Cyprus savers told to pay

Periodically, news breaks that could have notable ramifications. Today there is such news. Depositors at Cyprus banks will have some of their money confiscated via a one-time wealth tax. Savings deposits with a value in excess of 100,000 Euros will be charged a one-time tax of 9.9%. Accounts with lesser amounts will be hit by 6.75%.

In other words (for emphasis), if you have a bank account in Cyprus (as both many Cypriot citizens as well as quite a few Russian citizens do), you will find on Tuesday that your account value is smaller be either 9.9% or 6.75%.

For brief background, Cyprus is a small, sovereign island (country) that sits south of Turkey in the Mediterranean Sea and that has close ties to Greece. Like Greece, which received a series of bailouts in the past several years, Cyprus is in the midst of a banking crisis. Government debt is at unsustainable levels and banks face losses in excess of their equity. While the debt burden is small relative to the whole of Europe (Cyprus constitutes about 0.2% of total EU GDP), European countries are resistant to simply giving the government and Cyprus money freely. Not only would doing so elicit demands for equal treatment from other similarly-burdened nations, Cypriot banks are perceived to have been used for money laundering, and there is resistance to a bailout that would overlook (or even reward) such illegal activity.

In all other bailouts, governments have been given low-interest loans. These governments have then been asked to cut their spending, generally exacerbating recessions and provoking various degrees of civil unrest. While such government spending cuts are not enviable, there unfortunately is no good solution to these banking crises. Further, despite the hardships that results from austerity, these troubled countries have been the recipients of substantial bailouts and aid.

Today’s news is meaningfully different: Depositors at Cyprus’ banks are being asked to foot part of the bill. Already Cypriot citizens are lining up at cash machines trying to withdraw money (c’mon . . .  the authorities anticipated this would happen and have put certain freezes in place . . . they know what you had in the bank on Friday, and they’re taking a chunk of that). The tacit rationale for this ‘savings deposit tax’ is that it will collect much of the monies from wealthy Russians who have deposits in Cypriot banks.

In an ironic way, this deal is probably good for Cyprus. Seizing money in this way provides Cyprus with a needed cash influx. This seized cash is not debt and does not need to be repaid. It is a real cash infusion. Further, it appears the majority of the cash is being seized from wealthy foreigners [mostly Russians] with a smaller amount being usurped from Cyprus’ citizens. This infusion of cash should allow Cyprus to forgo some amount of deep austerity cuts. Austerity (cuts in government spending, salaries, and pensions) probably would have been worse for most Cypriots than this one-time hit to their savings accounts. I anticipate the Cypriot government probably can’t admit this publicly, and, as a result, only time will tell whether Cypriot citizens recognize the benefits from this deal. However, even if the benefits are appreciated, with human nature Cypriots still might feel resentful knowing they could have escaped the hit if only they had chosen a different bank.

This wealth-tax is not yet a done deal. It must be approved by Cyprus’ Parliament which will meet in an emergency session on Monday.

A potential spillover risk is that other EU citizens might ask, “If it can happen in Cyprus, where else might this occur?” If you have money deposited in a bank in Spain, Greece, or Italy, are you going to assume this was a one-time event isolated to Cyprus? Maybe you will, but even so, maybe your neighbor won’t. (On that note, if you’re worried about your neighbor panicking, isn’t it better to act before he does while there is still time to move your savings to a different bank?) If depositors opt to withdraw their money from these local banks and hold them in German banks instead, this will create a run on those local banks and exacerbate their problems.

A conspiracy-theorist might wonder whether governments and central bankers might actually want a crisis to arise from this. There has been a recent push to establish a banking union, in which banks would band together to provide deposit insurance. Under such a banking union, weak banks that got into trouble would be shut, but stronger banks would ultimately bear the cost. It is fine to create such a union at an outset or when all players are on level ground, but currently strong banks are resistant to setting up a union with weak banks (which fully makes sense). If the current Cypriot deal spurs a run on banks in Italy, Greece, Spain, etc, strong banks might be faced with a choice: either enter into a banking union and pay some costs to support the weak banks that will inevitably fail, or let them fail outright now. The problem with the latter is that failure would cause a crisis (ripple effect likely to cause multiple defaults and bankruptcies) wherein the losses to the strong banks might ultimately be greater than the losses expected from paying for the weak bank failures via the bank union.

This is a dangerous game. It is a game of chicken. It is a game detente, forcing the prudent to pay for the profligate or else face the threat of mutually assured destruction.

In terms of the need for bailouts (in Cyprus, Greece, or wherever), it is important to note that the fiscal ‘bad’ behavior has already been committed. Money was spent foolishly in the past and, as a result, current debts are too large to be repaid. How these debts are ultimately forgiven will weigh on all parties, even those who did not benefit from the unwise spending. It is frustrating, it is unfair, but it simply is the reality that must be overcome. It would be ideal if the parties with savings would simply share these savings and forgive unpayable debt, but this is not realistic behavior (nor could it be, as every debtor would ask to be forgiven, which also is not viable). This is only to say that the situation is unfortunate and frustrating.

Perhaps a crisis will spur a solution, though there is no guarantee of this. Alternately, another crisis could lead to a rise in popular support for local factions that favor severing ties with debtors rather than share such debts (meaning garner support for leaving the Euro).

There are too many possible permutations to predict how this will play out in the coming days. Even if the governing powers allay fears now, this news could resonate with investors/depositors when subsequent banks fall under duress in the future.

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