Because that’s where the money is…


And those who don’t pay attention, get fleeced…

If history is any guide, our political czars wouldn’t attempt something so crude as to just grab money from our accounts. No, they’ll do what they have always done: siphon it gradually by printing lots of money and inflating away our savings.

Cyprus and the Death of Deposit Insurance

by Robert Tracinski

From the beginning, the European crisis has been a story of small countries on the Eurozone’s “periphery” revealing fundamental problems at the heart of the system. Now a very small country on the outer edges of the periphery—the tiny Mediterranean island of Cyprus, with about a million inhabitants and 0.02% of Europe’s GDP—is triggering the latest wave of the crisis.

This is not really about Cyprus, of course, but about the precedent that is being set there. In exchange for an infusion of capital into the nation’s banks, Cyprus is being asked to impose a “special bank levy” that would take 6.75% out of all bank deposits up to 100,000 euros, and 9.9% above that.

This is described as a “wealth tax,” except that it’s not a tax. A tax is a regular rule that operates uniformly according to a pre-determine formula. A one-time, ad hoc seizure of money isn’t a tax. It is confiscation. Or we can use a plainer word for it: theft.

The big news isn’t this bank heist, but who is pulling it off. The plan was imposed, not by some wild-eyed revanchist Communists, but by the finance ministers of respectable European countries, who thought up the idea and imposed it on Cyprus. Like Willie Sutton, they know where the money is.

There are special circumstances that made them think they might get away with it. Cyprus is a small island with a large banking center that holds deposits many times larger than the local economy. A lot of this money comes from Russia, and Cyprus is reputedly a tax haven for Russian “oligarchs” (politically connected billionaires) and mobsters. In an American context, you might compare Cyprus to the Cayman Islands, which have been so vilified just having a bank account there is enough to end a politician’s career. Just ask Mitt Romney.

But in showing us what they’ll do to an unsympathetic target, Europe’s leaders are showing us what they would like to do everywhere: dig themselves and the crony banks out of a tight spot through the mass confiscation of wealth. It’s the ultimate bailout plan: they just take whatever they need.

And there is more to it than that. This is confiscation, but it a particular kind of confiscation with particular implications. It is the end of deposit insurance. Depositors, particularly small depositors, are supposed to have an ironclad guarantee that their money will always be there, no matter what—that they won’t wake up one Monday morning to find that 6.75% of it is gone.

That’s why the Cyprus heist is really important. It is a warning that the whole system of deposit insurance is coming unglued.

Deposit insurance is central to modern banking—or rather, it is central to the contemporary system of government-guaranteed, government-regulated, too-big-to-fail banking. Here is how the deal is supposed to work. The government guarantees ordinary bank deposits, but in exchange it imposes regulations meant to prevent banks from failing so that they will rarely have to call on the government guarantees. But then there’s a complication. While the government’s deposit insurance raises enough money to handle the failure of a limited number of smaller banks, there are some institutions that grow so big that the government doesn’t have enough money to cover their losses if things go wrong. That’s one of the reasons why these banks become “too big to fail,” which necessitates even more government support, in exchange for which they are supposed to be placed under an even heavier layer of regulation.

Cyprus is a signal that this whole system is failing. Government regulation doesn’t actually guarantee solvency; in fact, it is the insolvency of the governments themselves that triggered the Euro crisis. Moreover, when things really go wrong, the government can’t actually guarantee all of the deposits—and now we’re starting to wonder whether they’re still interested in trying.

When this system starts to come apart, its consequences are worse than an ordinary bank panic. In the bad old days, when individual banks and their depositors were on their own, if one bank failed—and if it was not bought out or rescued by another bank—its depositors might take a haircut, but only after shareholders and bondholders were wiped out. This gave all of the parties a strong incentive to make sure the bank was solvent and wasn’t taking too many risks. Under the current system, all of these parties are absolved from such a responsibility, but we pay a heavy price for it. When things go wrong, every depositor at every bank gets a haircut, while politics decides who gets hit worse. In the Cyprus deal, European bondholders will be protected, but Russian oligarchs will be looted, and small Cypriot depositors will get caught in the middle. Remember, also, that all of this is being done to avoid a run on the banks—but that is precisely what has been happening in Cyprus, with depositors emptying the nation’s cash machines in an attempt to withdraw their money before it could be seized.

Combine this news with Gretchen Morgenson’s summary of a Senate inquiry into huge trading losses at JPMorgan Chase, one of our too-big-to-fail megabanks. The bottom line is that big banks are still too big to fail and they are still taking undeclared risks backed by taxpayer money. Across the board, the general sense is that the system is failing and government leaders aren’t really trying to reform it. They’re just trying to restore the status quo ante, setting us up for a whole new round of financial crisis.

Can Cyprus happen here? Well, some on the left are already floating plans to rescind the tax exemptions on retirement accounts, making a grab for a big pile of your savings.

But will they do what Cyprus is doing with our bank deposits? Probably not. If history is any guide, our political czars wouldn’t attempt something so crude as to just grab money from our accounts. No, they’ll do what they have always done: siphon it gradually by printing lots of money and inflating away our savings.

I understand if you don’t find that very reassuring.

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