Here is a rant about events in Cyprus. Normal dispassionate service will resume here at the Mule in the next post.
Over the weekend, the European crisis took a sickening new twist in Cyprus. The government of Cyprus announced a “levy” on Cypriot depositors as part of a deal to secure a bailout of its ailing banks by international lenders. In doing so, it has dramatically demonstrated how completely Cyprus and other eurozone nations have surrendered their sovereignty to the technocrats of the European Commission, the European Central Bank (ECB) and the IMF.
The president of Cyprus Nicos Anastasiades has told his citizens, subject to getting the numbers in parliament, his government is about renege on past promises and appropriate the savings of pensioners to make good the failings of others. This is not the first time that the global financial crisis has claimed innocent victims, but it is perhaps the most striking example of this phenomenon.
Cyprus’s financial woes stem from the fact that their banks had significant investments in Greek government bonds. Back in March 2012, as part of the bailout of Greece, investors in these bonds suffered a “haircut” of 53.5%. Somewhat less euphemistically, holders of these bonds lost more than half of their investment. This left Cyprus’s banks in deep trouble and, while negotiations with Europe for a bailout continued, the ECB kept them afloat with emergency funding. The threat of suspending that ECB support was the gun to Anastasiades’s head that led him to agree to the disgraceful bailout scheme.
As the European crisis has rolled on, the European technocrats have become increasingly committed to “private sector involvement” (PSI). At face value, the principle is sound. The use of public money to rescue private sector banks leads to moral hazard. If lenders to banks expect to be bailed out, they may be tempted to allow banks to be ever more reckless in their risk-taking.
When a bank suffers losses, there is a hierarchy that determines who will suffer losses. The hierarchy typically works like this: investors in the bank’s shares are the first lose their investment; next to lose are investors in so-called “hybrid debt” (not quite lending, not quite equity, this includes things like preference shares); if the bank has issued “subordinated debt”, investors in these securities come next, followed by “senior debt” providers (typically in the form of bank-issued bonds). Depositors are the last to lose money and retail depositors with small balances typically have additional protection in the form of deposit protection provided by the government or a government agency*.
Depositor protection is extremely important. Despite being private companies, banks provide a critical role for the smooth running of an economy and so cannot be left at the mercy of the “creative destruction” of capitalism. In today’s society it is not really possible to opt out of the banking system and simply being paid a wage requires a bank account. It would be impractical, inefficient and unreasonable to expect every retail depositor to analyse the financial health of their bank before choosing where to deposit their money. When a bank collapses, shareholders should lose money. Wholesale investors should lose money. Retail depositors should be protected.
This reality is not lost on the lawmakers of Cyprus and for over 10 years, Cyprus depositors have supposedly been provided with deposit protection on balances under €100,000. The details of the levy have not yet been finalised, but the initial proposal involves a levy of 9.9% on all deposit balances over €100,000 and 6.5% on all deposits below €100,000. Anastasiades has effectively said, Oh, that deposit protection scheme? Well we had our fingers crossed when we made that promise. That explains the weasel word “levy” or “tax”. Of course your deposits are still protected against losses. You will not suffer a loss, it’s just that there’s a new tax we’re bringing in…
As if this dramatic breach of faith was not enough, there is no moral justice here either. Like Ireland before it (and indeed Australia), Cyprus did see rapid growth of private sector debt in the lead up to the crisis. So why not levy the tax on reckless borrowers not prudent savers?
Cyprus should rue the day that it surrendered its sovereignty by joining the euro zone in 2008. Cyprus would still be facing economic challenges today, but it would be free to determine its own fiscal policy, stimulate the economy (if it managed to keep politically-motivated deficit hawks at bay) and, of course, it would be able to honour its promise to protect retail depositors.
* Before the financial crisis, Australian depositors had no deposit protection. The assumption was that prudential oversight of banks provided sufficient protection for depositors. That changed after the crisis and now deposits below $250,000 are protected.