Money & Finance - Bail-out in Cyprus

Note: This was written over the week-end so events have been in constant flux. It seems there has been a delay in Parliamentary voting on this issue.

As we write this blog, we are seeing the terms of a new Cyprus banking bailout. True the total annual output of the Cypriot economy is only 17 billion euros representing just 0.2% of the combined eurozone economy. Granted their bailout needs are much smaller (17 billion euros) compared to Greece (380 billion euros), Ireland (85 billion euros), Portugal (78 billion) and the Spanish bank bailout of 41 billion.

Yet what completely blows my mind about this bailout is that Germany and the ECB have proposed that the depositors in the Cypriot banking system cover some of the cost.

The DEPOSITORS!

Imagine having to contribute up to 10% of your bank deposits towards the bailout of the very banking system you trusted to keep your money safe.

This is somewhat unprecedented.

I immediately consulted with one of our partners that specialize in international banking to confirm my understanding of the situation. It appears all banking accounts under 100,000 euros will have 6.75% of the funds seized. Accounts over 100,000 euros will have 9.9% seized. And then the Eurozone's emergency lending facility and the International Monetary Fund will inject the remaining amount to keep the banks alive.

The Cyprus government will also have to hike corporate tax to 12.5 percent from 10 percent and sell off state assets so as to help balance the public finances.

This is an answer to the long standing problem that has defined the Cypriot banking system as an offshore haven for nefarious Russian banking transactions.

By bailing out the banking system, they will in essence hurt the undesirable customers that have been a large part of their banking in the past. To quote our partner, the ECB and Germany are using a defibrillator to resuscitate the patient only to hit them over the head with a hammer.

European Bank Run

What happens when other Europeans learn that their deposits may not be as safe as initially conceived? Without knowing the true intentions of the ECB, on the face of it many may say hey…I’d better get my assets out of the bank before that happens to me. When large groups of individuals and institutions look to withdraw at once, you get something that looks like the great depression or 2008.

“Other depositors at weak banks all over Europe, in places like Spain, Italy, and Greece, will rightly wonder whether this is the beginning of a new era of bank bailouts, an era in which bank depositors are going lose some of their money.

What do you think those other depositors in Spain, Italy, Greece, etc., are going to feel like doing when they realize that, if their banks ever need a bailout, they might have their deposits seized?

That's right.

They're going to feel like yanking their money out of their banks.” - Henry Blodget, Business Insider.

Arguments Against

Taken from the Economist Schumpeter blog, they lay out the pitfalls quite eloquently from these series of actions.

“Whatever the rationale, it is a mistake for three reasons. The first error is to reawaken contagion risk elsewhere in the euro zone. Depositors have come through the financial crisis largely unscathed. Now they have been bailed in, some of them in breach of an explicit promise that they can be sure of getting their money back even if a bank goes belly-up.

Euro-zone leaders will spin the deal as reflecting the unique circumstances surrounding Cyprus, just as they did the Greek debt restructuring last year. But if you were a depositor in a peripheral country that looked like it needed more money from the euro zone, what would your calculation be? That you would never be treated like the people in Cyprus, or that a precedent had been set which reflected the consistent demands of creditor countries for burden-sharing? The chances of big, destabilising movements of money (into cash, if not into other banks) have just shot up.

The second error is one of equity. There is an argument to be made over the principles of bailing in uninsured depositors. And there is a case for hitting everyone in Cypriot banks before any taxpayer in another country. But there is no moral imperative for whacking Cypriot widows and leaving senior bank bondholders untouched, as appears to be the case here; or not imposing any losses on sovereign-debt investors in Cyprus; or protecting depositors in the Greek operations of Cypriot banks, as has also happened. The euro zone may cloak this bail-out in the language of fairness but it is a highly selective treatment. Indeed, the euro zone’s insistence that this is a one-off makes that perfectly plain: with enough foreigners at risk and a small enough country to push around, you get an outcome like Cyprus. (That is one reason why people are now wondering about the implications of this deal for little Latvia, also home to lots of Russian money and itself due to join the euro zone in 2014.)

The final error is strategic. The Cypriot deal has no coherence in the larger context. The euro crisis has been in abeyance for a few months, thanks largely to the readiness of the European Central Bank to intervene to help struggling countries. The ECB’s price for helping countries is to insist they go into a bail-out programme. The political price of going into a programme has just gone up, so the ECB’s safety net looks a little thinner.”

Bottom Line: This action taken by the Euro zone takes them down a slippery slope. Just as the uncertainty stemming from European banking stability has taken a backseat, this action has the potential to cause a flare-up of skittishness that will surely provide a headwind for today’s stock market rally.

- Joseph S. Kalinowski, CFA

References

http://www.businessinsider.com/economist-slams-the-cyprus-bailout-2013-3

http://www.economist.com/blogs/schumpeter/2013/03/cyprus-bail-out

http://www.businessinsider.com/cyprus-bailout-risks-europe-bank-runs-2013-3#ixzz2NoZ66oWb

http://www.businessinsider.com/cyprus-bailout-risks-europe-bank-runs-2013-3#ixzz2NoZkdSJp

http://www.businessinsider.com/cyprus-bailout-deal-2013-3#ixzz2NoaGKgKh

http://www.businessinsider.com/cyprus-bailout-deal-2013-3#ixzz2NoaRzMwY

http://www.businessinsider.com/cyprus-bailout-russian-angle-2013-3

http://www.businessinsider.com/cyprus-bailout-deal-2013-3

http://www.businessinsider.com/cyprus-bailout-statement-by-the-president-of-the-republic-mr-nicos-anastasiades-2013-3#ixzz2NoflyW6V

http://pawelmorski.wordpress.com/2013/03/16/cyprus-a-brutal-lesson-in-realpolitik-2/

 

 

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