More than five years after the global banking crisis first erupted in the summer of 2007, the global banking system continues to drift toward yet another crisis. The collapse of the banking system in Cyprus last week represents the latest milestone in that inexorable drift, as well as an important qualitative shift in the overall evolution of the crisis.
The creaky scaffolding of the global for-profit banking system has been buttressed for nearly six years now by massive (tens of trillions of dollars and foreign currency equivalents) government central bank liquidity injections in the form of virtually free interest loans to banks, plus trillions more of direct purchases by central banks of collapsed mortgage bonds and other securities from institutional and individual investors in quantitative easing ( QE).
The U.S. Federal Reserve alone has provided, at minimum, between $10-$20 trillion in near zero interest loans to banks and shadow banks, while additionally purchasing from investors more than $3 trillion of securities by means of QE, which continues at a rate of $85 billion every month with no end in sight. To date, no one really knows what price the Fed has paid for the $3 trillion in QE-financed purchases of mortgage bonds and other securities, but it is highly likely that the price paid to investors for their bad assets has been well above the true market value of those securities. The Fed, in effect, has provided a further massive subsidy to investors in addition to the zero interest free money. The public will never know, however, since the Fed doesn’t report such details—not even to members of Congress.
The consequence of this historic flood of free money and cash subsidies to banks and wealthy investors has not been to stimulate the real economy of goods and services. Rather, its main impact has been to accelerate speculation and securities prices (and thus profits) in equity (stock), junk bonds, U.S. farm real estate, foreign currency exchange, and some unknown volume of derivatives trading (unknown since the latter is not recorded on public exchanges).
Investors and banks have become addicted to—i.e. dependent on—the Fed’s free money machine over the past five years. Cycles of Dow Jones and S&P stock surges since 2010 have been tightly correlated with Fed QE injections. On three separate occasions in the past—in 2010, 2011, and 2012—the mere hint of Fed discontinuation of the zero interest or QE injections quickly resulted in sharp pullbacks in stock and other financial markets, resulting in an even more rapid return by the Fed to still further free money and QE purchases.
Even the recent modest 8 percent surge in home prices in the U.S. in the past year is traceable in significant part to speculators, hedge funds, and other shadow investors, both U.S. and foreign, purchasing large blocks of foreclosed U.S. housing units, undoubtedly financed by the continuing flow of free Fed money and QE. Here’s how it’s happening. The Fed loans the money at no cost to the banks who lend it, in turn, to hedge funds and private equity companies, who then buy large blocks of the vacant housing units previously held by the very same banks. Alternatively, the Fed buys the hedge funds—and other institutional investors’ bad assets—with printed cash (QE), who subsequently buy up large blocks of foreclosed properties from the banks. The new owners of the properties, the professional investors, wait until home prices rise 20 percent (i.e., half of the price decline since 2007). In the meantime, renting out the foreclosed homes at rising prices—then flip (sell) the homes for a massive capital gain. Banks get paid a handsome interest (5 percent-10 percent) and get to remove the bad assets from their balance sheets in the interim. They eventually repay the interest free money to the Fed. Banks gain. Investors and speculators gain. But 14 million homeowners are foreclosed (the total to date) and the U.S. economy gets no real stimulus from the money injection that benefits only the super-wealthy and their financial institutions. They then call that a housing recovery.
Additionally, QE and zero rates have had a decidedly negative impact on the U.S. economy and recovery. Zero rates after five years have resulted in a decline in disposable income for tens of millions of households, as zero interest on CDs and other household bank savings accounts since 2008 has meant a collapse of savings income. Five years of Fed zero interest rates is also precipitaring a growing crisis in pension funds and the imminent collapse of many of the remaining defined benefit pensions as a direct result of near zero rates on their remaining investments. Fed zero rates and QE has furthermore resulted in a diversion from real investment and job creation in the U.S. into speculative purchases of stocks, junk bonds, farm real estate, and other securities that produce no jobs and no reccovery.
Finally, not least, the massive Fed injection of free money into banks, shadow banks, and investors has precipitated a global currency war over the past year. Zero rates and free money plus QE has led to a decline in the U.S. dollar, provoking similar competitive devaluations of other currencies by means of similar central bank policies elsewhere in the UK, Eurizone, and Japan. That currency war and competitive devaluations has begun to translate into a slowdown of world manufacturing and exports that is becoming increasingly clear by the month in China, Europe, and is now beginning to impact U.S. manufacturing and exports as well. Fed QE and zero rates may have boosted bank profits, bonuses of their CEOs and senior managers, and made wealthy investors even richer but it has done little to nothing for the U.S. economy and continues to serve as a drag on the income of the bottom 90 percent households in the U.S.
In the past three years, other major economies central banks have begun to echo the Federal Reserve. Interest rates for banks have been driven to near zero levels by the Bank of England and European Central Bank (ECB) and increasingly aggressive quantitative easing policies have been introduced in successive stages by the Bank of England and ECB to supplement the near zero interest loans. The Bank of England is about to introduce yet another QE round while pressure grows for the ECB to do the same. Similarly, the Bank of Japan has also announced intent to adopt a QE approach as well, within weeks.
Central banks globally have been moving toward converging and coordinating their free money policies (QE + zero rates) in a desperate effort to keep the global, for-profit private banking system from descending into yet another general crisis.
In other words, the private banking system worldwide has been kept, for more than five years now, on a global financial life support system by means of the tens of trillions of dollars of money injections by the Fed and other central banks since 2008. However, the patient appears now to require ever more magnitudes of money to keep it from financially flatlining. The continual infusion of free money and subsidized purchases by the Fed and other central banks have not resulted in the patient recovering. It has only succeeded, temporarily, in preventing the patient’s total demise. And that’s where Cyprus comes in.
