Opinion

James Saft

SAFT ON WEALTH: Learning from Cyprus

March 21, 2013

March 21 (Reuters) – Even if you have zero exposure to the
euro, the sad tale of Cyprus teaches investors about important
old and new realities.

This tutorial comes compliments of the tiny euro zone island
off the coast of Greece, which has been a favored haven for
billions of euros from mostly Russian investors but is now
facing a financial meltdown.

First, there is still no free lunch. High-reward, low-risk
investment products aren’t.

Second, off-shore havens for money may save you money in
taxes but could well cost you far more in the end.

Third, financial repression isn’t a psychological disorder,
it is the new way of the world. So-called financial repression
is any one of a number of tactics which a government uses to
capture any money from any available source to help it meet its
goals.

These are lessons that depositors in Cyprus banks are
learning to their cost. It would behoove international investors
to take note as well.

Cyprus is a tiny country, far away and arguably someone
else’s problem. U.S. investors might easily dismiss its
troubles, even though they are huge. Still, they illustrate
trends which will apply worldwide, even though they are highly
unlikely to be replicated on anything near this scale in the
United States.

Cyprus is struggling under the weight of a bloated and
dangerously shaky banking sector which has grown to more than
seven times the size of its economy, largely on the back of
taking in off-shore deposits from wealthy Russians. While this
is a risky business model for an economy under the best of
conditions, it becomes a disaster when that huge banking sector
invests heavily in domestic real estate and Greek debt, both of
which have plunged in value.

A member of the euro currency, Cyprus first struck a deal
with the EU and the International Monetary Fund for a bailout
which included an involuntary contribution, called a levy, from
bank depositors. This deal, now in flux, called for accounts
under 100,000 euros to be snipped by 6.75 percent and larger
accounts, many off-shore money, by 9.9 percent. Cyprus has been
on an extended bank holiday since the bailout was first mooted,
effectively trapping deposits.

Let’s be clear: there is no sign anything anywhere near this
is going to happen in the United States, so cancel those
freeze-dried food orders.

NO FREE LUNCH

While deposits in Cyprus banks are insured to up to 100,000
euros, and any policy which violates the spirit of that is an
outrage, the truth is that depositors should have known better.
And here I am not even talking about an in-depth analysis of a
bank’s balance sheet, or even spending one’s time reading about
the euro crisis and its potential knock-on effects.

There was a very easy way that everyone with money in a
Cyprus bank could tell they were sitting at the end of a very
long limb: the deal was too good. Deposit rates for euro
accounts in Cyprus were recently at 4.45 percent, as against
just 1.5 percent in banks in Germany. In fact, a depositor who
put one euro each in a typical German and Cyprus bank five years
ago would have enjoyed nearly twice the cumulative returns,
according to central bank data.

Repeat after me: there is no extra reward without extra
risk.

Much of the money in Cyprus banks came from Russia-based
depositors. McKinsey & Co estimates that there is some $21
trillion globally in offshore accounts, a figure which has grown
sharply in recent years.

All of that money is today in more danger than it was a year
ago, and very likely will be less secure yet in another year.
First off, big centers are becoming far more aggressive in going
after tax evaders, as shown in recent U.S. efforts to go after
Swiss accounts.

As well, we live in a time of rolling bank crises. While you
might do well to make sure that your bank is sound, ultimately
your bet in a bank is a bet on the domicile, because those banks
depend in turn on the backing of their governments. Offshore
centers have large financial systems relative to their
economies, and, like Cyprus, could easily be caught in
situations where a banking crisis is beyond their ability to
solve without seizing assets.

FEELING REPRESSED

Financial repression, which takes many forms, has
historically been a popular way for governments to dig
themselves out of debt holes. A prime way to do this is to keep
interest rates artificially low – quantitative easing anyone? As
well, governments can and do try to capture pools of capital by,
if not confiscating it, then at least channeling it in ways
which will be useful to the government in addressing its debt
problems.

A great example of this is forcing pension funds to invest
in government debt, or, as is being considered in Cyprus, in a
kind of national fund.

Any roadblock to the free movement of capital is a form of
financial repression. Cyprus, where depositors are likely to
receive either shares or bonds issued by the banks in which they
hold money, is a perfect example.

More of this is coming. My guess is you are better off at
home than abroad, as it is harder to do voters out of their
capital than honored guests, as the Russians have learned.

Bottom line on Cyprus is: don’t over-react, but don’t be
surprised if more of this kind of thing happens.

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