What Lessons Can We Learn From Cyprus?

It looks like the European Union will bail out the Cyprus banks to the tune of 10 billion euros, which is approximately $13 billion.  Of course, this is pocket change to the United States.  The U.S. government spends (wastes) that much in less than 2 days.  I predicted in my last post that there would be some kind of bailout deal, because there is no way they were going to allow the banks to go under.  It would have spelled almost immediate trouble for troubled banks in other troubled countries.  It would have meant the breakup of the European Union.  Instead, they will try to kick the can down the road one more time.

The latest "deal" will take huge amounts from the big depositors.  It will hit anyone who has over 100,000 euros in deposits in the troubled Cyprus banks.  This will affect rich Russians, who really should have known better.  When an institution is offering above-normal interest rates, it should be a sign that something may be wrong.

There are some lessons that Americans (and others) can learn from this whole debacle.  The first lesson is that you should never have bank deposits in any one bank that is above the FDIC limit.  That limit is currently $250,000, which went up from $100,000 after the fall of 2008.  It is completely unnecessary to have this much in deposits in any one institution and perhaps foolish anyway because you are losing so much to inflation.  Unless you have a net worth of $5,000,000 or more, there is absolutely no reason to have this much liquid savings in one bank.  And if you are worth more than that, then you should have a great tax attorney who specializes in international banking and foreign investments.

Another lesson we can learn from Cyprus is that the big banks will almost always be saved (or nationalized).  The governments of the world will simply not allow the big banks to fail because their whole system depends on them.  The big banks and the government work hand in hand and depend on each other (not in a good way).  So while I think the Federal Reserve would tell Congress to balance the budget to avoid hyperinflation, I am not as certain about what the Fed would do with the banks.  Would the Fed risk hyperinflation to save the banks?  I think this is the one major danger that we face.

Unfortunately, the whole banking system is a mess.  Banking is a legitimate business that should serve society like any other business.  A bank should be a place where people can deposit their savings for safety.  A bank should be a broker or an intermediary between lenders and borrowers.  Banks should serve useful functions.

The problem is that the government, through the Fed and the FDIC, has created unprecedented moral hazard.  The big banks can be almost certain that they will be bailed out if they get into trouble.  This encourages them to take on risky bets, whether they be mortgage-backed securities or Greek bonds or something else.  The banks are being bailed out now as we speak.

I don't really agree with those who say you should take all of your money out of the banking system.  While the system does rest on confidence and the ability to be bailed out, it probably won't go down.  As stated above, the big banks will almost always get bailed out.  If the FDIC doesn't make good on a promise, then the whole system may collapse.  So I think your money is probably safe, as long as you don't go over the FDIC limit.  If it isn't safe in an American bank, I'm not really sure that you can find complete safety anywhere.  And even under a mattress is not complete safety, for several reasons.

With that said, you should always diversify your assets.  You don't want all of your eggs in one basket and this would include any banks, foreign or domestic.  But if the banks go under in the U.S., then you better live on an isolated island with plenty of food.  This might be one of the few scenarios where the preppers could actually be right.