The Cyprus precedent

By Felix Salmon
March 17, 2013
stuck my neck out in January, saying that Cyprus was "certain" to default.

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I stuck my neck out in January, saying that Cyprus was “certain” to default. After all, the Europeans weren’t willing to come up with the €17 billion needed to bail the country out, and EU economics commissioner Olli Rehn told the WSJ’s Stephen Fidler that Cyprus would have to restructure its debt. But now the bailout has arrived, and — in something of a shocker — there’s no default. Instead, €5.8 billion of the bailout is going to come directly from depositors in Cyprus’s banks, in the form of what the EU is calling an “upfront one-off stability levy”.

Don’t for a minute believe that this decision is part of some deeply-considered long-term strategy which was worked out in constructive consultations between the EU, the IMF, and the new Cypriot government. Instead, it’s a last-resort desperation move, born of an unholy combination of procrastination, blackmail, and sleep-deprived gamesmanship.

The details aren’t entirely clear yet: we’re told that deposits of more than €100,000 are going to have to pay a tax of 9.9%, for instance, but it’s not obvious whether that applies to all of the large deposit or just to the amount over €100,000. And there’s still a real chance that the Cypriot parliament could scupper the whole deal. But for the time being, everybody’s going on the assumption that the deal will go through, that Cyprus will get its €10 billion bailout from the EU, and that everybody with a Cypriot bank account in Cyprus (a group which includes members of the UK military) will see their accounts taxed by at least 6.75%.

In January, I said this wouldn’t happen:

The last thing that Cyprus or any other country needs is a bank run, which will leave the national balance sheet in the classic pinch where “on the left, nothing’s right, and on the right, nothing’s left”. What’s more, in many ways the precedent of forcing depositors to take a haircut would be even more damaging than the precedent of imposing a haircut on Greek bondholders: at that point there would be really no reason at all to have deposits in any Mediterranean country.

It might seem a little bit like shutting the stable door after the horse has bolted, but the lines in front of broken ATMs certainly suggest that there will indeed be a substantial bank run out of Cypriot banks when they reopen on Tuesday morning. (Cyprus’s loss, here, is likely to be Latvia’s gain.) Cyprus has been relying up until now on its status as an offshore financial center, especially for Russians. That has bloated its banks with deposits, and if the deposit bubble bursts, the government has no money at all to bail out the banks. Cyprus’s president, Nicos Anastasiades, said today that he was forced to choose this path because the only alternative was the collapse of Cyprus’s two major banks, with “catastrophic” consequences. What he didn’t say is that those banks aren’t remotely safe yet — not with the prospect of a massive bank run hanging over their heads.

And of course it’s not only Cyprus where a bank run is a very real fear. If bank deposits can be seized in Cyprus, they can be seized in other EU countries as well. Ed Conway has a fantastic post explaining exactly why this is a horrible idea:

Given that this policy was not merely rubber-stamped but engineered by Eurozone finance ministers and the IMF (indeed, the IMF wanted an even deeper cut of deposits), it sends a disquieting message to anyone with deposits in a euro area bank. Although the ministers were quick to insist that this is a one-off and is “exceptional”, anyone even vaguely acquainted with the initial Greek bail-outs will remember precisely how long such exceptions last.

“The best the rest of the world can hope for,” says Neil Irwin, “is that Cyprus’s case is sufficiently unique that it won’t spark panic in Athens and Madrid (or in Lisbon, Dublin and Rome).” But his post is headlined “Why today’s Cyprus bailout could be the start of the next financial crisis”, which gives a reasonably good idea of how optimistic he is that any bank run in Cyprus will be contained.

And Europe won’t be home dry even if depositors in Portugal do decide to keep their money in their home country on Monday morning. That might make this bailout look like a brilliant wheeze. But the consequences of this choice are permanent: countries like Ireland and Portugal might not be at risk of a deposit tax right now, but they’re still getting bailed out on a continuous basis, and the more fraught the bailout negotiations become, the more likely it is that the EU will insist on bailing in depositors. It’s an option on the table, now, and as a result a deposit run is surely more likely to happen whenever a Eurozone country finds itself in need of a bailout. Which, of course, is always the worst possible time for a bank run.

