He use Cyprus as an example of a debtor who can't afford to repay its debt and the EU as an example of a creditor who can't afford to keep throwing money at the debtor.
Regular readers know that the way out of this financial box is to use future bank earnings to fill the hole.
By definition, banks are special. They are designed to be able to operate with low or negative book capital levels.
Banks can do this because of the existence of deposit guarantees and access to central bank funding. When banks have low or negative book capital levels, deposit guarantees effectively make taxpayers their silent equity partners.
This is an important point.
So long as a bank's interest income exceeds its interest expense and cost of doing business before banker bonuses, the bank is capable of generating and retaining earnings so that it can rebuild its book capital level.
A bank's ability to rebuild its book capital is used by requiring the bank to recognize upfront the losses on the excess debt in the financial system (see Swedish Model and Iceland). This protects the real economy as the debt service burden of the excess debt is not placed on it.
As a result, the real economy can continue to use the capital it generates for reinvestment, growth and supporting the social contract. Meanwhile, the banks use their earnings to rebuild their book capital levels.
There is a well-known joke from the last decade of the Soviet Union about Rabinovitch, a Jewish man who wants to emigrate. The bureaucrat at the emigration office asks him why, and Rabinovitch answers: "There are two reasons. The first is that I'm afraid that in the Soviet Union, the communists will lose power, and the new power will put all the blame for communist crimes on us, Jews – there will again be anti-Jewish pogroms …"
"But", interrupts the bureaucrat, "this is pure nonsense, nothing can change in the Soviet Union, the power of the communists will last forever!" "Well," responds Rabinovitch calmly, "that's my second reason."
It is easy to imagine a similar conversation between an EU financial administrator and a Cypriot Rabinovitch today. Rabinovitch complains: "There are two reasons why we are in a panic here. First, we are afraid that the EU will simply abandon Cyprus and let our economy collapse…"
The EU administrator interrupts him: "But you can trust us, we will not abandon you, we will tightly control you and advise you what to do!" "Well," responds Rabinovitch calmly, "that's my second reason."
This is the deadlock at the core of Cyprus's predicament: it cannot survive in prosperity without Europe, but nor can it with Europe – both options are worse, as Stalin would have put it. ...
Cyprus by definition cannot repay its debt, while Germany and the EU cannot simply go on throwing money to fill the Cypriot financial hole .... there is something wrong with the entire system in which uncontrollable banking speculations can cause a whole country to go bankrupt.