THE CYPRUS DEPOSIT “TAX”: “DON’T CRY FOR ME (NICOSIA)!”

3/18/13

Cyprus’s looming decision to effectively confiscate part of every bank account in the country as a means of partially financing a bailout of the Cypriot banking system is the big financial news story today, and deservedly so.  Whether I can say anything spectacularly original about the story I don’t know, but perhaps I can add some fresh insight.

Like legions of others, I am appalled that, should this proposal pass (As of this writing, the vote in the Cypriot parliament has been postponed until Tuesday and the banks will remain closed until Thursday.), the new law will run roughshod over centuries of corporate law and established business practice.   While the senior debt of the banks will remain unscathed, depositors, who are at least pari passu (equal in terms of liquidation payouts…not a literal Latin translation) with and probably at least structurally senior to the senior debt, will take hits ranging from, at this writing, 3% to 15% depending on how much money they have in the bank.  Deposit insurance will make no difference; as of this writing, insured and uninsured depositors will pay the same “tax.” This defies both law and practice and certainly rattles the confidence not only of insured depositors but also of investors.  The ramifications for the reliability of deposit insurance are obvious.  In addition, bondholders and potential bondholders, and not only in Cyprus or even only in Europe, have to be asking something like “If the government can override law and established practice to benefit me, why can’t it do the same thing to hurt me?”   This does not create an environment that is conducive to prudent risk taking.  

On the other hand, one might easily, and justifiably, retort that the bondholders’ rights were ignored in the bankruptcies of General Motors and Chrysler.   Many of us bemoaned the abuse of the law in those cases and predicted dire consequences for the bond markets and the investment environment in general.   So far, though, we have seen no effects.  It’s as if no one cares.   But remember that people, and especially the current generation of financial, political, media, and business leaders, have a hard time dealing with the long run.   Their sense of history is lacking and their memories, and attention spans, are short.

Sure, there are extenuating circumstances here.   Cypriot banks are unusually heavily funded by deposits, so there aren’t many senior bondholders to go after.   (But there are plenty of uninsured deposits; uninsured deposits exceed insured deposits in the Cypriot banking system and, as the Wall Street Journal pointed out in today’s (Monday, 3/18’s) editorial on the subject, it looks like relatively modest “tax” on uninsured deposits could raise the 6 billion or so euros expected of depositors in the bailout deal.)   Cypriot banks are havens for money laundering and other nefarious financial finagling, and any deposit tax will thus hit, say, Russian gangsters much harder than the Cypriot in the street.  And, after all, Cyprus is too small to set much of a precedent. There were also extenuating circumstances in the GM and Chrysler bailouts, though.   But the law is the law and is not to be brushed aside due to extenuating circumstances.   Politicians, and others who would like to take your money, can always come up with extenuating circumstances.

There are many who are assuring us that there will be no runs on European banks because the European Central Bank (“ECB”) has at its disposal an assortment of tools, including its aggressive use of Long Term Refinancing Operations (“LTROs”) to keep the banks solvent and/or liquid.  But such mechanisms would be useful in this situation only in an indirect way, if at all.   In this case, a run would not have its genesis in a fear that depositors’ money will disappear; a run would emerge from the fear that a portion of seemingly insured deposits will be seized in the form a one time deposit “tax,” as in Cyprus.   Instead of “I’d better get my money out before it’s all gone,” the fear would be “I’d better get my money out before the government takes (some) percent of it.”   The motivation would be different, but the result would be the same.  At that point, such mechanisms as the LTROs would be brought in to stem the chaos, but the chaos would have wrought its damage, and possibly would continue.

U.S. markets don’t seem to much care about Cyprus; they closed today (Monday, 3/18/13),the first trading day after news of the planned deposit tax leaked, down only modestly after a tougher night in Asia and a wild ride here.  But, again, memories and attention spans are short among the people who seem to matter in today’s world, as is the sense of history of those same people to whom we, perhaps foolishly, entrust so much.