Financial topics

[Higgenbotham]

Around the end of the twelfth and beginning of the thirteenth centuries, Florence was the site of an incipient banking industry which gained great importance in the fourteenth century. The following families owned many of the most important banks: The Acciaiuolis, the Bonaccorsis, the Cocchis, the Antellesis, the Corsinis, the Uzzanos, the Perendolis, the Peruzzis, and the Bardis. Evidence shows that from the beginning of the fourteenth century bankers gradually began to make fraudulent use of a portion of the money on demand deposit, creating out of nowhere a significant amount of expansionary credit.53 Therefore, it is not surprising that an increase in the money supply (in the form of credit expansion) caused an artificial economic boom followed by a profound, inevitable recession. This recession was triggered not only by Neapolitan princes’ massive withdrawal of funds, but also by England’s inability to repay its loans and the drastic fall in the price of Florentine government bonds.

In Florence, public debt had been financed by speculative new loans created out of nowhere by Florentine banks. A general crisis of confidence occurred, causing all of the above banks to fail between 1341 and 1346. As could be expected, these bank failures were detrimental to all deposit-holders, who, after a prolonged period, received half, a third, or even a fifth of their deposits at most.54

MONEY, BANK CREDIT, AND ECONOMIC CYCLES (page 71)

JESÚS HUERTA DE SOTO
TRANSLATED BY MELINDA A. STROUP
SECOND EDITION

Ludwig von Mises Institute
AUBURN, ALABAMA

http://mises.org/books/desoto.pdf

The deal will wind down the largely state-owned Popular Bank of Cyprus, also known as Laiki, and shift deposits below 100,000 euros to the Bank of Cyprus to create a 'good bank'.

Deposits above 100,000 euros in both banks, which are not guaranteed under EU law, will be frozen and used to resolve Laiki's debts and recapitalise Bank of Cyprus through a deposit/equity conversion.

Cyprus government spokesman Christos Stylianides said: 'We averted a disorderly bankruptcy which would have led to an exit of Cyprus from the euro zone with unforeseeable consequences.'

Asked about the level of losses on uninsured depositors in Bank of Cyprus, he told state radio: 'The assessment is that it will be under or around 30 per cent.'

However, some reports suggest that figure could be as a high as 60 per cent.

The raid on uninsured Laiki depositors is expected to raise 4.2 billion euros, Eurogroup chairman Jeroen Dijssebloem said.

Laiki will effectively be shuttered, with thousands of job losses. Officials said senior bondholders in Laiki would be wiped out and those in Bank of Cyprus would have to make a contribution.

http://www.dailymail.co.uk/news/article ... vings.html

Anna Schwartz

I think she basically said that it is not a liquidity crisis it is a solvency crisis. Pettis is saying the same thing. He also points out that at the start of every solvency crisis they claim it is a liquidity crisis.

When do we call it a solvency crisis?
http://www.mpettis.com/2013/03/21/when- ... cy-crisis/

The bureaucrats, politicians, and media are calling it all kinds of things except for what it is - a solvency crisis.

[Reality Check]

(related to ) Anna Schwartz (quoted from Higgenbotham)

I think she basically said that it is not a liquidity crisis it is a solvency crisis. Pettis is saying the same thing. He also points out that at the start of every solvency crisis they claim it is a liquidity crisis.

When do we call it a solvency crisis?
http://www.mpettis.com/2013/03/21/when- ... cy-crisis/

The bureaucrats, politicians, and media are calling it all kinds of things except for what it is - a solvency crisis.

All fractional reserve banks are technically both insolvent and bankrupt at all times, based on the rules applied to any other type of business.

Only special rules created by governments, accounting firms and banking practices, subject to change at anytime, re-define the terms to mean a bank is not insolvent if it only owes ten times ( or five time, or twenty times ) more than it's assets.

If one controls the government and banking elites of Cyprus, these rules can be changed at will to make any bank solvent, or insolvent, at your command.

In the event it becomes widely perceived by the monied class that the Euro-Zone's political and banking elite are coercing corrupt governmental powers in Cyprus to make the playing field uneven in Cyprus for their own interest, then banking runs in other parts of Europe are almost certain.

[Reality Check]

The ongoing part of what is happening in Cyprus, is the ongoing capital controls, that are being created from then air as the Cyprus banking crisis continues.

These controls are absolutely required so that most banks in Cyprus can appear to re-open, but the free flow of money between banks, between banks and bank customers, and between Cyprus and other countries are still totally restricted and controlled by the government of Cyprus.

Such control must be maintained so that the selective confiscation of deposits can occur over a period of months.

These capital rules are going to be very different than for the rest of the Euro-Zone, when most banks in Cyprus re-open, so they we be apparent to all who attempt to do business with anyone, or any business in Cyprus.

The Euro-Zone wide banking crisis related to Cyprus is not over.

[Higgenbotham]

All fractional reserve banks are technically both insolvent and bankrupt at all times, based on the rules applied to any other type of business.

All fractional reserve banks are illiquid, but being illiquid doesn't make them insolvent. Being insolvent means the assets of the bank don't exceed the value of the liabilities, so if the bank were to be liquidated it would be worth less than zero. The Laiki bank referred to above in the article is being described as insolvent but so far as I know none of the bureacrats, politicans, or media have said it.

[Reality Check]

All fractional reserve banks are technically both insolvent and bankrupt at all times, based on the rules applied to any other type of business.

All fractional reserve banks are illiquid, but being illiquid doesn't make them insolvent.

My point exactly.

The relationship between insolvency and liquidity is different for fractional reserve banks, than for any other types of business.

Those special rules, the rules unique to fractional reserve banks, are created by people. People in governments, people in accounting firms, people in banking associations.

