Can Little Cyprus Cause Bigger Problems?

Posted by urbandigs

Sun Mar 17th, 2013 09:18 AM

A: I want to get away from the red-hot Manhattan real estate story today, not only because its been the same story for so long now and I'm tired of talking about the same thing over and over, but more so because of the silliness taking place in Cyprus this weekend. That's right, that little island-country floating east of Greece, may cause some bigger problems down the road. It was reported this weekend that the EU will force a bailout of Cyrus's banking system at the expense of savers in the form of a "tax on deposits" up to 9.9% for deposits over 100,000 euros; 6.75% tax for deposits under that amount. Cyprus banks were still struggling from assets held after the restructuring of Greek debt. To avoid a full fledged run on Cyprus banks, officials "took immediate steps to prevent electronic money transfers over the weekend". Now Cyprus's Parliament is in emergency mode, postponing a session to approve the new tax on deposits, but in my opinion, the damage is already done and who knows if this little spark can cause a bigger fire later.

How are investors/savers in Spain, Italy, etc. going to react to this ridicoulous penalty imposed by the EU on Cyprus deposit holders? How does the EU not consider these unintentional consequences of such actions?

Mish states it best in his discuss "Contagion-Begging Actions; Expect Bank Runs Following Cyprus Idiocy":

In Cyprus, a decision was made to screw savers with a 6.75% to 9.9% "Tax" on deposits.

Supposedly this move was made to "avoid unsettling investors in larger countries and sparking a new round of market contagion." In reality, the action was mandated theft, imposed by EU officials to protect senior bondholders.

How can such an action do anything but cause contagion? Why would any rational thinking Spanish person keep any money in Spanish banks? They shouldn't and I suspect they won't.

Rest assured there is going to be vengeance over this action.....and deposit fear will spread everywhere.
I am wondering the same thing. How can this not cause 'deposit fear' as Mish calls it, to spread throughout the weakest parts of the EU?

I don't know, this just seems like a really really bad call from the EU. Forbes already has a title out that seems to agree, "The Botching of the Cyprus Bailout: Worse Than Lehman Brothers":
Hank Paulson badly botched the Lehman Brothers crisis of 2009. But at least he had an excuse. Panicked by the speed of Lehman's meltdown, he had no time for second thoughts. By comparison the German-led group of EU officials who engineered this weekend's Cyprus bank bailout don't have a leg to stand on. Although they had years to consider their options (Cyprus's problems are closely related to, and have long been almost as obvious as, those of Greece), they have opted for a "solution" that amounts to probably the single most inexplicably irresponsible decision in banking supervision in the advanced world since the 1930s.

As my colleague Tim Worstall has pointed out in a well argued contribution yesterday, they have weakened - perhaps catastrophically - the principal pillar sustaining modern banking. This pillar is deposit insurance.
At a time when US equity markets reached new highs and Manhattan real estate "couldn't be hotter", this news brings a few unwelcome storm clouds. Will this be another "non-event" or is this potentially the trigger to something more? It may be worthwhile to keep our eyes on this given the levels of complacency out there (the VIX is at its lowest levels since early 2007).