This last weekend was an example of the motto be careful what you wish for as the bailout of Cyprus turned into a bail in for bank savers there. Whilst Cyprus is only 0.002% of the Euro area economy I pointed out in my update of February 11th that the situation there had the potential to become yet another Euro area debacle.
So she needs help from her Euro area colleagues and the amount required for such a small economy would be like a mouse for an elephant. But as we know mice can unsettle elephants and if we look at an obvious solution which would be a debt haircut we find our elephant does indeed have a problem. You see it was badged as a “one-off”!
Indeed I then went further.
We also know that the “solutions” applied so far in the Euro area have invariably made matters worse and accordingly I fear for Cyprus and her economy.
As I review the shambles that took place over Friday night and Saturday morning I see that my worst fears did in fact come true. I would call the Euro area leaders comedians except for the obvious fact that as Fleetwood Mac put it the result is “Its not that funny is it?”
Cyprus has not been in the Euro for long
It was only on the 1st of January 2008 that Cyprus joined the Euro having used it to replace the Cypriot pound. So it has not taken long to go wrong has it?
Indeed this benefit of joining the Euro quoted by the Governor of the Bank of Cyprus now creates at best a wry smile.
in a stable environment governed by EU laws and regulations
So how did things go so wrong so fast?
I reviewed the situation concerning the Cypriot economy on February 11th but there have been two clashing issues.
1. Cyprus has become a favoured destination for Russian savers with some of the money being heavily suspected to be part of a mafia/oligarch web. In other words there has been a money laundering issue. Getting accurate measures of the scale is difficult but of the 68.4 billion in Cypriot banks as of the end of January some 20.9 billion were from non-Euro residents.
2. This moved from a policing/regulatory issue to a financial disaster when Cypriot banks took the advice given by many of the “experts” favoured by the BBC and decided to invest such funds in Greek government bonds. After all what could go wrong? Also exactly what have the regulators been doing?
As the Greek government bond market collapsed and then was hit by the debt haircut called the Private Sector Initiative as well this plan shot up the list of financial debacles and disasters. The Governor of the Bank of Cyprus put it thus.
The Greek PSI alone cost Cypriot banks nearly 25% of the country’s GDP, because of excessive concentration of Greek debt in the balance sheets of the two largest Cypriot banks.
And of course in a world of privatisation of bank profits but socialisation of bank losses this led to this.
The Cypriot taxpayer is now facing a bank bailout package that could be as high as €10 billion, which is equivalent to over 50% of Cyprus’s GDP. As a proportion of GDP it is one of the largest bank bailouts ever, second only to the 1997 bank bail out in Indonesia.
The proposed solution
Firstly we get the standard response of more austerity.
the adoption of consolidation measures amounting to 4 ½ % of GDP
As the Cypriots considered the downwards push given here to her economy they may have wondered about what “ further measures mobilising internal resources” might be?! Well here they are.
Bank savings/deposits up to 100,000 Euros will be taxed at a rate of 6.75% and those above will be taxed at a rate up to 9.9%
You may be wondering about the bank deposit scheme in Cyprus? Exactly and a rubicon has been crossed here. Those in the know would be aware that Cyprus (like Ireland for example) could not fulfill the promises made by her deposit guarantee scheme but her ordinary citizens are likely not only to have been unaware of this but of course to have been promised exactly the reverse by their leaders. Also there has been an implied European backstop by the way deposit guarantee schemes were all set at 100,000 Euros which suggested some type of joint liability without actually providing it.
If we look for responsibility for this we see that apparently nobody is! Denials are everywhere as we face the prospect of the proposal inventing itself. Actually tucked away in the corner sitting quietly is the European Central Bank which had threatened to withdraw support from Laiki Bank (no more Emergency Liquidity Assistance or ELA) if a deal was not done.
Also in return bank savers will get shares in Cypriot banks. You may think that this adds insult to injury on the current prospects! But the spin is that this is an asset swap rather than a robbery.
