By James Saft
March 19 Unfair and a bungle it may be, but the plan to levy bank deposits in Cyprus does have its virtues.
This is especially true if the proposed 5.8-billion-euro levy is re-worked to shelter smaller depositors, allowing more of the burden to fall on the huge number of large offshore depositors, many of them from Russia.
The levy is a good thing for Cyprus in two ways: it helps to protect future taxpayers; and it will tend to shrink the island's grossly distended financial services industry. It will drive a stake through the heart of the idea that it is sensible for an economy within the euro area to have a banking system seven times the size of its GDP and will hopefully lead to the withering away of its offshore banking industry.
To be clear, as originally proposed, the bailout of Cyprus banks is an outrage. The terms, which are in flux, included a 6.75 percent levy on all deposits under 100,000 euros, with larger accounts subject to a 9.9 percent hit. Worse yet, senior bondholders, of whom there are few, were entirely sheltered. Natural justice argues for the pain to travel up the capital structure, and with every effort made to entirely shelter small accounts. Given the balance of deposits in Cyprus, this is workable.
"The bank creditor bail-in improves the creditworthiness of the Cypriot sovereign compared to the alternative where an additional 5.8 billion euros worth of bank recapitalization demands were to land on the public sector," Citibank economist and former Bank of England policymaker Willem Buiter wrote to clients.
The same logic holds for other euro zone economies. Introduce the idea that there is not an endless font of public money to rescue risk takers and the risk to the public drops. The flip side - that depositors elsewhere may spark bank runs - might well happen, but the alternative is to create an outsize burden for the state and its taxpayers.
Frankly, if you are a small Cypriot depositor your biggest potential liability isn't confiscation of your cash; it is the destruction of your economy and the capture of your political system by an overly large financial system. Just ask people in Iceland or Ireland.
There has been a rolling global bank crisis since 2007 and thus far, with the notable exception of Iceland which told foreign creditors to whistle, all efforts have centered round shielding risk takers from the consequences of their choices.
Is a Nicosia schoolteacher with 11,000 euros in the bank a risk-taker? No, and he should be shielded. But a Russian with 400,000 euros probably is, just as were those who lent money to Lehman Brothers in 2008 or JP Morgan today. A system in which those people make little calculation of possible loss is a sham.
If we look around the world thus far, bank rescues, and official policy, have generally had as their object easing the burden of debt, rather than rescheduling it. "Foaming the runways" for banks, in the words of former Treasury Secretary Tim Geithner, has taken a variety of forms, from policy that slowed the recognition by banks of their bad real estate debts, to the cost of homeowners, to extraordinary monetary policy and quantitative easing. Negative real interest rates - fixed income yields far below inflation - in the U.S. and much of Europe are a levy on savers every bit as real as what is proposed in Cyprus, and yet no one cries "confiscation."
Many in the euro zone, and elsewhere, would be better off if rather than channeling subsidies to the financial system to support its existing amount of debt we got down to the tough task of rescheduling and reducing debt.
The people of Cyprus, specifically, will be better off if they send a clear signal to the rest of the world that they will be better off not giving them their money to watch.
This is not to say that this is all a policy of sweetness and light. Bank runs are a possibility, as Buiter acknowledges. If banks are solvent, the ECB should lend support. If they are not, then restructure, eating away progressively at first equity, the junior and senior debt, followed lastly by depositors.
For Cyprus particularly shrinking finance will be painful, but unless Germans and Finns decide to make everyone's deposits whole the system is unsustainable and the pain must be allocated. For Europe, this implies that bank finance will become scarcer and more expensive.