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EMU = not Enough Monetary Union

Marc To Market's picture




 

It has been widely recognized that a critical challenge Europe faces is a monetary union without fiscal union. Yet the Cyprus crisis demonstrates is that monetary union is not complete. 

The capital structure of Cypriot banks is relatively unique.  As  a tax haven, its banks were funded primarily by deposits not bonds or wholesale funding as other banks.  European and Cypriot officials were willing to tax depositors.  Many claimed that this was illegal because of the existence of deposit insurance.  Rather than allowing the insolvent Cypriot banks from failing, which would have triggered the deposit insurance, officials imposed a tax.  When a confiscation of savings was challenged in Italy in the early 1990s, the legality was upheld.  This is to say that the precedent is that a deposit guarantee does not give savers immunity from a capricious tax.

If deposit insurance would be triggered, Cyprus does not have the funds to make good on it.  This is a critical flaw.  The protection offered by deposit insurance is only as strong as the provider of the insurance.  There is no EU-wide deposit insurance. Each country is responsible for their own. 

Can you imagine that responsibility for the deposit insurance in the US would fall to the states instead of the federal government?  It is simply not viable.  Yet within EMU, the creditor nations rightfully fear that a euro area wide deposit insurance would be a backdoor for fiscal transfers as the countries with strong banks would end up subsiding the weak and/or lax banks. 

The euro area banking system remains a patchwork of different rules, customs and expectations.  Part of the problem is that the euro area is over banked.  In the coming years,  consolidation and concentration among retail banking seems necessary, even if conflicts with the other thrust of limiting or reversing the "too big to fail" in the financial sector. 

That said, contrary to fears over the weekend, there has not been a run of depositors from banks in the euro area periphery.   The sovereign bond markets in the periphery had sold off earlier in the week, but have stabilized.  This is true even for Greece, which before today had seen its 10-year bond sell off for seven consecutive sessions, with yields rising about 125 bp over that period. 

It is interesting to note that the central bank of New Zealand reiterated earlier today that depositors need to recognize that deposits are not guaranteed in New Zealand.  This did not spur a market reaction or a reaction among depositors.   New Zealand is considering a new set of policies (Open Bank Resolution) that would allow a quick and orderly resolution of a failed bank.  It allows for insolvent banks to continue some operations, while shareholders, creditors and depositors would bear a proportion of the losses.    We note this not as a defense for Cyprus' initial willingness to tax small depositors, but rather to point out that different institutional arrangements that are possible.  

One sign of anxiety has been the increase in the basis swap, which is the cost of swapping euro for dollars. There are two ways to read it.  The first way is to see it as widespread flight from the euro as the re-denomination risk rears its ugly head.  The increase in the swap rate reflects demand for dollars.  The second way to read it is that the price was marked up to reflect the changed risk profile.   Our best information suggest some strong banks, outside of the euro zone, did lock in dollar funding for 2-6 months and this raised the cost of the cross currency swap for weaker credits.     

There are some who see the Cypriot crisis as a profound blow to the credibility of European officials.   We do not share that conclusion and see some positive outcomes, including making consolidation in retail banking sector more likely.   In the national division of labor, Cyprus found a niche as a tax haven.  This is not particularly helpful for monetary or banking union in Europe.  Cyprus will have to find another nice.  It would like to be a commercial and financial center that would help facilitate trade the natural gas that lies off its coast.  This is still to be seen. 

European officials willingness to force at least some depositors to participate in the burden sharing shows a greater willingness to broaden out the participation in future aid packages.  Recall that in Ireland's case the Troika argued against senior bank bond holders taking a haircut for fear of setting a dangerous precedent.   Of course, this means punishing the innocent along with the guilty, but that has been generally true throughout the policy response to the crisis.

We noted back in mid-January that the risks to Cyprus leaving EMU were greater than the market appreciated.  This was an important assessment from us as we tended not to place high odds of a Greek exit in 2011-2012 even though speculation elevated.   In recent days, we had thought that some compromise would be found.  It still remains elusive at this late date. 

