The draft proposal on the table to bail out Cyprus consists primarily of closing one bank--Popular Bank of Cyprus, also called Laiki Bank--transferring deposits of 100,000 Euros or less to another large bank called Bank of Cyprus, and freezing deposits exceeding 100,000 Euros. The frozen assets, which evidently amount to somewhat over 30 billion Euros, will be used to fund Cyprus' share of the cost of the bailout (5.8 billion Euros). How much frozen account holders will ultimately receive is unclear, since the funds for paying them out would have to come from bad assets of Laiki Bank--defaulted loans and the like. The hit they will sustain apparently could be large.
At first glance, this revised bailout appears not unlike bank liquidations as seen in the U.S. Account holders with insured deposits (i.e., at or below the $250,000 threshhold) are fully protected, and those holding excess balances are at risk, taking losses if the assets of the bank don't fully cover the nominal value of their accounts. But the Cyprus bailout is different.
The process by which Cyprus and the EU got to where they are today was one of political fits, false starts, near collapses and last minute expediency. The first proposed bailout included a levy on all deposits, a proposal which the Cypriot legislature roundly rejected. After scrambling futilely for assistance from Russia, the Cypriot government bowed to the stern diktat of the European Union that depositors be tapped. But both the EU and the Cypriot government wanted to protect insured deposits (those of 100,000 Euros or less), so the burden had to fall on deposits in excess of the insured amount. And because Laiki Bank is suspected to be the bank of choice for a supposed den of money launderers, tax evaders and other scoundrels, the blade fell on its large depositors. Large depositors at other banks were spared the guillotine.
What's missing is the due process of law. There isn't even a flimsy facade of legal due process. This isn't an ordinary liquidation of a troubled bank. Cyprus got into financial trouble, asked for a bailout, was told by the EU that a Cypriot contribution would be a prerequisite, and only then did Cyprus figure out who would pay the piper. The ultimate resolution is politically driven, not the result of the application of established legal procedures.
If the large depositors of Laiki Bank are iniquitous Russian oligarchs as some EU officials have hinted, one can't feel terribly sympathetic about their plight. Legality doesn't seem to have played much of a role in the way many wealthy Russians acquired their riches. But, ordinarily, modern nations seize property only in accordance with the rule of law. If a bank depositor isn't proven to be liable, for one lawful reason or another, then he or she shouldn't be deprived of property.
It wasn't Robin Hood, or even Jesse James, who absconded with the assets of large depositors of Laiki Bank. It was the sovereign governments of the European Union. When governments depart from the rule of law, capital will start exiting stage right. Large depositors in any EU nation that's financially shaky will likely behoove themselves to move their capital to safer places. The shaky countries may get shakier. The EU tries to present the Cyprus situation as a unique, one-time problem. But how many well-to-do depositors want to leave their money at risk, in case that's not true?
The EU will enjoy a near-term rebound from the Cyprus bailout. But longer term, it encounter trouble attracting the capital it badly needs to rebound from recession and fuel future growth. And it may well find that dealings with one of its major energy suppliers--Russia-- will take sharper tone. When the due process of law isn't applied, some people start thinking that might makes right. And that would be unfortunate for Europe, given the history of the last century.
Showing posts with label Cyprus. Show all posts
Showing posts with label Cyprus. Show all posts
Monday, March 25, 2013
Monday, March 18, 2013
The Central Banks' Failure to Eliminate Risk
Now, it's Cyprus--tiny Cyprus, with 0.2% of the EU's GDP--that's shaking up the financial world. The Asian stock markets are falling on Monday, March 18, 2013, and stock futures indicate that the European and U.S. stock markets are also headed downward. Runs have already started at Cyprus' banks, and a bank holiday was declared for Monday, in order to stop the outflow of rats from the ship.
The proximate cause of the panic is a proposed EU bailout for Cyprus that includes taking from depositors at its banks 6.7% of deposits under 100,000 Euros, and 9.9% of deposits exceeding 100,000 Euros. Surprisingly, this tax (which is to help pay for the bailout) would hit small depositors that were supposed to be fully insured up to 100,000 Euros. The bailout violates a sacrosanct principle of bank regulation--that deposit insurance cannot be impaired. Deposit insurance is the key to depositor confidence, and the foundation of commercial banking. America's banking system recovered from the Great Depression (which saw thousands--yes, thousands--of bank failures) only when deposit insurance was instituted. If you scare depositors, an entire banking system can go belly up in less time than it takes to scramble a couple of eggs.
The powers that be which fashioned the Cyprus bailout--the EU, the European Central Bank and the IMF--imposed the depositor tax because of the somewhat shady doings of Cypriot banks. They extended the scope of their businesses way beyond their home island, accumulating assets amounting to twice the size of Cyprus' GDP. Reportedly, around half of their deposits are from Russians, and suspicions of money laundering, tax evasion, and other alleged shenanigans lurk. The stolid burghers of northern Europe have been wrinkling their noses over the unsavory aromas rising from Cyprus' banks, and they evidently view a tax on depositors as fair compensation for the trouble the EU is now being put to.
