No one has denied that China was overdue for a credit shakeout due to the Chinese government’s desire to stem excess credit growth as the economy rebalances. The question has always been about how much of a shakeout Chinese policy makers are willing to accept and how destabilizing the shakeout would get regarding economic growth and employment. We seem to be reaching another level in terms of jitters with bank runs and commodities sector bankruptcies. Some thoughts below
Detroit was allowed to declare bankruptcy last year. While economists often focus on the barriers to entry, by removing the stigma from bankruptcy and easing the process, it makes lowers the barriers to exit. This stands in stark contrast with Europe. Consider Rome.
Here are some quick points on the Cyprus deal which the Eurogroup agreed to last night. The agreement outline is very much along the lines of what I have been recommending regarding bail-in guidelines and is therefore a much fairer deal than the deal presented to Parliament last week. But the debt sustainability of the sovereign remains a question, as do the capital controls and potential for deposit flight. The Cypriot economy will not do well in the coming years.
The latest information on Cyprus is that the ECB has told the Cypriots it could no longer extend the ELA facility being used by the now bankrupt Cypriot financial institutions. Cyprus has until Monday to find the funds to support their recapitalization or they will be cut off after the jump I will explain what led to this decision and what alternatives Cyprus now has.
Regarding Cyprus, recently I heard someone claim that depositors are not creditors of a bank despite the fact that deposits are bank liabilities. This is bollocks. Depositors are indeed creditors, particularly in Europe where they are legally pari passu with other unsecured creditors. Below is an extract from a presentation given by an ECB expert on bank resolution schemes addressing who gets preferential treatment in carving up the losses.
As I indicated three months ago, the IMF now supports capital controls in specific and extraordinary circumstances, particularly in view of its experience in Iceland. This is now relevant given the situation in Cyprus. Matina Stevins of Dow Jones has learned that EU and ECB officials are now working on a contingency plan for Cyprus which includes capital controls. Likely, they would go into place as soon as Cypriot banks re-open for business.
The Cypriot banking system is insolvent. Heaping private losses onto taxpayers is bad public policy. Let’s start with those two statements, because starting there makes clear that forcing losses onto bank creditors was the only choice in Cyprus. The question goes to which creditors and using what standards. That’s where the problem lies.
This morning we learned that after hours of tense negotiation, Europe has hammered out a 10bn euro “bailout” of Cyprus. I put the term bailout in quotes because the key feature of this deal is the bail-in of Cypriot depositors to the tune of 5.8bn euros. This means that depositors went to sleep on Friday night and woke up Saturday to find that their money, deposited safely in Cypriot banks had been seized and used to “bail out” the country. I see this as an extreme measure which, if the European banking crisis continues, will have very negative implications for bank depositor confidence in other European periphery countries.
I don’t want to be too glib here. I recognize that policymakers are in an extremely difficult position and that there is no longer any easy solution, but railing at the markets rather than trying to understand why they are doing what they do (which anyway makes them far more rational than if they responded to the pronouncements coming out of Brussels) is counterproductive. In fact this kind of pouting is just a part of the self-reinforcing downward spiral that I have described many times before. Policymakers are complaining that economic agents are behaving in ways that reinforce the crisis, even as they do the very same thing.
Hans-Werner Sinn is the sometimes controversial head of Germany’s Ifo Institute, A German-based center for economic studies. He has been in the news for his warnings about the Target2 system at the heart of trans-national money clearance in the euro zone. I have been critical of his analyses in the past. However, regarding the best outcomes in Greece, Sinn made some insightful comments recently about a Greek exit from the euro zone which I would like to highlight. I have underlined the important bits.
Read between the lines. Bank of America is on government life support. As a result, it is being forced to shed assets and cut staff in the hope that this will be enough to prevent its having to be bailed out or resolved. Moreover, a shrunken BofA will be easier to deal with when that moment does arrive.
As Eurocrats dissemble, ratios that quantify U.S. financial system exposure to European insolvency are dated, even as they are published.