About 5 days ago, on February 24, Russia illegally and without provocation and cause attacked the sovereign country of Ukraine. It is in everyone’s interest (with the exception of the military industrial complex) to end the fighting and establish a sustainable peace as quickly as possible. I explored options in my blog Saturday.  “Ukraine-Russia-NATO”  

Sanctions are being piled on as the main counter weapon of choice around the globe, along with supplying Ukraine with military equipment. But which sanctions of what activities (use of SWIFT, banning access of Russian airlines, banning any travel across Russian borders, banning trade in military products, banning all trade, etc.) should be imposed? If all or almost all countries joined together to shut down all trade, travel, and financial flows between Russia and the rest of the world until Russia ends this war and fully withdraws it troops, the impact on Russia (and hopefully to a lesser extent the rest of the world) would be devastating. While it is hard to predict whether the Russian people would primarily blame the U.S. and the West or Putin’s government for the hardships imposed—it is unlikely that Russia would withstand such isolation for long. Russia seems well on its way to such isolation.

While sanctions have historically not been a very effective tool for changing a country’s behavior, such total isolation, if it can be achieved, would almost certainly be more effective than the more limited sanctions normally imposed. “A new history of sanctions has unsettling lessons for today”  Putin will have to back down or escalate. Putin would indeed be boxed into a very difficult position and there is no knowing how he might react. It is hard to imagine Russian military escalation beyond Ukraine’s borders, but it is possible, especially in the ambiguous ways often favored by Moscow (e.g., cyber-attacks). If Putin is squeezed too hard, the risk of nuclear war could no longer be ignored. This is a dangerous period.  “Just short of nuclear–the latest financial sanctions will cripple Russia’s economy” Such comprehensive sanctions should be largely removed as soon as Russian troops are withdrawn from Ukraine territory.

But while it is foolish (i.e., contrary to American interests) to keep Russia as an enemy in the long run, and it was foolish to have made it one in the first place, the Kremlin should pay a price for its attack on Ukraine.

Sanctions impose a cost on their target but also on those imposing the sanctions. If, for example, Russia is denied access to western products, the sellers are also denied the sales. Moreover, for many if not most economic sanctions, the people of the sanctioned country tend to suffer more than the government that is the real target. For post conflict sanctions, thought should be given to the most effective ways to sanction Putin and his friends specifically with minimal damage to the Russian economy. The borders and trade should be reopened to all but a small list of Kremlin officials including Putin. Putin’s properties and other assets abroad should be frozen or confiscated to contribute to Russian reparations for damage now being inflicted on Ukraine. “Russia’s military attack on Ukraine will have consequences for Putin”

Yesterday (2/27.22 6:37 PM), Edward Luttwak tweeted: “Putin’s agreement to talks with Zelensky’s reps is an abject surrender: by now the Russians should have been in control in Kiev and across the Ukraine with Zelensky dead or exiled. Frantic to divert attention, Putin has placed Russia’s nuclear forces on high alert. Meaning: zero”

Let’s hope that he is correct.

Every action should be carefully measured against is costs and benefits both short term and long term. Another protracted cold war would be a costly mistake for everyone. All measures should ultimately contribute to peaceful and secure relations between all countries.  Greenwald–War propaganda about Ukraine

Cyprus and the Euro

Does the Euro need to be supported by closer European fiscal integration? Many countries do just fine without their own currency and no fiscal coordination with their currency’s issuer. Panama has used the U.S. dollar for well over a century with good success. Ecuador and El Salvador have used the dollar as their own currency for a much shorter time and are doing better for it. Etc.

The major failing of the Euro, along with its considerable benefits for the Euro zone countries and those doing business or traveling among them, has been the failure of lenders to properly price the risk of lending to the Greece’s and Italy’s of the world. The spread between Greek government bonds over German government bonds collapsed to near parity after Greece replaced its inflation prone currency with the low inflation Euro. Greeks, both private and public, responded by borrowing with abandon. Greece has many other structural problems that keep its productivity lower than its neighbors, but credit markets indulged its borrowing binge on the assumption that there was little to no risk that the Greek government would be allowed to default on its debt.  This gave Greece the illusion of a higher standard of living for a while. Richer brothers to the north would surely step in and bail it out if it couldn’t repay its debts. And so it was for a while.

Against German resistance, Greece finally defaulted on much of its debt (the so-called voluntary haircut – write down — of its debt held by banks to about 30% of its full value). This was an important restoration of market risk and hence market discipline of Greek and other EU periphery countries’ borrowing. It will potentially help save the Euro. Most banks were able to absorb their resulting loss, but some big Cyprus banks apparently were not.

The EU/ECB/IMF (the troika) have offered conditional financial assistance to Cyprus but not to cover the cost of recapitalizing Cyprus’s underwater banks. Cyprus is required to raise those funds themselves. At least this is my assumption. Press reports on what the external support covers are almost totally lacking and the conditions for the deal are not yet final anyway. There is a relatively straightforward approach to resolving these banks, though the details would depend on the particulars of its banking and bankruptcy laws. I do not know the details of these laws nor of the conditions of these banks (Laiki and Bank of Cyprus), but I assume that they are viable if recapitalized and worth more as going concerns than from liquidating them.

The insolvent banks should be put into receivership and instantly split into a good, fully capitalized, bank and a bad bank (i.e. what ever is left) to be liquidated. The good banks would be fully capitalized by leaving some of their liabilities with the bad bank, starting with its shareholders, then bondholders (of which there are not many), then uninsured depositors. These creditors would, in effect, be written off. This would enable the new good banks to continue operating without serious interruption. The only real debate should be about how far to cut into depositors (so-called bailing creditors in) to rebalance assets and liabilities. The Economist argues that the write-offs should stop with shareholders and bondholders and all depositors should be made good via bailout funds from the European Stability Mechanism.

