Of course, if you read this blog, you’ve already heard about the incredible (and not certain) actions taken by the government of Cyprus.
Cyprus wants to “tax” every depositor in every Cyprus bank to pay for a banking bailout. The depositors would lose some part of their cash deposits in the bank, and get shares in the bank in exchange for that cash. I am not certain of all of the details, but this appears to be close to the final deal which will be forced on depositors.
The forced and unexpected tax on deposits has called into question the idea that all Euros are fungible. Euros held in banks tend to be the same, but this move shows Euros are worth different amounts depending on the exact bank which holds them and how they are held.
This lack of fungibility insures there will be bank runs whenever the risks to specific countries becomes high. Deposits in Spanish banks are less valuable than deposits in German banks, simply because the risk of Spain being forced to impose a tax to support their banking sector is greater than it is in Germany.
I think this move could be the one that ends the long drama for Greece. Depositors in Greek banks must be thinking they are next in line for this kind of tax. The removal of assets from the Greek banking system will probably cause that economy to further implode – and at that point, why is Greece even bothering? If depositors are going to lose their money, they might as well have some say in how it happens, and that involves leaving the Euro.
Frances Coppola has a great summary of the risks involved with this proposed plan.
“The problem for depositors is twofold, really:
- their liquid assets (cash deposits) will have been replaced with illiquid ones (shares in banks that currently have little market value)
- they are forced to take the risk that the future value of those banks will not compensate them for the money surrendered to the sovereign.
So depositors have an immediate liquidity problem, and the possibility of future real losses.
…
Large depositors will eschew Cyprus in favour of non-Eurozone countries such as Latvia. Small depositors will withdraw funds in cash and stuff their mattresses, or they might buy gold. In fact there has been a slow run on Cypriot banks for some time now, as international depositors withdrew funds due to bailout fears: I expect this run to increase to a flood once banks re-open after the bank holiday.
The effect of large and small depositors removing funds on that scale will be a brutal economic downturn as the money supply collapses. In particular, the dominant financial sector will suffer a severe contraction, putting thousands of jobs at risk and paralysing lending to Cypriot households and businesses. And that is IN ADDITION to the estimated 4.5% economic contraction that is already happening due to austerity measures imposed on Cyprus in 2012 to reduce its fiscal deficit, and the further measures required in this bailout. “Deep recession” is already forecast for Cyprus. A major bank run will be economically catastrophic. And the effect of that economic disaster will be to increase both the fiscal deficit and the public debt as a proportion of GDP. After all, even if the government doesn’t increase borrowing, a collapse in GDP immediately raises the debt burden to unsustainable proportions, spooking investors and causing unaffordable rises in yields on sovereign debt.
One thing we need to remember about bank runs is they are not always logical. Bank runs involve fear and real uncertainty, all tied up with some form of distrust in a lack of getting paid back. It only takes a little bit to start a bank run, because small movements in the amount of deposits have outsized impacts on a banks ability to pay all of the depositors their full deposit.
Remember, Greece has an economy about the size of Indiana. It’s a very small place economically. It would not take much to cause a bank run in Greece which far, far exceeds the willingness of the Eurozone to control. And why would anyone believe the promises made by the Eurozone at this point?
This is why I suspect this move by Cyprus could have impacts far larger than just a haircut on depositors in Cyprus. The move puts every deposit in every problem country bank at risk right now, today. It means a Euro in a Greek bank is worth less than a Euro in a German bank. Euros held in banks are worth less than cash Euros.
This how and why bank runs start. Once bank runs start in Greece, the pressure to leave the Euro will be tremendous. The next few weeks could be interesting for the Eurozone.
Perhaps the Euro is so fragile as to be vulnerable to a bank run in Cyprus, at the periphery of the Eurozone periphery. It just seems like an outsized influence for an economy that is one-twelfth the size of the Greek economy which itself, as you say, is about the size of the economy of Indiana.
The size of Cyprus isn’t the big issue – it is the fact that any writedowns have been forced on depositors anywhere in the Eurozone. Any banks in the weakest member countries will now be suspect- this could happen in Malta or Greece very easily. Once these runs start in the little countries, the entire EZ banking system is going to be under additional stress, which of course increases the pressure for extending the bank run to larger countries, which…
This is an awful idea and I am very surprised they did it.
There are real concerns with this tax making the EZ far more prone to large scale bank runs. Once the bank runs start, the pressure to leave the Eurozone will be gigantic – far, far beyond what we’ve seen in the past.
While the deposit write down may be new, the bank run story in the European periphery is not. Do you really think anyone in Greece keeps more than is absolutely necessary in local banks? Greek depositors have had worse things to worry about than a little write down, like having their entire accounts frozen overnight and then converted into Drachmas at pennies on the Euro.
The same fears should have been in place in Cyprus. That there was something required for a bailout is not a surprise – the only part that is a surprise is the fact depositors are required to pay.
I don’t think there was as much fear of the overnight bad event as most people think. The EZ has been telegraphing every step for months in advance. This recent move for Cyprus changes that entirely. There is now substantial overnight risk in Europe, for the small countries. If the larger countries have exposure, then all of a sudden there is this risk for them as well.
Then, even worse, this was sprung on Cyprus overnight. Is there something else we do not know about which will be shoved down the throat of a larger country? On Thursday, I would have thought not. Today, who knows? I doubt it, but…
My first instinct is that the markets (and twitter) are blowing this out of proportion, but you’re probably right to be cautious. Better to be safe than sorry.
Yes, this is probably overblown. But the precedent is so terrible. I can’t believe they did this. Even if it is just a bunch of Russian near-mafia money. The equity holders need to get wiped out at least, and it is not clear this will happen.
Geoff, think about all those P.O’d Russians It could be one heck of a run on thier remaining 90% after the initial haircut. I don’t think most people would be willing to leave the rest of thier cash there for the taking.
And what is going to happen when the next wave of Euro crisis hits in a bigger country? The bank run might not happen Tuesday, but it could happen anytime in the next year. As soon as finances become strained, a bank run in any euro nation is possible.
It’ll shake out that sub-100k accounts will be left alone, otherwise, we’ll see bank runs all over Europe by the end of the week.