Consequences and Issues
There are a world of themes and issues here. Let me start with Cyprus and then widen the discussion to the Euro and the rest of the world.
Cyprus faces economic collapse
1. A weakened economy now has found itself committed to yet more austerity. We know what happens next from what we have already seen elsewhere in the Euro perpiphery. This has been given a further push by withdrawing between 6.75% and 9.9% of the deposits from the banking system. Cypriot residents had 42.8 billion Euros of bank deposits as of the end of January and this will shrink by at least 3 billion Euros now. So another credit crunch has been created with an extraordinary contraction in both the Cypriot money supply and the perceived assets of Cypriots. Actually it was already falling as of the end of January with some 1.7 billion Euros being withdrawn from the banking system.
So there are genuine fears for the Cypriot economy that we could see a collapse on the scale of Greece. Odd is it not that the word “rescue” in the Euro area then leads to a collapse and yes I will update my financial lexicon.
The Euro Area
There are issues here as the rhetoric does not match the actions. Let me quote the European Commission President Jose Barroso.
In other words, in the euro zone, we are now equipped for any crisis
Well apparently not even a relatively minor Cypriot one. Also should he pick up the phone to Russian President Putin he is unlikely to be calling to emphasise this.
President Barroso said that Russia and the European Union are making good progress in a number of areas of common interest
Savers and bank depositors
What has happened over the weekend has emphasised quite a few debating points about the status of savings as it like money,wealth,income and so many other economic concepts faces a challenge. We have two initial impacts for savers, the first emotional and the second factual.
1. Shock and surprise no doubt followed by fear for the future.
2. An actual financial loss.
If we move on from the contractionary effect of this we get to some economic theory.
Savings and bank deposits are a (usually) short notice loan to a bank. The modern era of electronic banking and at times instantaneous movement of funds has moved the general perception away from this. In practice bank deposits have often become more flexible and usable than cash itself as we found ourselves at times asking the question,what is money?
But as has happened so often in the credit crunch era (some of this has been by chance and some by deliberate disinformation and misrepresentation) the flexibility which has made bank deposits look more like cash indeed if I may put it this way have more “cashness” than cash has hidden another trend which is that bank deposits have become riskier and riskier. How much the risk has risen depends to some extent on where you hold your money but in an increasingly interconnected system of “too big to fail” you cannot fully escape it.
I am sorry if this comes as a shock and I repeat that a lot of effort has gone into disinformation in this area so if you feel cheated right now then I feel that you are right to do so. For example consider bank savings guarantee schemes are often not of the scale required although there is an element here of this being a Euro area problem as at the limit countries like the US or UK can simply print more cash to settle debts in a way that individual Euro members cannot. However of course money printing has issues for the exchange rate and inflation as we are reminded yet again of the concept of Catch 22.
Where this has really lurched forward over this weekend is the way that one can call what has happened an asset-swap. Now whilst this is technically true we have seen a swap from an asset with value (cash) to one of little or no current value such as Cypriot bank shares. Otherwise there would be no point! We hit here a very significant point and we are right up to date which is the shift from a bank deposit to equity. I believe that this is very wrong and is a perversion of genuine finance but we cannot rule out that it will happen again and if you are not involved in Cyprus this is what is most significant about what has just taken place. The rules of the game just changed.
I have covered some fundamental issues today and consider this to be one of my thematic posts to which I intend to return. But before I leave the conceptual debate I would like to point out where this has really gone wrong. Those who point out there are two sides to a balance sheet in their rush to include savers and their money in their schemes need also to deal with the debtors too rather than only the savers. In the phrase balance sheet is the word balance after all…
As to events they are spiralling around today as new numbers emerge and then disappear and we have even had a rumour that Gazprom of Russia will step in. But perhaps the clearest signal of the omnishambles taking place is that the Central Bank of Cyprus is unsure whether tomorrow will be a bank holiday or not!