Cyprus bank deal wipes out some large depositors, will confiscate up to 40% from others

The quest to make the Great Cyprus Bank Heist more “progressive” appears to have found its unappealing Holy Grail, as word comes this morning of a new asset seizure deal that will keep the little people from suffering any losses… by soaking the ever-loving hell out of large depositors.

Under European Union banking laws, the first 100,000 euros (about $130,000 U.S.) are protected by deposit insurance, a guarantee that last week’s bailout deal would have voided by seizing 6.7 percent from the balance of insured deposits in every bank, while taking 9,9 percent from everything over 100,000 euros.  This deal sparked public outrage and was unanimously voted down by the parliament of the EU’s smallest nation.

Now they’ve decided to honor the insurance protection of deposits up to 100,000 euros, while considering just about everything over that limit to be fair game.  (And they’re not going to take any chances on having the new deal scuttled by the legislature – it reportedly won’t be brought up for a vote.)  In fact, the Cypriot government doesn’t even feel it needs to specify how much it will take, or from whom.  Various government ministers have said they might end up seizing 30 to 40 percent of accounts over 100,000 euros, and if I’m reading this Bloomberg News report correctly, some of the depositors at the defunct Cyprus Popular Bank could lose just about everything over the 100k insurance limit:

The revised accord spares bank accounts below the insured limit of 100,000 euros. It imposes losses that two EU officials said would be no more than 40 percent on uninsured depositors at Bank of Cyprus Plc, the largest bank, which will take over the viable assets of Cyprus Popular Bank Pcl (CPB), the second biggest.

Cyprus Popular Bank, 84 percent owned by the government, will be wound down. Those who will be largely wiped out include uninsured depositors and bondholders, including senior creditors. Senior bondholders will also contribute to the recapitalization of Bank of Cyprus.

The dissolution of the CPB will wipe out thousands of jobs, and that will only be the beginning of the island republic’s economic woes.  The outsized banking sector, a major component of the Cypriot economy, will never recover – no large depositor in his right mind will ever put more than 100,000 Euros at the mercy of their government again, and it will not be forgotten that even balances below that EU insurance threshold were threatened.  The EU’s long-term plan for Cyprus called for it scale its debt down to 100 percent of GDP over the next decade, but that’s laughably unrealistic now; as the economy collapses, a rise to 140 percent debt-to-GDP is more likely.  A swift loss of over 20 percent of the national Gross Domestic Product has been predicted.  With its economy permanently crippled, Cyprus might become entirely dependent on an endless stream of bailouts and rescue loans.  From a BBC report:

The chairman of the Cypriot parliament’s finance committee, Nicholas Papadopolous, said the agreement made “no economic sense”.

“We are heading for a deep recession, high unemployment. They wanted to send a message that the Cypriot economy ought to be destroyed, and they’ve succeeded in a large part – they’ve destroyed our banking sector,” he told the BBC.

EU Commissioner for Economic Affairs Olli Rehn conceded that the “depth of the financial crisis in Cyprus means that the near future will be difficult for the country and its people”.

European markets reacted positively to news of the new Cyprus deal, which is understandable, since there were fears of a complete banking sector collapse, or a massive unconditional EU bailout that would soak taxpayers throughout the rest of the Union.  But the “contagion” of the new Cyprus bailout agreement might be as difficult to contain as the old one would have been.  A feeding frenzy of cash-strapped governments grabbing a share of every insured bank deposit was a short-term nightmare, but the notion of amounts over the insurance limit growing even less secure could have long-term ramifications for Eurozone business and investment.  Here’s a curious comment from the BBC regarding the justification for today’s Cyprus bailout deal:
There is concern on the Mediterranean island that a levy on large-scale foreign investors, many of whom are Russian, will damage its financial sector.

Correspondents say Germany has pushed hard for a levy on investors who have benefited from high interest rates in recent years, rejecting a Cypriot plan to use money from pension funds.

Message to investors: benefit from high interest rates today, and money-hungry governments could take it all back tomorrow, and then some.

Escape from the clutches of the Cypriot government will not be permitted.  The UK Telegraph reports that border officials are searching luggage and confiscating amounts over 10k euros.  Use of debit cards and ATMs to access bank balances is still restricted – there is word that the amount Cypriot depositors can pull from ATMs each day will be reduced – and so is large-scale capital movement.  Owners of timed savings deposits, the sort of financial instrument that matures and pays interest in six months or a year, won’t be allowed to terminate them prematurely… or collect the money when they mature, as rolling such deposits over for another increment will be mandatory.  (Are the member states of a single-currency union supposed to restrict capital flow in this manner?  Imagine Illinois taking measures like this to crack down on capital flight into neighboring states.)

Russia, whose citizens have a huge amount of money in Cypriot banks, is hopping mad about the new deal.  Prime Minister Dmitry Medvedev snarled, “In my view, the stealing of what has already been stolen continues.”  The Telegraph reports that the Kremlin plans to freeze German assets in Russia in retaliation.  Germany is seen by both Russians and Cypriots as the driving force behind the bailout deal.

Analysts around the world are debating the implications of the Cypriot crisis.  Everyone says that having a such a huge banking sector perched atop a tiny economy is unwise… but did that actually cause the crisis that led to dissolving these banks and asset seizures?  Is there any threat of such a calamity occurring in other small-nation bank havens, such as the Cayman Islands?  James Saft at Reuters points to what the Cypriot banks did with all the money they were sitting on, in order to earn enough profit to continue offering high rates of return:

Cyprus is struggling under the weight of a bloated and dangerously shaky banking sector which has grown to more than seven times the size of its economy, largely on the back of taking in off-shore deposits from wealthy Russians. While this is a risky business model for an economy under the best of conditions, it becomes a disaster when that huge banking sector invests heavily in domestic real estate and Greek debt, both of which have plunged in value.

Saft, like many other analysts, assures nervous Americans that nothing like that could ever happen here.  But one of the reasons he cites is the U.S. government’s ability to manipulate the dollar through measures like quantitative easing – a strategy unavailable to Cyprus, which is part of the euro, and thus cannot control the currency.  Can quantitative easing continue forever?  Is debt on the scale of the U.S. government’s really a problem that can be monetized indefinitely, by printing dollars, without reaching some inflationary tipping point that hurts American consumers?

Saft also speaks of “financial repression” techniques employed by governments to deal with their debt crises, such as “forcing pension funds to invest in government debt.”  That was discussed last week in Cyprus… and it’s also been discussed by American liberals, greedily eyeing the huge amounts of cash floating in 401k accounts.  It seems like every reason cited for our immunity to a Cyprus-style debt crisis only reminds us of our similarities.  None of it is anywhere near as comforting as those analysts imagine it to be.