The Significance of Cyprus
The significance of Cyprus is that the IMF and the European Commission together decided that a bailing out of Cyprus two main banks, the Laiki and larger Bank of Cyprus, would require a $10 billion Euro loan to Cyprus. In exchange, the Laiki Bank would be dissolved completely and all its depositors would lose all their deposited funds—i.e. an old fashioned bank collapse a la the 1930s. For the larger Cyprus bank, initially the IMF and the Commission decided small retail depositors—those with less than 100,000 Euros ($130,000)—would be taxed (i.e. expropriated) at the 6.75 percent rate and larger depositors would be expropriated at 10 percent.
The 6.75 percent rate was a direct violation of European Union legal guarantees that deposits up to $130,000 would be insured. So much for legal protections in a banking crisis. Popular protests exploded immediately across the island nation. After the initial deal collapsed, the Dutch Commission spokesperson, Joeren Dijsselbloem, the following day publicly stated that the Cyprus bank bailout deal would serve as a template for future bank bailouts—presumably in Euro periphery regions like Spain, Portugal, and perhaps Italy. That’s when it hit the fan, as they say. Apparently, secret understandings by northern Europe bankers and central bankers included making retail depositors—average citizens with small deposits—pay in significant part for the anticipated bank bailouts should the Eurozone banking system continue to deteriorate.
The new phase involved not only partial deposit expropriations, but subsequent capital controls and limits on bank withdrawals of the rest of the remaining deposits as well. Withdrawal limits in the Cyprus deal were extremely strict. In effect, your remaining money in the bank was still yours, but you just couldn’t get it out, except in a dribble. Furthermore, if you did get it out, you couldn’t take it out of the country. All this meant the de facto creation of a two-tier Euro system with Cyprus Euros worth less than Euros elsewhere—i.e. a de facto decline in the value of the remaining deposits and thus further losses to depositors.
A second deal was eventually made. Depositors with $130,000 or less were now exempt from the 6.75 percent and those with more than $130,000 would pay more. How much more varied according to different estimates, but some estimates are as high as 65 percent in confiscated deposits. However much more is of little matter, for deposits now will be drained almost totally from the Cyprus banking system and the banking system that remains will collapse further. Money will not remain in the Cyprus banks and money cannot leave Cyprus. It will be hoarded by depositors and businesses alike. The recession in Cyprus in the real economy will descend into a massive depression.
The greater danger of Cyprus to the Euro and global banking system is a further loss of confidence in the banking system. The contagion will inevitably spread. Depositors in Italy, Greece, Spain, Portugal, and even northern Europe will no longer trust leaving their deposits in banks. They will no longer trust the insured deposits system. At the first indication of a possible major problem in a private bank—perhaps Unicredit in Italy, Santander in Spain, or some Belgium or even French bank—depositors will assume that a secret deal has been made. Deposits, lending, and money velocity will decline first in the periphery Euro economies. Perhaps a three-tier Euro currency system will emerge, with Cyprus and Greece Euros trading in the black market at a fraction of northern Europe Euros and with Spain-Portugal Euros somewhere in between.
Not just deposit security, but capital controls put in place in the final Cyprus deal will also mean greater distrust that savings might not be moveable from one Euro economy and bank to another. This will mean wealthy depositors and savers in the southern tier of the Eurozone may have a short term incentive to move their money now to northern Europe (Germany in particular) in anticipation of future capital controls.
Cyprus represents a new desperation on the part of central bankers and capitalist policymakers in Europe. The Cyprus debt deal has backfired, resulting in less banking stability and more real economic depression, job loss, and income decline. Cyprus banks and its government will soon require even more loans. Contagion is a psychological process and how and what people think (especially fear) is not easily checked by controls on cross-border flows. Contagion cannot be contained, only perhaps slowed somewhat.
A Euro-U.S. Contagion?
Which leads to the next obvious question: What about contagion crossing the Atlantic to the U.S.? As Ellen Brown and others have recently pointed out, it appears that U.S. and UK officials have been considering the same direct focus on potentially taxing/expropriating depositors in the U.S. and UK in the event of a future further banking crisis emerging (see Ellen Brown, “It Could Happen Here: The Confiscation Scheme Planned for U.S. and UK Depositors,” March 27, 2013).
As noted by Brown, a joint paper by the U.S. Federal Deposit Insurance Corporation and the Bank of England dated last December 10, 2012, revealed plans to confiscate deposits. As the paper noted, once money is deposited in a bank, it becomes legally the property of that bank, not the original depositor. Under the FDIC-Bank of England plan, in the event of the next banking crisis, depositors’ money can be converted into bank stock (which, of course, would be worthless in the event of a collapse of the bank in question).
In their desperation after five years amid growing evidence that both zero interest rates and QE have not solved the banking stability problem—and, in fact, may be making it worse—central bankers from the U.S. Fed to Europe to Japan have begun playing with fire.
What Cyprus, statements by European Commissioners, and secret documents by the FDIC and Bank of England all show is that deposit guarantees may not be worth the legal paper they are written on. A kind of financial Rubicon has now been crossed in the case of Cyprus. And it is only a matter of time before a new crisis in confidence in the private for-profit banking system emerges.
Jack Rasmus is author of the 2012 book, Obama’s Economy: Recovery for the Few, and Epic Recession: Prelude to Global Depression. He hosts the radio show “Alternative Visions” on the progressive radio network and blogs at jackrasmus.com. His website is: www.kyklosproductions.com and his twitter handle is #drjackrasmus.