Without a deal that would allow the recapitalization of Cypriot banks, the Troika is insisting that the Bank of Cyprus and Popular Bank are shutdown.   Early rumors that a Russian bank would purchase the latter have been denied.   Reports suggest that the Cyprus central bank is preparing proposals for capital controls, ostensibly so the banks can re-open.   This is also what may be required if Cyprus were to leave the union.  Greece remains the vulnerable to a collapse of Cyprus banks. 

From a larger perspective, European officials may find a silver lining in a potential Cyprus exit, even if that is not their fist choice.   It would likely be seen as a warning shot to other peripheral countries, for example.  However, what they have to be careful of, given the incomplete monetary union is Latvia, which is set to join EMU  on 1 Jan 2104 does not replace Cyprus as a tax haven/hot money center. 

 

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Wed, 03/20/2013 - 18:15 | 3354369 pocatello
pocatello's picture

Wow.

 

Try to include some grammar, punctuation, and spelling next time.

 

I volunteer to help you out.

Wed, 03/20/2013 - 14:07 | 3353121 suteibu
suteibu's picture

I only read Marc for the entertainment value, most of which is supplied by the commenters.  You can get the same analysis from CNBC but, sadly, without the much more valuable and insightful instant feedback.

I particularly like this from Marc...

"...Part of the problem is that the euro area is over banked.  In the coming years,  consolidation and concentration among retail banking seems necessary, even if (it) conflicts with the other thrust of limiting or reversing the "too big to fail" in the financial sector." (I corrected it for you - edit much?)

So, Marc thinks that consolidation is "necessary" even if it means that these mega banks stay "too big to fail."  Could he be a more blatant shill for the assholes that have caused all of our current problems?

Wed, 03/20/2013 - 16:09 | 3353756 Marc To Market
Marc To Market's picture

suteibu, from my perspective it is people like you who do not know what they are talking but pretend they do that is the source of "all our current problems".   Yes, wake up Suteibu, the sun is going to come up tomorrow and tomorrow's tomorrow, and it still won't be a garden of eden.  And there are conflicting policy objectives--maybe not to the navel gazers, but in the real world.  You and I might prefer an airplane, but what exists now--this historical moment and the existing institutional capacity and relationships is a bicycle.  We cannot simply go from one to the other.  Saying we want an airplane is nice.  Saying the bike is crap and we don't want it may be true, but it ain't getting us closer to getting what we want.   My analysis tries to discuss the underlying trends and patterns and where things appear to be headed, with an admiitedly incomplete information set.  I am not interested in saying how bad things are and how unjust.  Of course they are.  Show me a time when things were just and when my lion laid down with your lamb.  Never.  We are not on the cusp of a revolution nor utopia.  Where are we going?  Not where some ignoramous with a computer hidding behind  some fake name's idea of where we should be going.   

Wed, 03/20/2013 - 18:06 | 3354339 suteibu
suteibu's picture

Airplanes and bicycles?  Really?  I'm sure that makes sense to you. 

I left a comment on a recent post thanking you for a fact-based analysis.  Funny that you did not respond to that one with the same fervor that you now respond. 

The example from my previous comment today about what you describe is the necessity of having more too-big-to-fail banks is not a fact, it is your opinion expressed in such a way as to seemingly promote the idea.  You should not expect that notion to go unchallenged here. No one expects the world to be perfect but most here are smart enough not to continue to support the direction it is heading.

That you feel compelled to defend and explain yourself in the comment section shows that you are thin-skinned and that your articles are shallow and poorly written.  That you choose to call those who leave comments that question your opinions and abilities "ignoramus" (you misspelled it BTW) shows a considerable lack of humility towards your readers which is a common element found in your articles in general. 

As for hiding (not "hidding") behind a fake name (how do you know it is fake?), that's the way the site is designed.  In fact, anonymity is a key element of this site (didn't you know that?).  The Tyler's are also "hidding behind  some fake name."  You undoubtedly accepted the invitation to post your drivel here because you felt posting articles on a world class financial site would benefit you in some way.  But you should have understood that posting articles here does not guarantee you a devoted audience and that you and your ideas have to earn respect and credibility which should be evident to you given the mediocre vote ratings your articles usually earn.  It doesn't take an ignoramus to figure that out.

