This weekend, European policymakers opened up a new front in their ongoing war on common sense. The details of the Cyprus bailout included a bail-in of bank depositors, small and large alike. As should have been expected, chaos ensued as Cypriots rushed to ATMs in a desperate attempt to withdraw their savings, the initial stages of what is likely to become a run on the nation's banks. Shocking, I know. Who could have predicted that the populace would react poorly to an assault on depositors?
Everyone. Everyone would have predicted this. Everyone except, apparently, European policymakers.
The situation remains fluid, with even the final hit to depositors still unknown. The Financial Times is reporting that authorities are considering altering the plan to shift the burden on the tax away from smaller depositors. Moreover, at this point it is not clear is the parliament will concede to the measures despite a last minute push by ECB officials to affirm the deal before markets open Monday. And the impact on other nations in the European periphery remains unknown.
At this point, I would imagine the damage is done, regardless of any modification of the plan. Cypriots know that their savings are now on the bargaining table. To be sure, there will be repeated reassurances that this is a one-off event, but how trustworthy are such assurances? Indeed, if Greece is any example, this will not be the last bailout, and thus plenty of time for the European policymakers to insist on another bite at the apple. Perhaps if authorities completely backtrack on the plan could they stave off a bank run, but even on that I am not confident. Trust is easy to lose and hard to earn.
The bigger question is what does this mean for the European financial system as a whole? Will depositors across the eurozone view Cyprus as a unique situation? Or will Greek citizens come to believe that the next tranche of bailout funds might come with a new conditions to shore up government finances? Will taxes on deposits be an element of any future bailouts? If so, Italian and Spanish depositors might come to view their mattresses as safer than the bank.
Perhaps expectations of a broader bank run are premature. Early reports from Spain claim that no such run is in the making (of course, what else would they say?). But I suspect this is still a game-changing event, sure to make the financial system more unstable by aggravating the negative feedback loop that surrounds financial crises. What else could be the case when you remove a basic safeguard against panic in the banking system?
I can only sample the amazing amount of excellent commentary in response to this new development. Frances Coppola, in a must read piece, explains the economic consequences:
The effect of large and small depositors removing funds on that scale will be a brutal economic downturn as the money supply collapses. In particular, the dominant financial sector will suffer a severe contraction, putting thousands of jobs at risk and paralysing lending to Cypriot households and businesses. And that is IN ADDITION to the estimated 4.5% economic contraction that is already happening due to austerity measures imposed on Cyprus in 2012 to reduce its fiscal deficit, and the further measures required in this bailout.
Yes, exactly how will this help Cyprus emerge from their recession? If you guessed "it won't," you are correct. But expect European policymakers to drone on about how their plan will restore confidence in the economy of Cyprus. Coppola also bemoans the culpability in the ECB:
The FT confirms the ECB's role in forcing through the deal. It says the ECB threatened to stop providing liquidity to Laiki, Cyprus's second-biggest bank, which would have caused an immediate disorderly collapse. I have written previously about the ECB's disgraceful behaviour. This is the worst example yet.
Just two weeks ago I implored the ECB not to do anything stupid. They didn't listen.
Like me, Karl Whelan is challenged to see that this was a good choice:
Even if we get through the next week without panic, my gut feeling is that this decision is a bad one and the Europeans should have chosen from the other two options on the table. Over the longer-term, I doubt if financial stability in the euro area (and the continued existence of the euro) is compatible with a policy framework that doesn't protect the savings of ordinary depositors.
Nick Rowe points out that savers in Cyprus are suffering disproportionately because they lack the ability to print their own currency:
The difference is that inflation from printing too much money is a tax on currency too. Cyprus cannot tax currency; it can only tax bank deposits.
Joseph Cotterill (another must read piece), identifies the reason to spread the pain to small depositors:
The spin that this is about spanking money-launderers is rubbish. The 9.9% levy will be the cost of doing business for the average CIS corporate shell, as Pawelmorski notes. More to the point, someone clearly balked at increasing the rate above 10% for big-ticket depositors - because why else distribute pain to small holders to make up for it. Someone has an eye on Cyprus somehow maintaining a future as an offshore banking centre.
Too big a hit to large depositors would end any hope that Cyprus could hold onto its biggest industry. The anonymously penned Some of it Was True blog wonders if there are any rules in European finance:
Probably of more lasting importance is the latest bout of rule-changing by the authorities. Debt unwindings are generally well-defined in law. First equity, then sub debt, then deposits and senior bonds together, and all treated equally. Most of these principles have been tweaked over the last few years, but the tweaks are getting steadily more aggressive. The ECB, holders of Athens-law and foreign law Greek debt all got different treatment; the Dutch didn't restructure SNS Reeal paper, they confiscated it; the Irish banned lawsuits against the ultimate wind-down of Anglo Irish. This is scratching the surface compared with the rule-changes of the past but it's getting steadily more creative.The referee has gone from being quasi-neutral arbiter, to pulling off his black shirt to reveal a Manchester United one underneath and awarding himself a series of penalties. While there's clearly no point in market participants playing the shocked blushing virgin in the face of a situation where the consequences of following the legally-logical steps are socially unacceptable, the uncertainty generated creates costs too.
Edward Harrison (yet another must read) takes a fatalistic view of the news:
It was inevitable that we would be in crisis again. The austerity world view of crisis resolution is completely at odds with the capacity of the eurozone's institutional architecture to handle a crisis. And so, we keep doubling down on the same policy of austerity in exchange for reforms which has created the downward spiral to begin with. I wish I could be optimistic here. But I think it is going to get worse. I hope I'm wrong. And I certainly hope that periphery depositors still have enough faith in the euro to ride this one out. If the Cyprus panic metastasizes, it will get ugly.
Peter Siegel at the FT places the blame on the Germans:
Unbeknown to the Cypriot delegation members as they entered the hulking Justus Lipsius summit building in Brussels on Friday night, their fate was already sealed: their German counterparts wanted about €7 billion [$9B] for the estimated €17 billion [$22B] bailout of their country to come from deposits in the country's banks.
"They were hand in hand with Finns, who were much more dogmatic," said one senior eurozone official involved in the 10-hour marathon talks that stretched until 3am on Saturday morning. "Had that not happened, full bail-in," the official added, using the terminology for wiping out nearly all Cypriot bank accounts.
Felix Salmon see the German influence as bad for Euope and Germany itself:
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.
For their part, the Germans deny responsibility for actions against small depositors:
"It was the position of the German government and the International Monetary Fund that we must get a considerable part of the funds that are necessary for restructuring the banks from the banks owners and creditors - that means the investors," German Finance Minister Wolfgang Schaeuble told public broadcaster ARD in an interview.
"But we would obviously have respected the deposit guarantee for accounts up to 100,000," he said. "But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people."
Bottom Line: In the short-run, the implications for the European periphery might be limited. But, in the long-run, it is hard to see the assault on Cypriot depositors as anything but a step backwards for financial stability in Europe. This crisis remains far from over.