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Monday, March 18, 2013

Cyprus Fall-Out

Just a quick review of Drudge paints a picture of a bail-out plan for Cyprus that was not well thought out, and which may be revised before the week is through.

CNBC News reports that:
Cyprus will put forward a new proposal on Monday under which a tax-free threshold or a lower tax rate for smaller depositors could be introduced, media reports said on Monday, in a move aimed at easing the pain of a bailout agreement which will impose an unprecedented tax on savers.

Banks in the country were shut on Monday for a public holiday, and would remain shut on Tuesday and Wednesday, the agencies said. The news comes amid fears that the decision to force uninsured depositors to fund part of the country's bailout could many prompt savers to withdraw their holdings.

Reuters cited a government source in Cyprus as saying that the country is mulling a tax-free threshold on the bank deposit levy for smaller deposits. It cited a parliamentary official as suggesting that deposits up to 20,000 euros could be exempt. Remaining deposits up to 100,000 euros would be taxed at 6.7 percent and those exceeding that amount at 9.9 percent, the official told the news agency on condition of anonymity.

Earlier Dow Jones cited two unnamed European officials as saying savers with 100,000 to 500,000 euros would face a 10 percent tax, while those with savings over 500,000 euros would be taxed at 15 percent. Those with savings up to 100,000 euros would be taxed at 3 percent, according the report.
Under the original plan, every depositor under 100,000 euros would be taxed at 6.75 percent and those over that amount would face a 9.9 percent tax. The Cypriot Parliament has delayed a vote on the plan to Tuesday, an EU official told Reuters, "to allow time for more negotiations".
Germany also wanted to make clear that taxing the smaller depositors was not its idea. I think this is a P.R. battle that Germany will lose. And the Euro has declined.

Wolfgang M√ľnchau, writing at the Financial Times,warns that taxing the smaller depositors will lead to a bank run in Cyprus, and perhaps elsewhere:
The Germans rejected a loan which they were certain Cyprus would invariably default on. So the sum was cut to €10bn. A depositor haircut was the only way to co-finance this. When they did the maths, they found the big deposits would not have sufficed.

So they opted for a wealth tax with hardly any progression. There is not even an exemption for people with only very small savings.

If one wanted to feed the political mood of insurrection in southern Europe, this was the way to do it. The long-term political damage of this agreement is going to be huge. In the short term, the danger consists of a generalised bank run, not just in Cyprus.

As in the case of Greece, the finance ministers said: “Don’t worry, this is a unique situation”. This is true only in a very narrow legal sense. The bond haircut in Greece is indeed different to the depositor haircut in Cyprus. And when they repeat this elsewhere, it will be unique once more.

Unless there is a last-minute reprieve for small savers, most Cypriot savers would act rationally if they withdrew the rest of their money simply to protect them from further haircuts or taxes. It would be equally rational for savers elsewhere in southern Europe to join them. The experience of Cyprus tells them that the solvency of a deposit insurance scheme is only as good as that of the state. In view of Italy’s public sector debt ratio, or the combined public and private sector indebtedness of Spain and Portugal, there is no way that these governments can insure all banks’ deposits on their own.

The Cyprus rescue has shown that the creditor nations will insist from now that any bank rescue must be co-funded by depositors.
... There are some institutional impediments against bank runs within the eurozone. Some countries impose daily withdrawal limits, ostensibly as a measure against money laundering. Nor is it easy to open a bank account in a foreign country. In many cases, you need to have residency. You may need to travel there in person, and you need to speak the local language – or at least English.

But I would not take too much comfort from those impediments. Once fear reaches a critical mass, people will act, and then a bank run becomes a self-perpetuating process. There has been a lot of complacency about the eurozone crisis in the past eight months.

Many people even thought the crisis was over because Mario Draghi, president of the European Central Bank, gave a lender-of-last-resort guarantee. Bank depositors now understand that if the crisis was over, then that was only because the eurozone had found a new source of funding: their savings.

I have no idea whether or not there will be a bank run in the next few weeks. But surely it would be rational.

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