You want people to stop criticizing you?  Stop hacking out the first thing that comes to your mind and give us some depth, stick to the facts, and treat your audience with the same respect you want from them.  Mostly, stop being a know-it-all jackass.  The people here are not your average investors who get their opinions from network news or cable financial channels.  And could you take a few minutes to spell-check and edit before hitting "Publish?"

Wed, 03/20/2013 - 12:19 | 3352486 Svendblaaskaeg
Svendblaaskaeg's picture

"..European officials may find a silver lining in a potential Cyprus exit, even if that is not their fist choice."

Too much fisting of taxpayers going on already - please make it stop

 

Wed, 03/20/2013 - 11:51 | 3352384 gibbs
gibbs's picture

Nothing like the sound of a donkey's bray in the morning......

Wed, 03/20/2013 - 11:38 | 3352319 autonomos
autonomos's picture

One nation, one money. So no €

Wed, 03/20/2013 - 11:51 | 3352381 Ghordius
Ghordius's picture

one nation, one banking system - the currency can be gold or silver or EUR, whatever, the one has nothing to do with the other

fractional banking systems are constructs for the administration of public credit. if you do want to have them, you have to keep an eye on them, like all creatures of the state

Wed, 03/20/2013 - 11:54 | 3352402 autonomos
autonomos's picture

I agree. I meant: There is a reason if the Greek drachma is not as valuable as the German mark. And it's good for both people. But the euro seems bad for the Greeks

Wed, 03/20/2013 - 12:03 | 3352428 Ghordius
Ghordius's picture

autonomos, I have a love/hate relationship towards Greece and the Greeks - and this is not because I had to give so many fakelakis, there, it has more to do with some women stories

but one thing I'm sure of: if Goldman Sachs would not have proposed those derivatives scams to the Greek government, Greece would have had a completely different history in the last years

but the Great Vampire Squid covered our faces until the ship was on the rocks - and they are still laughing

nevertheless, there is nothing good or bad about a currency or Southerners, only a question of preferences for hard or soft money

Greece will rise again, it always had

Wed, 03/20/2013 - 12:13 | 3352472 autonomos
autonomos's picture

Thank for your reply. Would you please tell me where the following argument is flawed or to simplisitic?

- The Germans produce high quality cars.
- Foreigners want to buy
- They need Deutche Marks
- The value of the mark raises

- The Greeks do not export much
- The value of the drachma decreases
- Germans can go to a cheap holiday in Greece... 

But with a single currency this virtuous process does not work... 

Wed, 03/20/2013 - 12:29 | 3352546 Ghordius
Ghordius's picture

autonomos, if this simple view would be true there would be no international trade between many countries

this paradoxon was btw solved mathematically by David Ricardo, one of the last true economists we ever had on the globe

the current Greek problems have only something to do with the Greek ship of state that had it's bridge instruments sabotaged by the vampire squid

remember that gold was the first real common currency of the world (ok, in Attica it was silver, but this was later)

and don't forget that Solon was asked to make his constitution because Athens had a huge debt problem - in an age where debtors were sold as slaves to foreign countries - what were his solutions?

Wed, 03/20/2013 - 12:16 | 3352474 IamtheREALmario
IamtheREALmario's picture

Right, the financial monopolies KILL all free markets... for the benefit of those who create the fiat from thin air and give it to themselves preferentially.

Wed, 03/20/2013 - 11:32 | 3352302 Charles Wilson
Charles Wilson's picture

"If deposit insurance would be triggered, Cyprus does not have the funds to make good on it.  This is a critical flaw."

 

"Clevinger was dead. That was the basic flaw in his philosophy."

-Catch 22

 

CW

Wed, 03/20/2013 - 11:16 | 3352246 Nels
Nels's picture

Can you imagine that responsibility for the deposit insurance in the US would fall to the states instead of the federal government?  It is simply not viable.

