Update on Cyprus. What is extend and pretend?

European and other banks are propped up by the "extend and pretend" strategy. Bad loans are carried as if they were good(and credit is extended to the bank) and that's the pretend part. The day comes when the bank needs to make a payment and it can't. That's where the Cypriot banks are today.

The troika extended the time the banks need to come up with the funds. This usually requires a banking holiday. The two banks were supposed to open this last Tuesday, then today and the holiday is extended to next Monday. There is also talk of even further extension.

The contagion works like this. Banks owe depositors, who in turn owe other depositors and creditors. When the flow from a bank is interrupted, everyone if the flow suffers losses. Consequences can be severe as well as unexpected. For example, before unification a West German bank (Herstatt) went bankrupt and the interaction in the flow made the Franklin National Bank in America insolvent. That is the contagion part.