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EU Tips Its Hand on Cyprus Precedent, Markets Gasp


Earlier today, Cyprus reached a deal with the EU and the IMF to get its desperately needed €10 billion bailout package. The outlines of the deal are very broadly similar to the one floated last week and then voted down in Cyprus’ parliament, but with several notable twists: while depositors with less than €100,000 in savings would be spared, the larger depositors at the two biggest Cypriot banks would take bigger hits than they would have before. In addition, senior bondholders, which many had assumed were safe, stood to lose some of their money as well.

It turns out the markets, which had been calm throughout the heated negotiations leading up to this morning’s announcement, weren’t all that pleased with this outcome. Exacerbating the market’s reaction were the poorly chosen words of Jeroen Dijsselbloem, the Dutch Finance Minister and President of the Euro Group, a meeting of the Finance Ministers of the Eurozone countries:

Speaking to the Financial Times and Reuters, Mr Dijsselbloem said the relative market calm in recent months, coupled with the lack of market panic following the decision to force private investors and depositors to pay for the bailout of two large Cypriot banks, allowed the eurozone to go after private money more aggressively when banks fail.

The Wall Street Journal reported that Mr. Dijsselbloem soon walked back his unfortunate words (on Twitter, no less!), saying that despite what he might have claimed in his interview, Cyprus was a unique, one-off case and didn’t set a precedent for European responses to future crises.

But the damage was done: there was a selloff in the markets, especially in Europe’s banking sector. And though there was a limited recovery toward the end of the day, Mr. Dijsselbloem’s words can’t have been completely forgotten by investors and savers alike. As Felix Salmon noted, no matter what policymakers say and unsay, the game has subtly changed, and it could have real consequences for the rest of the troubled European periphery:

The chances of European banks being allowed to fail are higher now than they were pre-Cyprus. As a result, we should expect uninsured deposits to continue to flow from the periphery of Europe towards the center. Which in turn means extra pressure on Italian and Spanish banks, just when it’s least needed.

Solving Cyprus wasn’t going to be easy or clean no matter how the Europeans approached it. And it certainly can be argued that there was no other way for the Europeans to deal with this particular case. After all, bailing out a bunch of wealthy Russian depositors was not going to fly in Berlin or any of the other European capitals.

But we’re far from being out of the woods here. The pain is only just beginning for Cyprus, and it could easily get intolerable in a hurry. Exiting the euro is not yet out of the question in some powerful Cypriots’ minds, and the real consequences of such an exit may not have been gamed out properly, given how cobbled together and last-minute the Europeans’ response has been thus far.

[Jeroen Dijsselbloem, courtesy of Wikimedia Commons.]

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  • ojfl

    This is a very dangerous precedent and maybe that is the problem unnerving the markets. The precedent of confiscation of property without due process is wrong, morally and legally. And if that is the way these problems will be solved, what happens when Spanish banks are insolvent? What happens if Italian banks get in trouble next? How is the Euro going to sustain that kind of confiscation f wealth?

    • Damir Marusic

      This is not to defend how the Europeans have gone about this, but it’s worth noting that as far as due process, what has happened is not extra-legal.

      Small depositors will be spared. The EU guarantees deposits up to €100,000, not unlike what the FDIC does here in the US. And that is being honored.

      Much like in the US, those above the insurance limit are out of luck. Savers in effect lend money to the banks and get interest as payment in return. If the bank goes belly-up, they shouldn’t expect to be made whole.

      The Cypriot ‘deal’, as I understand it, was to unwind the two biggest banks according to existing law. This is why the deal doesn’t get voted on in parliament. And in that case, the big savers aren’t the first in line to collect.

      Still, as a precedent (if it is a precedent!) it should make big depositors look hard at their Spanish and Italian assets, as you say.

      • ojfl

        Damir Marusic,

        thank you for the answer. But the question still remains. Maybe I am not as versed in the European banking system as I should but I was under the impression that each country could still have some independence in their banking system. So, how would Cyprus, independently, solve these problems? Would they have the same resolutions?

        • Damir Marusic

          I’m not sure they can independently solve these problems as long as they don’t control their own currency. They can only default. In which case, again, people lose money.

          • Andrew Allison

            With respect, I fear that you don’t grasp what is happening: The government is guaranteeing insured deposits, and the creditors will get what’s left. If Cyprus did have control of its currency, it would solve the problem via devaluation, which would have the effect of impoverishing everybody. At least this way the insured depositors keep their buying power.

          • Damir Marusic

            @AndrewAllison:disqus We don’t disagree: that’s precisely what I’m saying. Or were you replying to someone else?

          • Andrew Allison

            We have a fundamental disagreement: You argue that Cyprus can’t “solve these problems as long as they don’t control their own currency.”, I argued that the cure you suggest would be worse than the disease in that the insured depositors would also be impoverished.

          • Damir Marusic

            I was responding to the question of what else could have Cyprus done for itself. The answer was basically: not much, apart from devaluing if they weren’t on the euro. I was not necessarily suggesting it as a preferable cure.

            That said, I do think much of this mess stems from Cyprus (and Greece, and to lesser extents Spain, and Italy, and France) being on the euro in the first place.

      • rvastar

        The EU guarantees deposits up to €100,000, not unlike what the FDIC does here in the US. And that is being honored.

        For now. But the lesson to be gleaned from this is that laws are not rights, a concept that too many politically naive Westerners don’t understand.