When those rules can be changed at will, or the enforcement ( or non-enforcement ) of already existing rules, can be changed at will, as in the seizure of assets from bond holders, stock holders and depositors, then banks that were not insolvent suddenly are, by the act of government seizure.

Calling a bank insolvent based on some arbitrary set of rules is one thing. Changing those rules at will, and making them different for different parts of Europe, is another, and seizing the assets of third parties based on the sudden decision to enforce rules against one bank, but not enforcing them against another is yet a third.

If you believe the definition of insolvency for fractional reserve banks are the same as for businesses that are not fractional reserve banks, then we disagree.

Otherwise I believe we are in agreement.

[Higgenbotham]

Morgan and his associates examined the books of the Knickerbocker Trust, but they decided it was insolvent and did not intervene to stop the run. Its failure, however, triggered runs on even healthy trusts, prompting Morgan to take charge of the rescue operation. On the afternoon of Tuesday, October 22, the president of the Trust Company of America asked Morgan for assistance. That evening Morgan conferred with George F. Baker, the president of First National Bank, James Stillman of the National City Bank of New York (the ancestor of Citibank), and the United States Secretary of the Treasury, George B. Cortelyou. Cortelyou said that he was ready to deposit government money in the banks to help shore up their deposits. After an overnight audit of the Trust Company of America showed the institution to be sound, on Wednesday afternoon Morgan declared, "This is the place to stop the trouble, then".[34]

As a run began on the Trust Company of America, Morgan worked with Stillman and Baker to liquidate the company's assets to allow the bank to pay depositors. The bank survived to the close of business, but Morgan knew that additional money would be needed to keep it solvent through the following day.

http://en.wikipedia.org/wiki/Panic_of_1907

In the histories of the Panic of 1907 I remember there being a lot of dicusssion about the question of insolvency versus illiquidity. I notice here that Morgan had determined Knickerbocker to be "insolvent" and Trust company of America to be "sound". However, even though Trust Company of America was determined to be "sound", there is also discussion about additional liquidity being provided during the run to "keep it solvent".

[Reality Check]

The mention of a Trust company puts this in focus.

The Banking system and the Monetary system are both totally dependent on "Trust" and "Full Faith".

The rules related to insolvency are arbitrary, and subject to change, as they relate to Banks.

The enforcement of those rules are arbitrary as they related to Banks.

When the people who make those rules, change those rules, and enforce those rules are no longer trusted by the monied class then people will no longer have Faith that their money is safe in Banks.

Distrust of Banks creates Bank Runs. Distrust of the government regulators of Banks creates distrust of all Banks.

[Higgenbotham]

When those rules can be changed at will, or the enforcement ( or non-enforcement ) of already existing rules, can be changed at will, as in the seizure of assets from bond holders, stock holders and depositors, then banks that were not insolvent suddenly are, by the act of government seizure.

Calling a bank insolvent based on some arbitrary set of rules is one thing. Changing those rules at will, and making them different for different parts of Europe, is another, and seizing the assets of third parties based on the sudden decision to enforce rules against one bank, but not enforcing them against another is yet a third.

Yes, I agree. The definition of solvency should not be arbitrary, but it is what it is. Looking at the big US banks, they would probably all be considered insolvent if the assets were marked to the actual value they would bring during a process of liquidation. Since the arbitrary rules allow these assets to be marked to something other than actual value, the banks are technically solvent at this time and place, based on rules that don't apply when valuing the assets of businesses besides banks.

[Higgenbotham]

Another aspect of this question of solvency is the banks have gotten so large worldwide as a percentage of the real economy that the concept of liquidating a bank and selling its assets off into the private economy is only theoretical. There's too much there to sell compared to what the rest of the economy would be able to absorb, and feeding bailout money into the banks makes that disparity worse. Now that the banking system is back up on its feet, sort of, the ability to liquidate any bank into the hands of investors outside the banking system is less than it was before. In practice we see the insolvent bank in Cyprus being folded into another bank which is insolvent, from the standpoint if that bank were to be liquidated there in all likelihood would be nobody in the private economy able to step up and buy the assets at a high enough price to clear the liabilities.

[Reality Check]

The definition of solvency should not be arbitrary, but it is what it is.

Here we may have two disagreements.

Many, perhaps most, laws and regulations, are arbitrary. Not sure I believe they all should not be so. Justice requires everyone be held to the same rules, some rules by their nature are arbitrary, that does not by itself make them unjust or morally wrong.

But I am sure the statement of "but it is what it is" is not correct. The rules we are talking about are arbitrary, unique to the fractional reserve banking system, subject to change, and frequently changed. All those things make such a rule the exact opposite of: "it is what it is".

The biggest problem is the that a rule is changed at will, to achieve an objective the rule was not created to achieve, and a rule is enforced, or not enforced, at will, and again for the purpose of achieving a goal that the rule was not created to achieve.

You mention the ever changing mark-to-market rules, and that is a good example of both changing the rules and also not enforcing the rules on a selective basis, for a purpose not related to the rule.

The Cyprus crisis has the risk of exposing just how willing the European political elites and Banking elites are to take peoples deposits ( and the equity of the stock holders of banks and the equity of bond holders of banks ) by changing the rules ( after the investments were made ), or changing the enforcement of the rules, to achieve some purpose totally unrelated to rules.

The capital controls being put in place will probably draw attention to this, the liquidation of select banks and seizure of targeted assets will also bring attention to this over the next few weeks and months.

But the concept of the Euro-Zone banking system tolerating, let alone coercing, a local government's putting in place capital controls intended to hold money and other investments captive from leaving the country, while rules are changed to allow targeted seizure of those deposits and other investment assets, is, in my opinion, the most likely perceived risk to spark runs on banks in Europe.