Whether or not the deposit tax is fair is, from a commercial standpoint, pretty much irrelevant. The financial markets thrive on confidence. The EU's financial crisis eased last summer when the head of the European Central Bank said, in substance if not words, that he would authorize the printing of money to prop up failing EU member nations. The bond vigilantes backed down. But the Cyprus bailout's tax on deposits is the opposite of money printing, and implies that losses are possible for holders of deposits in banks at other weak EU nations. There's nothing that shakes confidence like the prospect of losses, especially if one was supposed to be insured against them.
The financial markets have been coasting on a mellow buzz from toking up on central bank monetary accommodation. Ultra low interest rates and quantitative easing have taken the edge off volatility, and the markets seem to know no fear. But there is no way to eliminate financial risk. You can only transfer it somewhere. The Cypriots apparently wanted to transfer the risks and costs of their bankruptcy as far north as they could. But the folks up north didn't seem to cotton to that notion. So the risks and costs blew back, and as we now see, blowback can be nasty.
Who knows how this will all end. No doubt high ranking officials on both sides of the Atlantic are engaged, even as we write, in frantic discussions to figure out how to prevent the spread of financial contagion. The baseline problem is that the EU as a whole hasn't decided how to allocate the costs of resolving its financial crisis. This is probably a harder problem than the resolution of the U.S. government's current dysfunction, since, in Europe, people from disparate countries and cultures must somehow find common ground. Since these are the same people who fought two horrendous World Wars against each other in the 20th Century, it remains unclear if they will succeed.
In the meantime, remember that central bank monetary policy can provide a methadone high, at best. It won't last forever, and the aftermath may be a real downer. It's fine to feel good about the financial markets right now. But keep in mind that the central banks cannot eliminate financial risk, and if you relax your vigilance, risk could bite your left ankle in a flash.
The proximate cause of the panic is a proposed EU bailout for Cyprus that includes taking from depositors at its banks 6.7% of deposits under 100,000 Euros, and 9.9% of deposits exceeding 100,000 Euros. Surprisingly, this tax (which is to help pay for the bailout) would hit small depositors that were supposed to be fully insured up to 100,000 Euros. The bailout violates a sacrosanct principle of bank regulation--that deposit insurance cannot be impaired. Deposit insurance is the key to depositor confidence, and the foundation of commercial banking. America's banking system recovered from the Great Depression (which saw thousands--yes, thousands--of bank failures) only when deposit insurance was instituted. If you scare depositors, an entire banking system can go belly up in less time than it takes to scramble a couple of eggs.
The powers that be which fashioned the Cyprus bailout--the EU, the European Central Bank and the IMF--imposed the depositor tax because of the somewhat shady doings of Cypriot banks. They extended the scope of their businesses way beyond their home island, accumulating assets amounting to twice the size of Cyprus' GDP. Reportedly, around half of their deposits are from Russians, and suspicions of money laundering, tax evasion, and other alleged shenanigans lurk. The stolid burghers of northern Europe have been wrinkling their noses over the unsavory aromas rising from Cyprus' banks, and they evidently view a tax on depositors as fair compensation for the trouble the EU is now being put to.
Whether or not the deposit tax is fair is, from a commercial standpoint, pretty much irrelevant. The financial markets thrive on confidence. The EU's financial crisis eased last summer when the head of the European Central Bank said, in substance if not words, that he would authorize the printing of money to prop up failing EU member nations. The bond vigilantes backed down. But the Cyprus bailout's tax on deposits is the opposite of money printing, and implies that losses are possible for holders of deposits in banks at other weak EU nations. There's nothing that shakes confidence like the prospect of losses, especially if one was supposed to be insured against them.
The financial markets have been coasting on a mellow buzz from toking up on central bank monetary accommodation. Ultra low interest rates and quantitative easing have taken the edge off volatility, and the markets seem to know no fear. But there is no way to eliminate financial risk. You can only transfer it somewhere. The Cypriots apparently wanted to transfer the risks and costs of their bankruptcy as far north as they could. But the folks up north didn't seem to cotton to that notion. So the risks and costs blew back, and as we now see, blowback can be nasty.
Who knows how this will all end. No doubt high ranking officials on both sides of the Atlantic are engaged, even as we write, in frantic discussions to figure out how to prevent the spread of financial contagion. The baseline problem is that the EU as a whole hasn't decided how to allocate the costs of resolving its financial crisis. This is probably a harder problem than the resolution of the U.S. government's current dysfunction, since, in Europe, people from disparate countries and cultures must somehow find common ground. Since these are the same people who fought two horrendous World Wars against each other in the 20th Century, it remains unclear if they will succeed.
In the meantime, remember that central bank monetary policy can provide a methadone high, at best. It won't last forever, and the aftermath may be a real downer. It's fine to feel good about the financial markets right now. But keep in mind that the central banks cannot eliminate financial risk, and if you relax your vigilance, risk could bite your left ankle in a flash.
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