        All such “guarantees” are meaningless when the laws governing them can simply be changed or replaced whenever unelected EU bureaucrats decide to do so. And while the overwhemingly Leftist news media in the West can seek to fool the public with their neverending obfuscation and blame-shifting as they try to shield overreaching govts from any culpability for the 2008 economic collapse and it’s lingering effects, markets are smarter than that. This money-grab by the EU is a bridge-too-far, and my prediction is that it will have the same effect as Chavez’ nationalization of Venezuela’s oil resources – i.e, it will serve as the wake-up call to investors, as they realize that when you dine with the Devil, you will always be left holding the check.

        Much like in the US, those above the insurance limit are out of luck. Savers in effect lend money to the banks and get interest as payment in return. If the bank goes belly-up, they shouldn’t expect to be made whole.

        Too bad the same sentiment doesn’t apply to Western voters who have freely chosen the govts that have ruined their nations’ economies. They shouldn’t expect to be made whole either and should suffer through the hard consequences of their actions…without being able to use govt as some sort of mob enforcer, squeezing wealthier citizens for more and more “protection” money.

    • Andrew Allison

      It is not any kind of precedent, but simply a restatement of long-standing practice. The markets have, perhaps, been assuming that the eurozone would continue its recent policy of socializing bank losses.

  • Vagabundus

    This response limits the moral hazard of privatizing profits and socializing losses like the U. S. To big to fail policies. They are not seizing 40% of deposits, but guaranteeing 60 % of them. Without the ECB bailout, all you get is €100,000 and any amount over that is a total loss.

    They should thank the EU for their generosity, and be mad at the Greeks who’s deceit led them to this result, the banks employees who made the mal-investment, and the regulators who did not stop them earlier.

    • Tom

      On the other hand, the Cypriots have a right to be somewhat annoyed, considering the rather…stringent conditions the ECB initially laid on them, when the people who’ve been causing this whole mess (the Greeks) seem to have only gotten a slap on the wrist by comparison. While the two countries are not quite in the same situation, to say that Cyprus should be thanking the ECB for its generosity, especially when the ECB is really only doing this to save their own skins, is rather patronizing.

  • Philopoemen

    Isn’t Cyprus a bit of an oddball case, almost Luxembourg-ish? I seem to recall it’s a banking haven for rich Russians. Can this really be extrapolated onto the rest of the EU?

    • Damir Marusic

      Probably not directly, no. Banks in Spain (probably) and Italy (certainly) really are too big to fail. But why go on record and talk like this, then? (From the FT article above):

      “Taking away the risk from the financial sector and taking it on to public shoulders is not the right approach,” said Mr Dijsselbloem, who is also the Dutch finance minister.

      “If we want to have a healthy, sound financial sector, the only way is to say: ‘Look, where you take the risks, you must deal with them, and if you can’t deal with them you shouldn’t have taken them on and the consequence might be that it is end of story’,” he added. “That’s an approach that I think we, now that we are out of the heat of the crisis, should consequently take.”

      It’s not wrong what he’s saying. Depositors shouldn’t in all cases be bailed out by taxpayers. Banks make mistakes, and people who put vast sums of money in them need to take these risks into account.

      But it sure seems like a bad idea to be saying it this loudly right at this very moment.

      • Philopoemen

        It certainly isn’t very tactful, but at the same time does anyone really believe the EU can keep indefinitely pouring money into every bank that shows signs of trouble? That obviously isn’t sustainable – should he say what investors want to hear, or say the unspoken truth that everybody already knows?

        • Damir Marusic

          There’s always the option to say nothing all. Politicians are usually good at that.

          • Andrew Allison

            With respect, the whole point of the exercise was to make it clear that the days of socializing eurozone bank losses are over.

          • Damir Marusic

            I guess we’ll have to wait and see. I doubt they’re categorically over in any and all cases. I’m not certain we’re even done with Cyprus. Their banks are still not ready to open.

        • Mark Michael

          The government regulators who deemed sovereign debt as riskless and then tolerated those governments to borrow too much, lie about their books (claim to be keeping their budget deficits below 3% of GDP when they were playing games) and not reassess that “riskless” rating makes them culpable. The ECB employees, the national CBs should all be punished in a serious way. Instead, they never even get a slap on the wrist. They are a key failure point in this system. In fact, they are the “root of all evil” in this bad melodrama! They should be the upright ones who are the policeman who blows the whistle first. Instead, they are deaf, dumb, and blind for far too long.

  • John Burke

    It’s hard to think of anything more destablizing to banking than government-sponsored seizure of deposits or even the prospect of such a seizure (if I had deposits in a Spanish bank, I absolutely would have removed them last week). I think it would be far better to put the insolvent banks into some form of bankrupcy, honor the €100,000 insurance, and let larger depositers, who assumed the risk when they made uninsured depisits, get whatever they get. Granted, this might be ruinous to the Cypriot economy and potentially disruptive to the wider banking sector. However, the ECB, Germany, Russia and others could still intervene to soften the blow and contain it at whatever cost they were willing to bear. The total cost of the workout would be shared by the banks, their shareholders, bondholders and larger depositors, the Cyprus state, and outsiders, but the promise of no risk deposits would be clearly honored.

    • Andrew Allison

      “The total cost of the workout would be shared by the banks, their
      shareholders, bondholders and larger depositors, the Cyprus state, and outsiders, but the promise of no risk deposits would be clearly honored.” is exactly what has transpired.

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