· arch 17, 2013, 12:00 PM
Observations On Cyprus
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By Stephen Fidler
The Cyprus bailout agreement that emerged Saturday morning in Brussels has already spurred some thoughtful observations. Without going over similar ground, here are some other thoughts.
Finding the path of least resistance: Euro-zone decision making is not a matter of grand design or of optimizing outcomes, but a question of finding the path of least resistance. It’s messy, and deals are usually forged at the last minute by sleep-deprived ministers.
Because of Cyprus’s special characteristics–a huge and weak banking sector relative to the size of the economy with a small amount of debt, and a relatively small marketable government debt, mostly issued under English law—on this occasion the path of least resistance was to tax bank depositors.
It is hard to see another euro-zone economy where other options would not be easier than burning depositors. On the other hand, if it isn’t to be the last bailout, it will probably be the last where foreigners bear the brunt of losses. In other peripheral countries, government bondholders and bank depositors are overwhelmingly domestic.—which means big knock-on effects for domestic economies in the event of restructuring.
One close observer* told me a month ago: “The IMF wants a sustainable solution, the Finns an Icelandic solution and the Germans a cheap solution.” Translated: The International Monetary Fund didn’t want to make its Greek mistake and wanted a deal from the outset that would cut debt to levels that Cyprus could credibly repay; Finland wanted to burn deposit holders; and Germany wanted to minimize its contribution to the bailout. Hence, Saturday morning’s deal.
The decline of sovereign immunity and the major difference between creditors operating under domestic law and those under English or New York law: In Greece and now in Cyprus, investors holding bonds not governed by domestic law have escaped without restructuring. In both cases, the amount of such foreign-law bonds was not decisive, but the disinclination to restructure them—and thereby risk lawsuits and asset seizures—is significant and may be reinforced by the outcome of the court actions in New York between Argentina and its creditors..
Let banks grow at your peril: Three European countries where banks grew to multiples of GDP—Iceland, Ireland and Cyprus—have been brought low.
Euro zone=political poison: Was this the shortest-ever honeymoon for an incoming government? The political costs seem likely to be high.
Property rights are conditional in a financial crisis: There seems to be widespread shock that bank deposits are not sacrosanct, and are being taxed by the government. But taxing is what governments do, and this is the kind of thing that happens in a financial crisis–though often property rights are diluted less dramatically, through inflation. Faisal Islam of Britain’s Channel Four points out that British depositors in Cyprus are still probably better off, even after a 6.75% tax, than they would be had they kept their deposits in the U.K., where savings accounts have been yielding less than inflation for some years and where the pound has devalued against the euro.
Finally, it’s clear that solidarity among governments in the euro zone is limited and conditional, and that euro-zone creditors are increasingly inclined to mix “bail-ins” with their “bailouts.” But while getting debt down to sustainable levels is essential to escaping the crisis, in the short-term it can undermine financial stability. While this is threatened, the European Central Bank and its satellites have to step in—as we shall probably see when Cypriot banks open their doors again. The less governments step in to help others out, the more the central bank provides the essential glue keeping the euro zone together.
*UPDATE: He’s since said I can quote him. It was Mujtaba Rahman, senior analyst at Eurasia Group.
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