Cyprus: The bank ‘rescue package’ designed to destroy the economy?

March 18, 2013 – CYPRUS - Even though the haircut of bank deposits had been on the agenda of the EU for more than a month now, featuring in Commission memos and being openly discussed by European politicians, most of whom, refused to rule it out, few people thought the Eurogroup would go ahead with it. It was an idle threat, to force Cyprus privatize SGOs and increase the corporate tax, was the prevailing view. And after all, President Anastasiades had emphatically declared in his inauguration speech that “absolutely no reference to a haircut on public debt or deposits will be tolerated,” adding that “such an issue isn’t even up for discussion.” Finance Minister Michalis Sarris made similarly reassuring statements, arguing that it would be lunacy for the EU to impose such a measure because it would threaten the euro system. The decision to impose an unprecedented all-out haircut on Cypriot deposits was a painful one, but it was the only option to avoid bankruptcy of the state, said President Nicos Anastasiades yesterday. Germany and the leaders of the Eurogroup opted for this lunacy, calculating that Cyprus is too small and inconsequential for the haircut on its bank deposits to cause contagion in the eurozone. Of course, the markets could view the decision differently, perhaps not when they open on Monday, but a few weeks later as it becomes apparent that not even deposits in European banks are safe from raids by the Eurogroup. It is obvious from the statements made that Anastasiades was blackmailed into accepting this euphemistically called ‘solidarity levy’. If he did not accept it, the European Central Bank would not provide Emergency Liquidity Assistance to the Cypriot banks, after the March 21 deadline (it had been extended by two months in January) and the banks would have collapsed on the same day, with people losing much bigger parts of their deposits than the seven to 10 per cent that would be taken now. The eurozone struck a deal on Saturday to hand Cyprus a bailout worth €10 billion, but demanded depositors in its banks forfeit some money to stave off bankruptcy despite the risks of a wider bank run. The one-off levy on bank deposits agreed between Nicosia and international creditors will impact all Cypriot account holders. Monday was declared a bank holiday, and electronic money transfers with the troubled banks were unilaterally frozen. Cyprus residents awoke to the news, that they had been outwitted. Thousands lined up at banks to withdraw their funds out of ATMs before banks reopen on Tuesday. In addition to Cypriot commercial and co-operative banks, Barclays, Russian Commercial Bank and Societe Generale, among others, would be affected. One deputy yesterday wondered whether it would be better to allow the two banks that required liquidity assistance from the ECB to go under instead of accepting the haircut. But the problem would not be confined to these two banks as there is inter-dependence among the banks and a bank run on two would spread to all. This will be Anastasiades’ main argument in explaining why he agreed to the bail in of deposits. The alternative would have been the collapse of the banks, state bankruptcy and exit from the euro. Under the circumstances the president opted for the lesser of two evils, even though we doubt there would be many people who would give him credit for that. In effect, the EU offered a ‘rescue package’ that is designed to destroy, rather than rescue what is left of the Cyprus economy. –Cyprus Mail TEP

Cyprus bailout shock unsettles markets across Eurozone: Bailing-in depositors with banks in Cyprus is a serious policy error that will destabilize the European banking system and threatens to accelerate bank runs in future. There is a good reason deposits have been the most protected form of bank liabilities. It has nothing to do with fairness. Deposit protection is the most successful banking policy enacted in the last 60 years. It has banished the runs that plagued banks and savings institutions in the early 20th century, leading to the suspension of thousands of banks a year in the early 1930s, and which erupted again briefly in the mid-1980s, felling hundreds of savings and loans in the United States. If European policymakers need reminding about the terrible dynamics of a bank run they need only consult Robert Bruner and Sean Carr’s monograph about “The Panic of 1907,” or “Integrity, Fairness and Resolve,” the history of the savings and loan crisis published by the Federal Reserve Bank of Kansas City. “Depositors knew all too well what to do,” in the savings and loan crisis, the Kansas Fed wrote. “They gathered up their lawn chairs, thermos bottles ad portable radios and lined up outside the banks as if they were embarking on a familiar American outing. In a sense they were. Only two months ago, depositors across the U.S. witnessed scenes right out of the Great Depression during a panic that temporarily shutdown Ohio’s privately insured thrifts,” according to the Fed, quoting from contemporary news reports. Bank runs are rational when depositors fear they may not be able to get all their money back, or face lengthy delays. But what is individually rational, is collective madness. –Reuters

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