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Wednesday, March 20, 2013 3:24 AM

Fraudulent Guarantees; Fictional Reserve Lending; Comparison of US to Cyprus; What About New Zealand?

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Reader "MB" who lives in New Zealand is concerned about confiscation of deposits. He writes ...

Hi Mish

Apparently articles are appearing in a NZ newspaper editorials saying that the NZ government has the same policy of confiscation as that being used on Cyprus by the EU. In the event of a banking crisis, the government will be able to take deposit funds to bail out a bank.


A letter to the Reserve Bank of New Zealand states Reserve Bank policy looks like theft.
As a super-annuitant who depends on interest from term deposits to top up my pension, I'm horrified to learn that the Reserve Bank will put in place a process by which ordinary bank depositors will, without notification and without their consent, have their savings used to bail out a bank in financial distress.

If a banking crisis arises, banks will be able to freeze bank accounts overnight and reopen them the next day, but the account will have been "shaved".

Those of us who suffered loss of retirement savings in the finance institutions' crashes in 2008 thought we'd be safe keeping the remainder in our banks, especially the Kiwi-owned bank.

What a shock to learn that our money isn't safe after all.

This is a terrifying prospect for those of us who have no way to replace any losses because our days of being able to earn are long behind us.

Open Bank Resolution (OBR) Policy

To understand what Jill and others are concerned about, let's go straight to the source, the Reserve Bank of New Zealand's Open Bank Resolution (OBR) Policy
Why should depositors bail-out banks?

The OBR policy is designed to ensure that first losses are borne by the bank’s existing shareholders. In addition, a portion of depositors’ and other unsecured creditors’ funds will be frozen to bear any remaining losses. To the extent that these funds are not required to cover losses as more detailed assessment of the position of the bank is completed, these funds will be released to depositors. At a high level, this outcome replicates the outcome that would apply in the event that a failed bank was liquidated. The primary advantage of the OBR scheme, however, is that depositors would have access to a large proportion of their balances throughout the process. This contrasts with what would happen under a normal liquidation, where depositors might not have access to any of their funds for a significant period.

Why aren’t deposits guaranteed?

During the recent global financial crisis the government took the decision to put in place a temporary guarantee on retail deposits. On 11 March 2011 the Minister of Finance announced that further guarantees would not be provided following the expiry of the existing scheme. Furthermore, the Minister ruled out the possibility of introducing a compulsory deposit insurance scheme. In coming to this conclusion the Minister noted that deposit insurance is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly. The full statement from the Minister can be accessed at http://www.beehive.govt.nz/release/maintaining-confidence-financial-system
The subject of New Zealand is on the verge of going viral. Typically when that happens, the concern is overblown. And that is precisely the case here.

Sensible Policy

Readers who are unfamiliar with my overall stance on deposit guarantees, especially in light of my posts on Cyprus may be surprised to learn that I commend the Reserve Bank of New Zealand's policy for precisely the reasons it stated:

"Deposit insurance is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly."

Consider a US example.

In buildup to the housing bubble crisis, investors flocked to shaky institutions that paid the highest yields on deposits simply because the deposits were guaranteed. The FDIC guarantee enabled hundreds of banks such as now-bankrupt Corus to secure funds used to build condos in Florida and Las Vegas.

No one in their right mind would have placed money in Corus and other such banks without those guarantees. In essence, deposit insurance helped fuel the housing bubble.

The difference between the policy of New Zealand and what happened in Cyprus is the guarantee itself.

Wikipedia has a nice table of 99 countries with deposit insurance. Those without deposit insurance are at least being honest.

The problem in Cyprus was the fraudulent deposit guarantee, made by the ECB, and repeated just last month by the president of Cyprus.

Fraudulent Guarantees

Guarantees in and of themselves are inherently fraudulent by nature. A look at money supply numbers will show why.

Base Money

click on any chart for sharper image

The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks.


M1 is narrow money supply. It consists of currency, demand deposits (checking accounts), travelers checks, and other checkable deposits. Travelers checks are actually double-counted but the numbers are so small the error is essentially meaningless.


M2 consists of M1 plus savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs).

There are better measures of money supply, such as True Money Supply (TMS) and I encourage you to learn about them. I used to maintain charts of TMS (I called it M') but Michael Pollaro does a fantastic job.

I used M1 and M2 above because those are the widely reported numbers, and the numbers most economists follow.

For the purpose of this discussion, M1, M2, and Base Money supply will suffice. The next chart will help explain why.

Total Credit Market

Chart Recap

  • Base Money Supply: $2.9 Trillion
  • M1: 2.4 Trillion
  • M2: 10.4 Trillion
  • Total Credit Market Debt Owed: $56.3 trillion

One Giant Ponzi Scheme

Clearly far more money has been lent than exists. How can it possibly be paid back? If it can't be paid back, how good is a guarantee?

In 2010 Bernanke proposed ending reserve requirements completely, but long-time Mish readers understand that is the de facto state of affairs already.

For example, even the $2.4 trillion in M1 money that is "guaranteed" to be in your checking account and "available on demand" isn't in your checking account at all. It too has been lent.

I have talked about this before on numerous occasions but it's worth a review.

Please consider my March 23, 2010 post Bernanke Wants to End Bank Reserve Requirements Completely: Does it Matter? What Chaos will Result?
There are no reserve requirements on savings accounts right now.

There are reserve requirements on checking accounts, but you have to take into consideration the fact that Greenspan allowed sweeps in 1994.

Sweeps allow banks to move (sweep) money from checking accounts into savings instruments nightly (unbeknown to customers who think the money is really there in their checking accounts).

Once Greenspan allowed banks to sweep, banks did so in mass, and the end result is there are essentially no reserve requirements on checking accounts either.

The bottom lines is banks will continue to do what they have done since 1994, and that is to keep enough reserves on hand to meet estimated withdrawals.
Fictional Reserve Lending

Should banks (large too-big-to-fail banks) run out of reserves, the Fed is Johnny on the spot, ready and willing to create reserves out of thin air. However, other banks can't count on it.

In essence, the system is one giant Ponzi scheme (not just in the US but everywhere), kept afloat by wizards willing to ramp money supply every time big banks get into trouble.

An enabling factor to all the bank leverage is Fractional Reserve Lending (which on numerous occasions I have likened to "Fictional Reserve Lending" but is really better thought of as "Negative Reserve Lending".

Please see my 2009 post Fictional Reserve Lending And The Myth Of Excess Reserves for further discussion. It's well worth a read.

Amusingly, people were arguing at the time such policies would soon cause massive price inflation, but I took the other side of the bet (and still do - for the time being).

The Fed, was and still is willing to step in and help any "too big to fail" bank, but numerous small banks went bust in the Great Financial Crisis, and depositors with money over the FDIC limit did on occasion suffer losses.

In that regard, the Reserve Bank of New Zealand at least has the courage to tell the truth, with precisely stated reasons: "deposit insurance is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly"

I am planning a follow-up post on the fraudulent nature of Fractional Reserve Lending, deposit insurance, and related topics, but the five key points for now are as follows:

Five Key Points

  1. In a Fractional Reserve Lending scheme, the notion there are meaningful reserves is ridiculous
  2. Far more money has been lent out than really exists (the rest is a fictional accounting entry)
  3. Fractional reserve lending constitutes fraud (just as lending something you do not own is fraud)
  4. There is no way for all this money to be paid back (so it won't be)
  5. Of all the central banks, the Reserve Bank of New Zealand has the most sensible policy for the most sensible reasons of all the central banks.

Mike "Mish" Shedlock

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