And you think it is viable at the federal level?  FDIC, like the insurance fund of Cyprus, does not have sufficient money to backstop any TBTF bank.  With fictional/fractional reserve and no limits on derivatives, FDIC premiums are priced way too low.  With the current policy of giving a pass to crime at the big banks, the moral hazard is at extreme levels.

If this was done at the state level, there'd be some chance that at least one of the 50 states did things honestly.

Wed, 03/20/2013 - 11:48 | 3352368 Ghordius
Ghordius's picture

+1, fully agree. as we are seeing, the megabanks are being bailed out without even blinking, and they are meanwhile transnational and beyond any government's supervision

if you want to have any kind of retail customer protection, keeping it smart, small and conservative is the only way - separate the banks between the local/protected and the buccaneer/unprotected - done it once in the 20th century, just dust off that law

and a banking union in europe makes no sense - and it has nothing to do with the currency union - it also didn't when gold was the thing

Wed, 03/20/2013 - 11:09 | 3352214 Marc To Market
Marc To Market's picture

very good bank brussels guy.  I provide analysis and you simply say no it is wrong and appear to some unnamed "former EU boosters" .  Aren't you brilliant ? Please, is that all you got?  Did you not eat your breakfast?  Isn't it a simply logical fallacy to claim I am wrong because some people disagree with me ?  Is there any proof that EU credibility has eroded and will never be the same?  I am surprised by how conventional these comments on ZH once one strips aaway  the personal attacks and bile.   

Wed, 03/20/2013 - 12:14 | 3352450 defencev
defencev's picture

Your analysis is right on the money. Do not be surprised by the comments over here: that type of mentality is cultivated on this vicious blog. Let me mention another thing. In case of fiscal union the transfer of federal funds to cover local lossess would have been expected. However, nobody would allow to local banks operate on the "Cypriot principles" which was:

less scrutinity, lower fees, higher yeilds (and implicit expectation of EU bailout if necessary). The first principle led to de facto take over of Cyprus banking system by Russian mafia, the other two led to funding through "assets" like Greek bonds (though here the

"sovereign" pressure from government structures should not be discounted) which in turn led to huge losses. Therefore ,by no means Cypriot establishment are victims here. The circus which we saw during several days is, of course, understandable but is just that: a pathetic circus. As you correctly indicated, "the crisis" should have been resolved by now but do not underestimate the role of Russian mafia: they will fight tooth and nail for their funds ( I hope everybody understand what I mean by Russian mafia: think Gazprom and beyond).

Wed, 03/20/2013 - 11:56 | 3352383 JOYFUL
JOYFUL's picture

Personal attacks and bile?

Hey man, wake up, Brussels didn't even tousle your toupee! You're a freakin comedy act, and that's just the unintentional part!

Cyprus will have to find another nice.  It would like to be a commercial and financial center that would help facilitate trade the natural gas that lies off its coast.  This is still to be seen. 

or...

From a larger perspective, European officials may find a silver lining in a potential Cyprus exit, even if that is not their fist choice.

So you prefer unconventional critiques, to go with your ah, unconventional contributions to the dialogue>???

It would be 'nice' if you were to take the 'fist' outta your ass first, before you start typing...and then pry the foot outta your mouth, long enough to do some reflection pon the swill you serve out to the punters here. Your 'put more State on the plate' stuff is consistently 'no star' fare.

This ain't no greasy spoon Marc! You can't take the heat...stay outta the kitchen!

Wed, 03/20/2013 - 14:44 | 3353219 Marc To Market
Marc To Market's picture

joyful jerk off, i can take the heat, but this childish scatological insults against me, how I support myself, or the god my grandparents pray to is hardly heat.    I am just trying to help you focus on the real issues. You even hide behind the anonimity the internet and ZH offer you.  You my spineless critic are the one who cannot take the heat.  Oh yes, if you do the CIA might get you.    I do not write for you to agree with me and frankly if a jerk like you would agree with me, you would force me to re-think my analysis.  I offer nuanced analysis and in your comments you like to defacate on everything and every one.  How far has that gotten you, you witless wonder ?  Is the world better off?  Are you?  

Wed, 03/20/2013 - 12:12 | 3352465 Ghordius
Ghordius's picture

lol - if you can't take the heat... good one

may I ask why is this thing going around that an european banking union would be "a good thing"? it ties with this constant request of "europe has to be a bit more like the US, you know, otherwise my head hurts"

Marc, you have to admit, if you read ZH comments, that the "EU=US" oversimplification has been swallowed whole by millions, thanks to CNBS idiots et al

Wed, 03/20/2013 - 14:47 | 3353260 Marc To Market
Marc To Market's picture

Ghordius I have no clue what you are talking about.  Do you?  No where do I say that the EU must be like the US.  I say the a nation level deposit insurance does not seem to any more viable than a state level deposit insurance would be.   Do you know what an analogy is ?  You are doing a good job convincing me not to read ZH comments.   As you can see many more people read the posts than comment on them--because the personal attacks and confusion of assertions with arguments makes most readers not comment.  This kind of behavior does an injustice to ZH and discussion of the issues.  So frankly I do not think these ZH comments reflect anything but the tiired adolescent anti-authority aggressive largely white male views from guys who hide behind fake identities and  have nothing better to do with their time but criticize others.

Thu, 03/21/2013 - 04:18 | 3356033 Ghordius
Ghordius's picture

Marc, as discussed above, if you are not able to shrug away personal attacks than indeed you should not prowl in the comment section, then criticism of the kind you write about is feral, here

allow me to explain: we have in Europe a lot of people that would like to have a giant federal superstate like the US

we have also a lot of people that would like to go back to no eurozone and no EU

and then we have people like me that prefer flexible solutions - like the current status quo, confederative structures suited for sovereign nations

in this, I see no value in a deposit insurance that goes beyond the national level, and maintain that a greater solution would be just another Too Big Too Fail setup - and we already have too many of those. I maintain that every system has to have a clear critical failure path built in

----

my comment about the EU not being the US was a kind of "meta-comment" that goes back to discussions here that stretched over a year

Wed, 03/20/2013 - 10:35 | 3352101 bank guy in Brussels
bank guy in Brussels's picture

Marc Chandler writes in his above article, astonishingly:

« ... some who see the Cypriot crisis as a profound blow to the credibility of European officials.   We do not share that conclusion and see some positive outcomes ... »

Ha!

Absurd

Even many of the former EU boosters see this as the point of no return

EU credibility will NEVER be the same ... NEVER

 

Wed, 03/20/2013 - 11:56 | 3352406 Ghordius
Ghordius's picture

"EU credibility will NEVER be the same ... NEVER"    and this is a good thing

an informed and critical citizenship is of fundamental importance for any free*, democratic* and liberal* nation and even more for alliances and confederations of nations of this kind

"sheeples"? no, thanks

(*) not using those terms in the way they are used in some parts

Wed, 03/20/2013 - 11:41 | 3352332 disabledvet
disabledvet's picture

What needs to be explained...in my view...is that "in Germany there are many political jurisdictions. They just don't call it Germany." and of course this has true for THOUSANDS of years. The Greeks blamed Germany "for giving them 500 billion" instead of the "5 they promised." I'd there is a crime being committed I'm having a hard time "blaming Germany." as an American I can say with meaning "the Germans fight...and win." it's just that in the USA these folks "have created huge bonding authorities" and so while Europe and certain Americans seem to be maintaining a "love/hate" relationship vis a vis "the third Reich" in the USA...outside of fighting and winning that war (no sure thing btw) there is nothing but love for the Germans over here. "Palatine Bridge" is the name of a town nearby. To get your name on a town you have to earn it here..."and they did it by coming over here and making it happen." (there obviously is a fascinating fondness for Belgium in these here parts as well. The closest I got was Strousburg (sp?)...it was beautiful of course. "and Chimay Beer." seriously though "this is serious business"...about more than money of course...how ironic that "savings is the issue." do I have to explain "it could be worse"? Obviously not to anyone from Europe. That's why what Cyprus is "trying" STRIKES me as patently absurd. But yes...as much as I...ahem..."love to be categorized"...I have no problem being proven wrong either. How interesting..."Phuck arguing let's categorize."

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