Depending on the particulars of the banking law, an insolvent but otherwise viable bank is put into receivership. This removes the shareholders from any control over the bank. Immediately the good assets of the bank, including its branch network and equipment, and staff would be sold to a new bank, which would assume all insured deposits and a proportionate amount of the uninsured deposit sufficient to match the value of the assets purchased. Ideally the new bank would be sold immediately to new private owners. But if more time is needed to organize its sell, it would be sold temporarily to the government for one Euro. What remains of the old bank would be liquidated and the proceeds would be apportioned in accordance with the priorities provided in the law to the credits (deposits that were not transferred to the new bank). As all of the good assets were transferred to the good bank, there would be virtually no further assets in the bad bank to recover and the remaining creditors would receive little to nothing.  The overall loss to depositors will depend on the losses incurred by the bank on its assets that made it insolvent in the first place. The orderly resolution described above almost always result it much smaller losses to creditors than a disorderly default in which the bank closes its doors totally.

Market discipline would clearly be more strengthened if uninsured depositors were also at risk of losing money. But increasing that risk unexpectedly and to too large an extent could cause deposit runs throughout Euro (and the world). Ultimately, but maybe not at the moment, this would be a good thing for the banking sector. Banks would have to behave more prudently or run the risk of losing deposits. Such market discipline is more effective in limited excessive risk taking by banks than is tighter supervision; though required capital and senior convertible bonds should be significantly increased in the future. In my view, the full recapitalization of all insolvent banks should be financed by bailing in as many uninsured depositors as needed to cover their capital deficiency. The IMF’s position, opposed by the EU, was that a good bank should assume only the insured depositors and receive sufficient good assets to cover them. This would leave all uninsured deposits in the bad bank, which were expected to suffer losses of 20 to 40 percent of their value.

The Cypriote officials originally proposed something quite different. They proposed a one-time levy on all depositors with a lower tax rate on smaller insured deposits. Thus both insured and uninsured depositors in good banks as well as bad ones would be paying to cover the losses of insolvent ones. Not exactly a boost to market discipline of banks. Depositors everywhere and especially in the Euro zone were shocked and the Cyprus Parliament rejected the proposal.

It will be interesting to know what motivated this crazy idea. For one thing it protects the shareholders from the loss of their shares and control of their banks, which is not a good idea from the point of view of the health of the banking system, though it may have been a deliberate goal of the plan (the shareholders are likely to be influential people in Cyprus). Antonis Samaras, the President of Cyprus, suggested that he wished to diminish the loss to large depositors (which include many wealthy Russians, some of whom have dealings with his law firm). Steve Hanke states that about half of Cyprus banks’ deposits are owed to Russians (including those of Russian subsidiaries established in Cyprus).

Whether lightening the burden of large depositors (sharing the burden more equitably according to the President) involved murky deals with Russians or the mistaken belief that it might save the large offshore deposit business Cyprus had developed (the deposit liabilities of its banks were eight time Cyprus’s GDP) only time will tell (maybe). Cyprus’s banking business is more like that of Iceland or Ireland before they crashed and burned several years ago, than the typical off shore financial centers like Cayman. The deposits in Cyprus are with Cyprus banks. If they become insolvent, depositors (or tax payers somewhere) lose. Foreign depositors in Cayman banks are actually depositing in branches of international banks with headquarters and assets elsewhere. Loses incurred by Cayman branches would be a small fraction of the total assets of the global bank and more easily absorbed.

Cyprus’s misguided attempt to spare large depositors at the expense of depositors in general, even if rejected in the end, greatly unnerved depositors everywhere and is likely to weaken rather than strengthen market discipline of bank risk taking.  By making the depositor haircut a levy/tax, Cyprus intended to bypass the bankruptcy/resolution provisions of the banking law and deposit insurance provisions. They created a mess.

A Nation of Riches

America is a rich nation, despite its many problems and challenges, many, such as war adventurism, the product of hubris born of our success. Many elements contribute to our riches, but overwhelmingly toping the list are the people who have come here to live in freedom and with the opportunity to achieve their ambitions with hard work and a bit of luck.  “Eternal vigilantes” is the price we must pay to preserve the institutions and attitudes that help defend our way of life from those who want to run them for us.

We are rich in many ways. We are rich in our neighborliness toward our fellow man (we are the largest charity givers in the world), born in part by our gratitude for the respect for our persons and property shown to us by our neighbors. We are rich in the diversity with which we are able to live and conduct our lives, within the domain of mutual self-respect.

Our fellow citizens have come from all over the world. They are self-selected by their desire to be free and to work hard. And they bring with them those elements of their cultures that have enriched their lives in their home countries.

I shared in and enjoyed some of that richness last night at a concert by the Washington Balalaika Society featuring Olga Orlovskaya (soprano) at a local Presbyterian Church. The WBS ( is dedicated to performing traditional Russian music with Russian folk instruments (Balalaika, dombra, bayan). Olga Orlovskaya is a great granddaughter of Fyodor Chaliapin, the greatest Russian opera singer of the 20th century. Of the dozens and dozens of concerts and plays to choice from in the Washington area last night (or most any night) my Russian friend Andrei Makarov convinced me to attend this one and what a treat it was. America is indeed a rich country.