Deposit Protection Racket

22/03/2013 at 2:58 pm

“Nice banking system you got there. Be a shame if something … happened to it.”

Obviously this paraphrases the lengthy talks which took place earlier this month between the Cypriot government and the Troika – the biggest, most powerful and most ruthless gang of organised cross-border lenders in the world. But it is the case that the Troika’s three bosses (the European Commission, ECB and IMF) have their desperate borrower firmly by its heart and mind. Impertinent Cyprus initially tried to stop the Troika taking a cut of its bank deposits, voting it down in its little parliament on Tuesday. So Cyprus was given the chance to vote again (and get it right this time, or else). We shall see, probably tonight, whether Cypriot lawmakers give up some of their bank deposits in return for being allowed to keep the system as a whole propped up by Troika lending.

The idea of a government-sponsored bank raid might have seemed outlandish a few years ago. What is truly fascinating about the events of recent days, however, is the equanimity which has met them. Like the reaction to the elections in Italy we wrote about last week this surely has something to tell us about the current level of market confidence.

After all, we have been somewhere very similar before. Almost two years ago, scary demands from lenders were emerging about something called “private sector involvement” (PSI) – the idea that holders of Greek bonds should share the pain of bailing the country out with European taxpayers. Initially a German idea, it was approved by Merkozy (remember them?) and in due course officially adopted as part of the restructuring arrangements for Greek sovereign debt last year.

At the time, PSI caused chaos. As this blog observed on 8 July 2011, for example:

… Markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.

From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.

It really was pandemonium: no one knew what was going to happen, and almost everyone was panicking.

This time the background is the same. Deposit-holders have taken the place of bondholders; a dangerous precedent is being set; there is the risk of cross-border contagion in the eurozone and elsewhere; the whole plan was an unexpected surprise. But this time the panic is missing. Peripheral eurozone bond yields have not shot higher, equity markets are not materially weaker and the euro is about where it was a week ago.

Part of the explanation may lie in practicalities. Punishing Greek bondholders was a larger-scale and more arbitrary exercise than going after Cypriot banks. Cyprus is a country half the size of Wales with a population of 1.1m. It has GDP of about €18bn, and less than $1bn in gold and foreign exchange reserves. And yet it has €68bn of bank deposits, about a third of which are estimated to be of Russian origin.

This latter estimate is necessarily imprecise. The attraction of Cyprus as a banking centre lay in a combination of many things: low tax rates, an accommodating approach to offshore investment, a common law heritage which recognises the validity of trusts – and strict rules on banking secrecy. Suspicions of money laundering improprieties were raised months ago and led to an investigation of money laundering controls as a precondition of the Troika’s bailout.

Nonetheless, whatever one thinks of the properness of Cypriot banking, the sanguine response to the confiscation of bank deposits in a eurozone country is noteworthy, and especially so in the context of PSI and the reactions to it at the time.

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