From a drily technocratic perspective, this move can be seen as simply being part of a standard Euro-austerity program: the EU wants tax hikes and spending cuts, and this is a kind of tax: “a one-off wealth tax”, as Matt Yglesias puts it. Other taxes would raise less money, or if they didn’t they would be more harmful to the Cypriot population, since much of this one is going to be paid by Russians. Cypriots are sadly going to have to pay somehow, and although this is an unpleasant way of forcing them to do that, it’s also extremely effective and almost impossible to replicate by any other means.

But there’s something sacred about bank deposits, and especially about insured bank deposits. The one part of this scheme that no one is defending is the 6.75% tax on deposits less than €100,000 — the level to which Cyprus guarantees all deposits. As Nick Malkoutzis puts it,

Anastasiades also has to explain to Cypriots why small-time depositors have to pay a similar levy to the one some eurozone countries supposedly demanded so alleged Russian oligarchs would be forced to pay for bailing out the island’s banking system. Furthermore, he has to inform them why the Cypriot government’s pledge to guarantee deposits up to 100,000 euros – supposedly even in the most extreme circumstances – is not even worth the paper it was written on.

What we’re seeing here is the Cypriot government being forced to break one of its most important promises — the promise that if you put your money in the bank, and your deposits total less than €100,000, then they will be safe. What’s more, there’s no good reason for insured deposits to be hit in this manner: the same amount of money could be raised just by taxing the uninsured deposits at a slightly higher rate. The insured depositors are being hit, it seems, just so that the uninsured depositors can be taxed at single-digit rather than at a double-digit rate.

Meanwhile, people who deserve to lose money here, won’t. If you lent money to Cyprus’s banks by buying their debt rather than by depositing money, you will suffer no losses at all. And if you lent money to the insolvent Cypriot government, then you too will be paid off at 100 cents on the euro.

This is more by accident than by design. As Joseph Cotterill explains, Europe dragged its feet on Cyprus for so long that it effectively missed the deadline for doing a bond restructuring. It takes time to put that kind of a deal together, and there simply isn’t enough time between now and Cyprus’s next big coupon payment to do that. As a result, the EU found itself with a massively reduced menu of options: either fund the bailout itself, in full — an option which the Germans were adamant would never happen — or force a haircut on Cyprus’s depositors. Given the balance of power in the Eurozone, it comes as no surprise that in this battle, Germany won and Cyprus lost.

They won dirty, too: by forcing a tough all-night negotiating session in which Anastasiades was given what you might call an offer he couldn’t refuse. Either confiscate deposits wholesale, or see those deposits rendered even more worthless when the ECB cuts off its funding to Cypriot banks, a decision which would — through devaluation and insolvency — lead to depositors losing as much as 60% of their money.

The big winner here is the ECB, which has extended a lot of credit to dubiously-solvent Cypriot banks and which is taking no losses at all. And although they might wake up bruised, the big Russian depositors are probably winners too, given that they risked losing everything and will end up losing just 10%. Finally, of course, there are all the hedge funds who have been betting that the Cypriot government won’t default: they’re all popping Champagne right now.

The big loser are working-class Cypriots, whose elected government has proved powerless in the face of decisions driven by Germany, and who are now edging towards fury. The Eurozone has always had a democratic deficit: monetary union was imposed by the elite on unthankful and unwilling citizens. Now the citizens are revolting: just look at Beppe Grillo. Across the continent, they’ve lost their democratic right to determine their own fate at the ballot box, and instead they’re being instructed what to do by Germans. Now, in Cyprus, they’re simply and directly losing their money.

Someone with €8,000 of life savings in the bank can ill afford to lose an arbitrary €540, but that’s exactly what is going to happen. The Cypriot parliament is probably not going to revolt this weekend, but any politician who votes for this bill is going to have a very, very hard time getting re-elected. This decision is important not only because of the precedent it sets with regard to bank depositors, but also because of the way in which it points up just how powerless all the Mediterranean countries (plus Ireland) have become. More than ever before, it’s Germany’s Europe. That’s bad for Cyprus — and it’s not even particularly good for Germany.

31 comments

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Cardinal rule #1 when trying to solve a financial crisis:

THOU SHALL NOT F**k INSUNRED DEPOSITORS.

Now we’ll see what happens when you break the rules!

Posted by y2kurtus | Report as abusive

I read the news announcement of this and my first thought was, “Oh my God. They’ve blown it up.” Add a few unprintable words. My 2nd thought was they have 1 day to fix this. All the “confidence” they claim has been established is gone because now no depositor in any Eurozone bank can feel safe keeping money in that bank, partly because of fear of tax but more because of fear of bank runs and then failure to pay off. I hope Monday AM is not as bad as I fear.

