Thursday, April 04, 2013

Creative Thinking 101

How do you stop the notorious 'run' on a bank, when depositors decide they need their money back all-at-once,  that leads to its collapse? That poser has puzzled great minds since the first time it happened. Conventional wisdom has dictated that the bank (or stock market) stays closed in hopes that the crowd waiting at the door gives up and goes home for lunch.

The latest 'euro-crisis' in Cyprus has opened a new and highly creative door, revealing an old, but little-used solution - simply steal the deposits. Not all mind you, just the ones that belong to the fabulously wealthy. Naturally everybody who doesn't have deposits thinks this is a 'mah-vellous' idea. The bank simply 'confiscates' the deposits over a certain amount, in a quantity sufficient to guarantee the liquidity of the joint. This can't bode well for banks, or at least banks as they exist now.

The notion of a bank in the first place was primarily as a 'safe place' to store the family boodle, away from access by the ravening hordes who would have attacked the family castle or kidnapped family members for torture, to lay hand on it. It seemed a sensible idea to entrust it to a friendly hebrew - exempt from usury laws - who had cooked-up the notion of holding somebody else's money to facilitate business dealings. It wasn't long before the notion of using money to make money in 'legalized, virtually risk-free gambling' took root. Whatever it was, it surely beat the idea of burying it in a can in the backyard.

It didn't take long before governments developed the view that it was a public 'good' that citizens 'save' money in banks. It freed-up a large domestic source of cheap (relatively) currency for  annual bond sales. The notion of lending to governments wasn't wasted on banks who soon realized, with some accommodating legislation, that loaning to citizens was even more lucrative. And so the situation to-day, where banks can apparently loan, or 'invest',  their deposits to develop 'holdings'.  So much so that they can actually run out of ready cash should too many depositors make withdrawals.

In times past other cash-rich 'investors' might come to the rescue of a beleaguered bank - preventing a collapse of it's 'holdings' and getting themselves a piece of its 'action'. In other times, there was no rescue the bank collapsed and the wolves 'devoured' the holdings at less than cost. In the latter case, depositors generally lost most or all of their money.

To-day governments guarantee deposits to some extent and banks are required to have some deposits 'reserved' to cover a partial run. In actuality this 'reserve risk'  can be farmed-out to other banks, or economic entities by way of  'insurance' . It sort of goes sour when the insurers themselves become 'cash-strapped', too - as happened in the latest mass meltdown. Then only governments can help by 'guaranteeing' a print of more money. That 'cash infusion' to banks and commercial houses may have prevented a catastrophe in 2009, but the same thing caused world-wide inflation in the nineteen twenties - and a worldwide depression in the thirties. Timescale-wise the panic of 2009 has another 6 years to run.

Any deposits in excess than the insured maximum are at the mercy of the stability and security, or lack thereof, of the banking establishment. Most banks nowadays discourage large accounts by paying less interest on them and/or by levying service fees. They encourage 'speculative saving' on investments - their mutual funds- where risks of loss devolve back onto the investor, or in this case the depositing customer. (I think they use these depositor funds to 'hedge' against their own corporate 'holdings' which are designed to make a profit for the entity and its investors - which might explain in part why bank profits seem immune to the vagaries of the investment market.)  Banks are the best of 'blue chip' stocks.

Banks have always been able to 'borrow' deposits, at interest, to lend at greater interest. This, with the concomitant fees charged at both ends, is how they 'make their money' (investment 'holdings' aside). The new wrinkle is that, in addition to the old 'pyramid' thing about using new deposits to pay-off old deposits, banks will now be able, not only to use, but to 'disappear' significant amounts of deposit obligation. This couldn't be good for  'high-roller' business.

'Wise' people with lots of money have been, historically, loath about advertising their wealth, or wanting 'the public' to know how much they have, or where it's located. To this end many people take it off-shore - testing the good name of some foreign entity to keep their funds secure from outside viz government or lawsuit, interference. Switzerland, until fairly recently, made a national industry of bank secrecy. The Caribbean and private European banks seem to have grabbed a bigger market share. The Arabs and orientals have done their own (largely closed, in-house) thing for a long time.

The Cypriot 'template' is now being bruited as the 'saving grace' of banking but, so far, there is no indication it can, or will, work, even for the immediate purpose. It does, however, virtually guarantee that Cypriot banks won't have the same problem with large depositors in future.

 'Smart' people, like  Russian oligarchs, don't  stick around to get burned when somebody starts playing with matches.

No comments: