Game theory and cross-border deposit guarantees

What was it that Jeff said?  Nonetheless this issue has been bothering me, especially after reading EconomistMeg.  Let’s say that “Germany” guarantees bank deposits in Spain.  But the guarantee cannot be unconditional.  That is, if Spain leaves the euro anyway and redenominates its bank deposits into lower-valued pesetas, Germany will not make the Spanish bank depositors whole.  For one thing the implicit liability is too large, for another Germany would be offering Spain a huge free lunch and relying too much on political pressure to stop subsidized exit from happening.  For yet another thing you cannot reward those countries which totally break the basic rules.

So the guarantee is actually “we cover your bank deposits against many contingencies, except the one we all fear the most.”

Could that work anyway?

Perhaps it depends on the motives for deposit flight.  If the motive is “I’m afraid that my bank in particular will fail, and I’ll be left in the cold before the whole system goes down,” the German guarantee may be worth something.  Such depositors, with such fears, will be reassured.

If the motive is “I see the whole domestic system going down, leading to peseta redenomination,” the guarantee won’t stop the bank run.  Or should I say “the non-guarantee will not stop the bank run”?

Thinking about this problem makes one less optimistic about the prospects for a cross-border deposit guarantee.

Another issue is that the Netherlands, Slovakia, Finland and others may not feel the same “responsibility rights” as Germany when it comes to “saving the eurozone.”

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