Posted by jomiku | Report as abusive

…”This is more by accident than by design.”… -pure malarkey Felix. Stop being an apologist for a system that doesn’t work and get into the underpinnings that fundamentally insure that this is not going work out. That’s why you didn’t see this coming- you have a blind spot. This kind of financial feudalism is here to stay for much longer than anyone would care to imagine and has been trending parabolic since 2008. Get a grip!

Posted by Mbuna1 | Report as abusive

Isn’t a byproduct of this decision to force people not to have a savings account but an investment account?

I am not saying that they decided to force people to have an investment account, but methinks that, if bondholders are not getting any haircut and depositors are, the “rational” way to go from here is to eliminate your savings account and buy whatever bond/equity/money market you can put your hands on.

Posted by lgg | Report as abusive

Little mention of the fact that Cyprus banks trouble are entirely due to the infamous Greece PSI orchestrated by the Troika and German blackmail.

Posted by alea | Report as abusive

Well, you think that the other countries should have paid for the irresponsibility of Cyprus? 17 bn would have been necessary in time, now it is only 10bn. So the timing is not the issue. Is it better for a country outside the EZ where inflation is decreasing the value of savings (it is about 6% in Hungary, for example, only in one year)? Or the unemployment or the increased taxes like in other countries in trouble? There is no free lunch, some way it has to be paid for and it is always the citizen who pays.
The money which is missing from the budget was
- either embezzled – by the government the Cypriots elected so who is responsible?
- or spent just over the means of the country – so it benefited the Cypriots. So who should make up for it?

Posted by Lacz | Report as abusive

Here’s a little puzzle for the Very Serious People who put this together: what does Cyprus do when hundreds of Russian Oligarchs win their compensation cases at the ECHR? And will the ECHR recognise any of the other EU member states as jointly liable?

Even more interestingly, every EU member, including Cyprus, has acceded to Protocol 1 (Art. 1 of which guarantees the right to property), but the EU itself has not.

Posted by DrFuManchu | Report as abusive

Interestingly enough – my prediction is that this will be backed off to a 4.5% “Flat Tax” and Cyprus Bank Customers will be so thankful – they’ll submit willingly. Not as if they have much option.

The Corporate tax hike of 20% is not mentioned much in reference to this situation.

Now the Turks to the North – that should be interesting.

Posted by Questionisthis | Report as abusive

Felix is speaking, as usual, from both end of his f….mouth!

Does he understand or not there are 17 sovereign nations in the FMs conclave under Dutchman and they’ve to decide unanimously to safeguard the EZ.

The exit of Cyprus is not an issue inside EU or Council or ECB. Ther real issue on Cyprus has been – for sometime now – money laundering especially by Russian oligarghs and also Russian banks.

Political decision was imperative to re-structure Cyprus Bnaking system, so ECB can avoid default.

Posted by hariknaidu | Report as abusive

Your article reminds me of Alice in Wonderland.

Nothing is done by chance. All along the EU had given us reassurances that no haircut would take place, corporate tax would not increase as this is the bread and butter of the Cyprus economy. Cyprus is a service based economy and relies on tourism and services as in IBC. The fact that they cornered our delegation and gave them a ‘take it or leave it’ option that is catastrophic regardless of which is chosen, shows the real face of the Eurogroup. This was a clear backstabbing and aims to sink Cyprus as an IBC, ruin the banking system and drive Russian deposits to ‘other’ banks in EU. They also aim to force a pro-Turkish solution to the Cyprus problem that either wise could have not been forced and lay claim to the gas reserves Cyprus has recently discovered.

The Eurogroup gave freely 240 million to Greece with no guarantees but in the case of Cyprus they could not risk of losing 5.8 billion and force an unprecedented haircut.

Come on, give us a break.

This was clearly a German initiative that has a huge Turkish community and lobby.

They have bullied a small country into submission but its not over yet. Lets see how markets react on Monday, lets see how the EURO currency deals with the pressure, lets see if there is an outflow of deposits from the other countries that are receiving aid, lets see if there is instability in the EU.

We are going to keep the banks closed until Thursday, regardless of the fact that Eurogroup delegates are pressuring us to not do so. We will not vote today in parliament for the haircut, we will stall. We will wait and see how EU and world reacts.

Eurogroup has opened Pandora’s box. They have gone back into what has been a sacred right in the EU thus far, the right to own property and the sanctity of bank deposits.

