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Posts Tagged ‘Cyprus’

Cypriot Bungled Bailout Matters

Posted by Steve Markowitz on March 30, 2013

The European Union’s first bailout attempt of Cyprus was a dismal failure.  That plan included a tax on all bank deposits that was rejected by the Cypriot Parliament.  A more recent deal scraps the tax on depositors, but will still include losses for depositors and bondholders.

Cyprus’s largest bank, Laiki Bank, will be wound down with major bondholders taking losses.  In addition, depositors with over €100,000 will be penalized.  Some of Laiki Bank’s debt will be moved over to the Bank of Cyprus, the country’s largest lender, which will survive after the bailout.  However, many Bank of Cyprus depositors facing losses over 50% of their assets.  Since this will not be a tax it does not require Cypriot parliamentary approval.

Cyprus is a meager part of the European Union’s GDP, less than 1% with less than 1 million residents.  The banking crisis became a much larger problem for Europe for two reasons.  First, Cypriot banks became haven for foreign investors, mainly Russian making its banks eight times larger than the entire economic output of Cyprus.  In addition, as part of the European Union, allowing it to implode risk contagion to other peripheral EU countries.  Finally, it should be noted that the Cypriot banks took huge losses and became insolvent because of its holdings of Greek sovereign bonds, another EU basket-case.

While Cyprus’s is an insignificant piece of the European Union’s economy, the way the crisis has been “resolved” will likely lead to huge consequences for Europe going forward.  Unlike in other EU bailouts, Cypriot depositors were forced to take haircuts on deposits.  This brings into question an issue not raised in Western banks since the Great Depression; the safety of deposits.  If the issue is contained to Cyprus, it will be insignificant.  However, it is only a matter of time before depositors in other weak European countries become concerned about the safety of their bank deposits.  This will lead to a run on those banks.  Prime candidates are Italy and Spain, countries that are indeed “too big to fail”, but at the same time the EU does not have the assets to bail them out.

The bailout of Cyprus is reported to cost the EU less than $10 billion.  Given this relatively small amount as compared to the total European Union GDP, why have they risked so much for the future of the larger EU banking system?  The answer is political.  Germans voters are wary of the bailouts of weaker neighbors and Andrea Merkel’s party faces an election.  This tough approach to Cyprus is designed to mollify German voters.  However, in the long run it places much more at risk for European unity.

Another interesting question is why the fiscally conservative Germany remains part of the European Union with its many weaker and fiscally irresponsible partner countries.  The answer is self-interest.  Germany is much more efficient than its southern partners.  In previous years these countries could have lowered the value of their currency to become competitive against Germany.  With the creation of the Euro, the cost of products from these inefficient countries has risen compared to Germany’s products.  Is not surprising, therefore, that while Spain’s unemployment rate is currently 25%, Germany is a mere 6%.  While the cost of the bailouts for Germany is high, the cost of dissolving the European Union would be even higher.

With the template of the Cypriot bailout in place, the EU has made it policy that under some circumstances it will demand member states seize depositor assets as a price for bailing out its banks.  The message for depositors in European peripheral countries is clear; should banks in your country become financially at risk, your deposits will also become at risk.  Human nature demands action of these depositors.  Depositor funds will move from weaker countries to stronger ones, thereby exasperating the already existing financial strain on weaker European countries’ banks.  This has the makings of Europe’s next banking crisis and it will be the result of self-inflicted wounds.

Posted in Banks, European Union | Tagged: , , , , , , | Leave a Comment »

Cypriot Parliament Rejects European Bailout

Posted by Steve Markowitz on March 19, 2013

Yesterday we posted Cyprus Bailout Taxes Bank Deposits that reviewed the proposed bailout of Cypriot banks by the European Union.  The entire banking system in Cyprus is insolvent and requires a bailout from the European Union, which means from Germany.  Germany has a case of bailout fatigue after the bailouts of Ireland, Greece and Portugal.  Prior to agreeing to the proposed Cypriot bailout, the EU placed some unique demands on Cypriot bank depositors in the form of taxing the deposits.

Today the Cypriot Parliament not surprisingly rejected the bailout plan with not one politician voting in favor of it.  Even if taxing bank deposits was reasonable, no politician could survive in a democracy by agreeing to such terms.

The European Union and its Central Bank should have understood the political realities of their proposed Cypriot bailout, but instead with arrogance proposed a plan that could not be approved by the government.  There is a more dangerous aspect to this error than merely bad judgment.  Should depositors in other European banks fear for the safety of their deposits, contagion could result in runs on banks far outside of Cyprus.  Should that type of panic begin it is hard to determine where will end.

It would not be surprising to see upward pressure on the price of gold as a result of the Cypriot bailout fiasco.

Posted in Bailouts, Banks | Tagged: , , , , , , | Leave a Comment »

Cyprus Bailout Taxes Bank Deposits

Posted by Steve Markowitz on March 17, 2013

Cyprus is a miniscule part of the 17 country European Union accounting for only 0.2% of the EU’s total economic output.  Its total economy is valued at only €18 billion.

Cyprus has become the fourth EU country requiring a bailout after Ireland, Portugal and Greece.  Spain has so far avoided an official bailout, but its banks have been given assistance by the European Central Bank.  Other countries are not far behind including Italy with a much larger economy.

This weekend the European Union announced a bailout of Cyprus that includes an unusual requirement.  In return for €10 billion, CNN reported that all depositor accounts in Cyprus’s banks will be taxed a one-time fee on Tuesday.  Those with less than €100,000 in deposits will pay a tax of 6.75% and those with over €100,000 will pay 9.9%.

Not surprisingly citizens of Cyprus have responded with panic, mobbing ATM machines in attempts to withdraw deposits.  However, the banks placed a limit on withdrawals of only €400 and it is reported that there is a shortage of cash.

After making the announcement, Cyprus’s President Nicos Anastasiades justified the action Sunday saying, “A disorderly bankruptcy would have forced us to leave the euro and forced a devaluation”.  In other words, Anastasiades offered the same Progressive doubletalk that the steps were required to protect the people.  However, this justification will be more difficult to accept given the tax levied on depositors.

The reality of the Cypriot bailout is similar to bailouts that have occurred for banks and sovereign debt throughout the world in recent five years.  These actions were taken to protect the banks and their investors, both private and sovereign investors. These flawed policies have also resulted in economies worldwide jumping from one crisis to crisis in a downward spiral.

Attempting to pay for bailouts by taxing bank depositors is a ratcheting up of wealth redistribution towards the financial sector, protecting large banks and fiat currencies.  While the policies may have some success in the first two goals, this move in Cyprus will increase the pressure on fiat currencies.  It is only a matter of time until fear contagion spreads.  If the Cyprus can take money from bank depositors to pay for the irresponsible behavior of others, it is only a matter of time until other countries take similar steps.

In justifying bailouts and irresponsible government spending, those supporting these actions often refer to the learned economist John Maynard Keynes who was a proponent of government spending to offset slowdowns in the private sector.  However, such rainy day Keynesians ignore the second half of Keynes’ theory that requires governments to save for a rainy day during more vibrant economic times.  This part of the equation has not been met in decades.

Economist Keynes was well aware of the dangers of inflation and the related issue of governments debasing a fiat currency.  Keynes’ written below in a 1919 essay says it all.

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some…. Those to whom the system brings windfalls… become “profiteers” who are the object of the hatred…. the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right.  There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.  The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

Posted in Bailouts, European Union | Tagged: , , , , , , | 2 Comments »