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.

Bank Holiday in Cyprus

What happens when it's lifted? A bank run?

Echoes of 1933: the Cyprus Heist by David Beckworth

The Cypriot Haircut by Krugman

You can sort of see why they’re doing this: Cyprus is a money haven, especially for the assets of Russian beeznessmen; this means that it has a hugely oversized banking sector (think Iceland) and that a haircut-free bailout would be seen as a bailout, not just of Cyprus, but of Russians of, let’s say, uncertain probity and moral character. (I think it’s interesting thatMohamed El-Erian manages to write about this thing, fairly reasonably, without so much as mentioning the Russian thing.) 

The big problem, however, is that it’s not just large foreign deposits that are taking a haircut; the haircut on small domestic deposits is a bit smaller, but still substantial. It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

Why some people are concerned. What is Krugman implying about El-Erian?

Bubbles, Gorton, Krugman and Cyprius-Iceland-Ireland.

The Яussians Are Coming! The Яussians Are Coming! by Krugman

...
As long as you haven’t bought into the Barney-Frank-did-it school of thought, you realize that the global crisis of 2008 was in a fundamental sense made possible by the erosion of effective bank regulation. As Gary Gorton (pdf) has documented, we had a 70-year “quiet period” after the Great Depression in which advanced countries had very few major financial flare-ups; Gorton argues, and most of us agree, that the key to this quietness was a constrained, regulated financial system that also limited the opportunities for excessive non-bank leverage. 

But this regulation in turn depended, to an important extent, on limited international capital flows; otherwise regulations made in Washington or elsewhere would have been bypassed via havens like, well, Cyprus. And once capital controls began to be lifted in the 1970s we entered an era of ever-bigger financial crises, starting in Latin America, then moving to Asia, and finally striking the whole world. 

So what are we going to do about this? Cyprus, as a euro-zone country, should really be part of a euro-wide safety net buttressed by appropriate regulation; it’s insane to imagine that the euro can be run indefinitely with merely national deposit insurance. But euro-area deposit insurance doesn’t seem to be in the cards — and anyway, there are plenty of other potential Cypruses out there. 

All of which raises the question, is the era of free capital movement just a bubble, fated to end one of these years, maybe soon?

"It's almost as if Europe is trying to start a bank run." by Matt O'Brien

Keynan Socialists are Diamond-Dybig people and believe (shadow) banking systems are vulnerable to bank runs.

Steve Landsburg on Gary Gorton and the origins of the financial crisis

The last time I blogged on this subject, our astute commenter Bennett Haselton raised a very good question: Bear Stearns is presumably not just sitting on Fidelity’s money; they’re investing it somewhere. Why can’t that investment serve as Fidelity’s collateral? The answer, if I understand Gorton correctly, is that the repo market is a very short-term market, typically 24 hours. For Fidelity to verify the quality of Bear Stearn’s investment project would take a week or so, by which time it’s too late for the information to be of any use. Fidelity’s ongoing concern is that Bear Stearns is pawning off its shakiest investments; to allay that concern requires due diligence; due diligence takes time; the repo market is all about getting things done NOW.

So what should we do about all this? Gorton, along with his colleague Andrew Metrick, argues that the repo market, like any banking market, is inherently susceptible to runs and therefore ought to be regulated. In this case, the regulations should focus on insuring the availability of sufficient high-quality collateral to keep depositors calm. Gorton observes that the existing policy responses to the crisis (e.g. the Dodd-Frank bill) do pretty much nothing to address this fundamental need. The Gordon/Metrick paper contains some specific proposals, which unfortunately Gorton never got to in yesterday’s talk.

(via Thoma)