The Germans are now steering Europe with the 4th Reich.

Regardless, Cyprus will rise, no matter how long it takes.

European solidarity is a myth, as Cyprus has just discovered.

Rest assured, other countries will follow. The EU has signed its own death sentence, slowly but surely this affair will drive it into dissolution, sooner or later.

Fuck the EU!!!

Posted by chris9999 | Report as abusive

f there is one lesson life has taught me, nothing happens by chance.

All along the EU had given us reassurances that no haircut would take place, corporate tax would not increase as this is the bread and butter of the Cyprus economy. Cyprus is a service based economy and relies on tourism and services as in IBC. The fact that the Eurogroup cornered our delegation and gave them a ‘take it or leave it’ option that is catastrophic regardless of which is chosen, shows the real face of the Eurogroup. This was a clear backstabbing and aims to sink Cyprus as an IBC, ruin the banking system and drive Russian deposits to ‘other’ banks in EU. They also aim to force a pro-Turkish solution to the Cyprus problem that either wise could have not been forced and lay claim to the gas reserves Cyprus has recently discovered.

The Eurogroup gave freely 240 million to Greece with no guarantees but in the case of Cyprus they could not risk of losing 5.8 billion and force an unprecedented haircut.

Come on, give us a break.

This was clearly a German initiative that has a huge Turkish community and lobby.

They have bullied a small country into submission but its not over yet. Lets see how markets react on Monday, lets see how the EURO currency deals with the pressure, lets see if there is an outflow of deposits from the other countries that are receiving aid, lets see if there is instability in the EU.

We are going to keep the banks closed until Thursday, regardless of the fact that Eurogroup delegates are pressuring us not to do so. We will not vote today in parliament for the haircut, we will stall. We will wait and see how EU and world reacts.

Eurogroup has opened Pandora’s box. They have trashed what has been a sacred right in the EU thus far, the right to own property and the sanctity of bank deposits.

The Germans are now steering Europe with the 4th Reich.

Regardless, Cyprus will rise, no matter how long it takes.

European solidarity is a myth, as Cyprus has just discovered.

Rest assured, other countries will follow. The EU has signed its own death sentence, slowly but surely this affair will drive it into dissolution, sooner or later. A new Eurocrisis and uncertainty is looming.

Fuck the EU!!!

Posted by chris9999 | Report as abusive

As the FT points out Cyprus represents a great deal of money transferred out of Russia, not all of it on the up and up. There’s a lot of rich Russians who are not going to be happy here.

And while the above is the reality another reality is that Europeans with accounts in Greece, Spain, Ireland and even France will watch what’s going on in Cyprus and decide not to take a chance in their own country. Hard not to see how this doesn’t cause a massive drain/run on those Countries banks.

Posted by Sechel | Report as abusive

The ECB’s stated goal was to separate state solvency from bank deposits so as to allow monetary policy to function in the Club Med countries. Now they are inextricably linked: a bank deposit is a subordinated claim on the state. Imagine how well this would work in the US, with New York State on the hook for its banking system. This is a Lehman event.

Posted by nixonfan | Report as abusive

Reading the follow-up stories, it seems Cypriots get upside potential in natural gas and equity in the banks. Cypriot banks don’t have a lot of debentures(that level in the capital structure is missing). This may be the best the country can do.

Posted by Sechel | Report as abusive

Hust remember what our Dear Leader Obama and his leftist goons have said; “it is the Government’s money not yours”. And so we have a glimpse of what they’ll do to out savings(401k,pensions, ROTHS/IRA whatever) to keep their vision of shared misery. Coming soon to an America near you.

MT: the only thing wrong with Socialism is you you run out of other peoples money.

2G

Posted by 2Gun | Report as abusive

Hust remember what our Dear Leader Obama and his leftist goons have said; “it is the Government’s money not yours”. And so we have a glimpse of what they’ll do to out savings(401k,pensions, ROTHS/IRA whatever) to keep their vision of shared misery. Coming soon to an America near you.

MT: the only thing wrong with Socialism is you you run out of other peoples money.

2G

Posted by 2Gun | Report as abusive

Hust remember what our Dear Leader Obama and his leftist goons have said; “it is the Government’s money not yours”. And so we have a glimpse of what they’ll do to out savings(401k,pensions, ROTHS/IRA whatever) to keep their vision of shared misery. Coming soon to an America near you.

MT: the only thing wrong with Socialism is you you run out of other peoples money.

