurance scheme or fund that would bail out banks that all of them would contribute to.”

    In my opinion nothing says putting lipstick on a pig better than this.

    Many banking systems already have a limited reserve requirement. ~10% US system.
    Look at that system now and all the options available:
    If a bank needed to reconcile a liability it had so many options: interbank, overnight window, Tier One and Tier Two Capital ratio’s, origination fee’s. So adding some ‘fund’ which doesnt actually ‘regulate’ woud be pointless. They still managed to instantiate too many deposits to credit unworthy customers. Hence the neo-liberal vision of ‘engineered credit’ which has manifested itself so visibly in the debt to savings ratios around th world. As it seems there is aplethora of ex-banking officials from regulatory bodies (the US story) coming foward and saying the regulatory system is still broken.

    Also relates back to why there isnt a forecast involving vertical and horizontal transactions, sectorial flows and real time data at the center of the orthodoxy to prevent these problems.

  22. It is the more accurate way to trigger a run on deposits! Musgrave, you are an ataloyah of libertarianism! I know, time ago I use to think as you. Has six years of crisis not open your mind?

  23. I first heard of the extension of the Cyprus Solution back in June. It was mentioned as an aside in “Bubble Economics – Australian Land Speculation 1830-2013” by Paul D Egan & Phillip Soos. This book is only available online and is a good read.
    Since then I’ve picked up a few mentions in various online publications but nothing in the MSM.Apparently the legislation for bail ins was in place in Australia early this year so it has been kept pretty quiet.

    I don’t think many people realise that as a depositor in a bank you are an unsecured creditor and way down on the list of claimants in the event that the bank goes bust.
    Normally,the government deposit guarantee would cover small (? how small) depositors. However, given the manifest stupidity and regressive tendencies of the present Federal government I have little faith in them protecting the common people.
    Then there is the squillions in superannuation. Wouldn’t the banksters just love to get their sticky hands on that.

    In a sane world the solution would be to let the rotten financial institutions go bankrupt, reimburse depositors,clean out the upper echelon, fold what is left into a viable institution (private or nationalised) then bulldoze a hole to bury the debris.

    But we don’t live in a sane world.

  24. I’m a bit slow – how does shifting a deposit liability from a commercial bank balance sheet to a government balance sheet “create money”? It shifts a promise to pay in government money from an entity that cannot guarantee to honour that promise to the only entity that can.

    Are people hyperventilating about the creation of whatever asset would be created to “balance the books” on the government side?

    Are depositors more likely to spend/draw down deposit balances when its conversion (to cash or reserves) is guaranteed than when it is not?

  25. Its great that you all enjoy a good argument and I enjoy the outcomes.
    I think you should consider that the majority of savers have no clue that they are lending the bank money by depositing money in a bank account. Most pay packets go straight into the bank and we are told from a young age that “its as safe as money in the bank”. So we trust the banks are a safe place to put our life savings.
    So the peasants will have their savings confiscated. Nothing has changed then since Little John imposed taxes on the peasants in his villages outside his Castle.
    Are Australian Government Bonds safe from a bail in? If yes I will put my super into Gov Bonds until the blow up. Anyone know?

  26. Let’s go back to Lehman Brothers, and why they went bankrupt. They went bankrupt because the federal reserve refused to back their loans — at the time they said they didn’t have the authority to take an entity such as Lehman Brothers, and there have been a number of arguments of whether they should or should not have since that time, but the US government could have backed their loans without the coast to anyone, other than the federal reserve printing money, which is coast free.

    This isn’t a question of whether the entity made bad loans or not or what their reserve was or was not, but go back to Lehman’s and the issue was whether the federal reserve would or would not back their loans, and once it was clear they wouldn’t then it was all over for Lehman Brothers.

  27. Dear Punchy (at 2014/12/05 at 14:40)

    Australian government bonds are zero risk. The Government will always honour the liability. I would bet anything on that assessment. They are like cash just a little less liquid.

    best wishes

  28. At some point, “What we’ve got here is failure to communicate; some men you just can’t reach”, becomes an appropriate standard response to Ralph Musgrave. One uses one’s finger to point towards a natural marvel and Ralph repeatedly does the equivalent of remarking on the quality of the manicure of one’s finger-nail, the length and thickness of one’s finger, whether it’s perfectly straight or somewhat kinked, the length of time the pointing lasts, etc.

  29. Excellent piece, but I think it’s not true that the FDIC has an unlimited supply of US dollars available to it. According to the FDIC website, it has a maximum credit line of $500 billion with the Treasury, at normal federal rates of interest, and the FDIC has to show how the loan will be paid back and present a reasonable payment schedule. I think the reason Jamie Dimon exercised his muscle on the omnibus budget spending bill was that he was worried about JPMorgan’s exposure to oil derivatives. Oil dropped by $50, something totally unanticipated, evidently an act of financial war by the Saudis, whether against Russia or us is unclear. The big derivatives banks have a $4 trillion exposure to commodities derivatives, and oil makes up most of them. So $500 billion may not be enough to cover the losses, and even if it were, who is going to pay that sum back? The few billion that the FDIC borrowed after 2008 were a major stress on the small banks whose premiums got raised to pay it off. Paying back $500 billion would bankrupt them.The few billion that the FDIC borrowed after 2008 were a major stress on the small banks whose premiums got raised to pay it off. Paying back $500 billion would bankrupt them.

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