Cyprus bank run

Bank holiday ends Thursday morning.

From Lehman to Cyprus by Floyd Norris

The European decision not to honor deposit insurance in Cyprus, by making all depositors contribute to the cost of a bailout, reminds me of the decision to let Lehman Brothers go under. Moral hazard is being avoided. The question is what that will cost. 

In the case of Lehman, the cost turned out to be far greater than anyone expected. Suddenly the crisis was affecting money market funds. We learned to our discomfort just how interrelated the world’s markets were. I doubt anyone involved in making the decision thought about money market funds until they learned one had just blown up, thanks to the Lehman failure.

 Andrew Ross Sorkin says not to worry:

There is very little chance that politicians would ever choose to use the model they developed in Cyprus in a country like Italy or Spain, where a run on the banks would have such profound implications. By the way, if you’re wondering why investors left so much money in troubled Cypriot banks, here’s a trivia question: Would you have been better off leaving your money in a bank in the United States or in Cyprus over the last five years? 

The answer: You would have been better off in Cyprus, even after the bailout, when your money was “confiscated.” If you had 100,000 euros in a Cypriot bank account over the last five years, where the interest rate has averaged about 5 percent, you would have about 127,600 euros today. Even after the bailout, which would require you to give up 10 percent of your deposit — 12,760 euros — you would be left with 114,840 euros. The American bank? The $100,000 you deposited at Bank of America five years ago is about $105,100, at the going rate of about 1 percent interest a year.

Germans wouldn't risk a run in Italy or Spain? Investors might not want to risk it if Cyprus gets messy.

 Cyprus Set to Reject Bailout

Cypriot banks were closed Monday for a bank holiday that has been extended through Wednesday. 

The governor of the Cypriot central bank, Panicos Demetriades, warned lawmakers on Tuesday that as much as 10 percent of the €65 billion in deposits placed in Cypriot banks would flee the country as soon as banks’ doors open Thursday morning, should Parliament approve the deposit tax.

Cyprus Bailout Incites Turmoil as Blame Flies

What happened next sealed the deal, which now appears to be coming apart amid strong protests from ordinary Cypriots. Jörg Asmussen, a German member of the executive board of the European Central Bank, told Michalis Sarris, the Cypriot finance minister, that stopgap financing for Cyprus would be cut off this week if no agreement was reached. 

Mr. Asmussen’s message “really did sharpen the thinking of Mr. Anastasiades,” said a European official with knowledge of what happened during the talks but who spoke on condition of anonymity because they were conducted in private. 

“The Cypriot president understood clearly he faced the collapse of his banking system and disorderly exit from the euro area,” said the official. 

What emerged was a deal that took a bite out of average savers, one that made sense in the wee hours between the dealmakers. In the light of day, as Cypriots tried desperately to pull their savings out of A.T.M.’s, it looked like a threshold that many experts say should never have been crossed.

Taxing Savers in Cyprus

Any tax on smaller accounts would set a terrible precedent. Savers in other troubled economies like Italy, Spain and Greece are now justifiably worried that their deposits may someday also be stripped of protection. 

European leaders have said that taking money from Cypriot bank deposits is a singular event, but this assurance will ring hollow in light of their poor track record in dealing with the euro crisis. The plan has now given savers in Spain, Italy and other countries incentive to withdraw money from their national banks or move it out of the country if they have offshore accounts. 

Imposing a bigger tax on deposits of more than 100,000 euros would not have the same ripple effect on confidence. A large percentage of those deposits belong to Russian businessmen, some of whom have reportedly laundered money through the island’s banks. These sophisticated investors were well aware of the risks they were taking by putting their money in offshore accounts, and Cyprus should not try to protect them at the expense of local depositors. 

Cypriot officials created this catastrophe by relying on a lightly regulated banking industry to drive up its growth rate while encouraging foreigners to use the island as a tax haven. European officials also deserve blame for not requiring more capital in euro-zone banks and for not anticipating the consequences of lowering the value of Greek bonds. They should not add to those mistakes with a punitive package that is disastrously counterproductive.