2G

Posted by 2Gun | Report as abusive

Interesting piece. Important to note that the guarantee of deposits up to €100k is an EU requirement for all member states, not something Cyprus did on its own.

Posted by SeanT2 | Report as abusive

Cyprus could avoid any bad aspects of the deal to them by defaulting. Why do Salmon and others (e.g. Krugman) so continually overestimate the benefits of default compared to continued membership? Also they continually overestimate the rigidity of the ECB, Germans, et al. They have to talk tough and get what concessions they can (although this one was indeed weird) but ultimately they will have to pony up with assistance in most cases.

Posted by ytwod3621 | Report as abusive

Gold and Silver suddenly doesn’t sound like a bad investment or vehicle to store wealth after all.

Posted by ActaNonVerba | Report as abusive

Good article. Like the author, I am somewhat baffled by this confiscation from private accounts.

Never in modern history has any despot or dictator (and there have been some pretty spicy ones liek Adolf H.) ever simply helped themselves to a slice of customer bank accounts.

It appears as though the EU is willing to destroy THE fundamental contractual principle of retail banking all for a measly 7 billion Euro.

Draghi has been conjuring up far more than this every single month since the crisis blew up two years ago, so why couldn’t he tap Ctrl-P just one more time ???

Is the reason why bond holders escape with no haircut, because the governments fear a CDS chain reaction meltdown more than anything else ?

Posted by rup3ert33 | Report as abusive

Since assets are traditionally listed on the left-hand side of the balance sheet, and liabilities to the right, shouldn’t the pinch be described the other way around?

On the right, nothing’s right; on the left, nothing’s left.

Posted by Christofurio | Report as abusive

So the russian mobs are going to lose $4 billion just like that. I don’t want to be in Merkel’s proximity for a while.

Posted by ElenaS | Report as abusive

“a last-resort desperation move, born of an unholy combination of procrastination, blackmail, and sleep-deprived gamesmanship”

Donald Trump proposed a 14% wealth tax on assets over $10 million back in 1999. That considerably more progressive. What happened was they started with something like that, and then the big banks watered it down so that it would be more squarely on the backs of the poor.

Posted by jsalsman | Report as abusive

@Chistofurio – yes, but it’s counterintuitive when dealing with bank balance sheets.

For a bank, “on the left, nothing’s right” means their assets, often loans to borrowers, are impaired and worth less that everyone thinks.

And “on the right, nothing’s left” means their liabilities – for a bank, that is their funding sources, not A/P or normal trade payables – is normally funds owed to depositors and bonds issued, (+ retained capital), and those fundings sources are disappearing.

So, fewer assets than thought + no liquidity = bank run, leading to bank death.

That’s why your debit card is called such – the bank carries your checking account as a credit liability on its books (it owes you the balance in your account; when you deposit money they debit cash, credit ‘Deposit Liability due to Christofurio’), and when you swipe your debit card, you are instructing your bank to send money to the merchant and post a debit to your account, lessening the credit balance on their books and decreasing the amount they owe you.

Posted by SteveHamlin | Report as abusive

It would seem to me that asserting that this doesn’t constitute a default is at best a matter of high semantics.

Posted by dWj | Report as abusive

Funny: One of the big selling points for ECB membership when it was invented was deposit insurance. And, the laws already on the books in Cyprus can deal with Russian mob money more than adequately.

Rather, what happened here is [i suspect] ECB and other central banks are the holders of the bonds, and rather than take the haircut they deserve due to their deliberate evasion of risk laws.. they’ve chosen this method to ensure bankers stay whole while the country rots.

Cyprus is correct to vote against the ECB action, correct to force bondholders to take the haircut rather than depositors, and correct to leave the Eurozone.

Posted by Unsympathetic | Report as abusive

Unsympathetic, that might all be “correct”, but in point of fact, a parliamentary vote in Cyrpus against the plan would kick off the mother of all bank runs. I hope legislators there understand pragmatism.

An ill-planned exit from the EuroZone would result in a lot more suffering for ordinary Cypriots than the planned savings account hair cut would. And the Russian kleptocrats who are using Cyprus to launder their money won’t suffer at all because they’ll have their money out and they’ll be gone before the switchover to any new currency.

Posted by Strych09 | Report as abusive

Money, money, money!

Posted by Leo_oeL | Report as abusive

Money, money,money!

Posted by Leo_oeL | Report as abusive

Steve,

Thanks. Now I get it!

Posted by Christofurio | Report as abusive