Treachery on the Isle of Adonis

Here’s Frances Coppola:

Plenty of people have questioned why small depositors had to be hit at all. The German financial minister, Wolfgang Schäuble, who appears to have masterminded the bailout plan, wanted large depositors to take a much larger hitso that small depositors could be protected. The IMF took a similar view. It seems that the Cypriot government did not agree. There is considerable speculation as to why the Cypriot government preferred to see small depositors hit. To me it seems most likely that it has to do with the Cypriot government’s wish to avoid upsetting Russia, given Nicosia’s hope that Russia will contribute to the bailout by softening the terms of its existing sovereign loan, and the considerable amount of money (some of it undoubtedly dirty) from Russian oligarchs that is held in Cypriot banks. But it is also possible that Nicosia is still hoping to maintain its foothold in the international tax haven network. Even with the 2.5% increase imposed as part of this bailout, corporation tax is a very competitive 12.5%, and the Cypriot government has encouraged growth of the financial sector by attracting deposits from overseas investors.  Frankly I think this is pie in the sky.

It’s interesting to note that all eight EU countries on the Mediterranean (or close by in the case of Portugal) opted to get into the euro, whereas most of the countries in the far north stayed out (Sweden, Denmark, Britain, and of course Iceland and Norway stayed entirely out of the EU.)  What explains this pattern?  Perhaps this is just the standard problem of clubs; those who see themselves as better than average prefer to stay out, and vice versa.

The Nordics and Britain look at the corruption in some of the Mediterranean countries with distaste, and stay away.  The Russians feel an affinity with the Mediterranean countries.  Putin is very close to Berlusconi, and Russian oligarchs like to put their ill-gotten gains in Cypriot banks.  And which country is stuck right in the middle of this Nordic-Mediterranean-Russian triangle?  Germany, which partly for historical reasons feels it must stay fully committed to “Europe.”  I’m less sure about the Benelux countries, but would note that they were founding members of the EU, and hence are more psychologically committed than the Nordics.  Finland has historical reasons for wanting to bond closely with Europe.  Germany’s misfortune is that it has two thirds of the northern eurozone population, whereas if the 5 standoffish northerners had joined, it would be only 40%.

The market monetarists have lots of good posts on Cyprus.  Here’s Nick Rowe:

Governments usually provide deposit insurance to prevent bank runs.

If the banking system is too big, and the banks’ losses are too big, relative to the government’s capacity to pay that insurance claim, that’s a problem.

But the problem is very different if the government (unlike Cyprus) can print currency to pay bank deposits that are liabilities in that same currency. If worse comes to worst, the government just prints as much currency as is needed to pay the depositors what they are owed. If that means is has to print “too much” currency, that’s a problem, because it means inflation will be “too high”. But that inflation will adversely affect the real value of currency and bank deposits equally. So even if people expect it might happen again, this doesn’t cause a bank run, where people try to get out of bank deposits into currency.

It’s a very different sort of problem in a country like Cyprus where the government cannot print money. If people see a “one-time tax” on bank deposits happen once, they might expect it to happen again. And if they expect it to happen again they will try to get out of bank deposits into currency. Which is a bank run.

The difference is that inflation from printing too much money is a tax on currency too. Cyprus cannot tax currency; it can only tax bank deposits.

If the banking sector is too big, and if bank losses are too big, relative to the country’s ability to pay, deposit insurance as a way to prevent bank runs is not credible and won’t work in a country that cannot print.

And David Beckworth:

What the EU and IMF did to Cyprus today is poised to be a repeat of what happened to U.S. banking in 1933. In February of that year, the governor of Michigan declared a statewide banking holiday as a means to resolve an impasse on how to wind down an important bank in Detroit. Like the Cyprus action today, the governor’s actions back then sent chill waves across a continent, as depositors in other states began to wonder if their governors would also call bank holidays to prevent withdrawal of funds. The fear was so poignant, that the Ohio governor made it a point to declare the bank holiday would not happen in Ohio. But it was too late, the die had been cast. By March 1933, 48 states had declared some form of bank withdrawal restrictions as the bank panic spread and fed upon itself. Only with FDR’s national bank holiday and the advent of national deposit insurance in March, 1933 was the bank panic stopped.

What is crazy about the Cyprus heist today is that it has the potential to create the same self-fulfilling bank panics across Europe, but without the benefits of a unified treasury to credibly commit to Eurozone deposit insurance. I can’t help but hear the echoes of 1933 now unfolding in Europe.

And Lars Christensen:

I am not arguing that Cyprus would not have had problems if the ECB had targeted NGDP, but I am arguing that if the ECB had followed a proper monetary policy rule like NGDP targeting then a banking problem or a sovereign debt problem in Cyprus would never had become an issue for the entire euro area.

My sense is that taxing the big depositors was sort of like letting Lehman fail–a very good idea that was very poorly timed.  Taxing the small depositors is a bad idea, badly timed.



37 Responses to “Treachery on the Isle of Adonis”

  1. Gravatar of Treachery on the Isle of Adonis | Fifth Estate Treachery on the Isle of Adonis | Fifth Estate
    17. March 2013 at 05:43

    […] See full story on […]

  2. Gravatar of Anonzmous Anonzmous
    17. March 2013 at 05:48

    “My sense is that taxing the big depositors was sort of like letting Lehman fail-a very good idea that was very poorly timed. Taxing the small depositors is a bad idea, badly timed.”

    I tentatively disagree. My perhaps naive take is that if the Russians feel they are being singled out, they will withdraw their deposits, killing the bank instantly.

    These banks aren’t failing because they have too many Russians trying to deposit money. They are failing because the banks reinvested that money in Greek debt. Right?

    In effect, the local smaller depositors are lucky. Without the Russians, they would lose far more than 6.6%.

  3. Gravatar of david david
    17. March 2013 at 05:57

    Deposit insurance requires bank regulation. Bank regulation requires an incorruptibility that can resist the siren song of Russian robber barony.

    Clearly that’s not going to work in Cyprus, if the government has the political capital to tax small depositors (!!??!) and yet not the will to aggravate Russian flows. I’m not sure what’s worse, if this is unpopular with Cypriots or if it is grudgingly supported.

    But the thesis of cultural separation implies that the Germans will still find a way to bail out German banks, anyway.

  4. Gravatar of ssumner ssumner
    17. March 2013 at 06:04

    David, Good points.

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    17. March 2013 at 08:17

    Sounds like a quarrel in a far-away country among people of whom we know nothing.

  6. Gravatar of marcus nunes marcus nunes
    17. March 2013 at 08:21

    Shows that the ECB targets German/Austrian NGDP! The Euro story maybe close to a close!

  7. Gravatar of marcus nunes marcus nunes
    17. March 2013 at 08:25

    And as John Donne put it 400 years ago:
    “No man is an island…”

  8. Gravatar of Nick Rowe Nick Rowe
    17. March 2013 at 08:55

    Commenter “Doctor Why” (a Cyprus resident) made a very good point on my blog post:

    “Third, if the haircut (conversion to equity) was limited to uninsured deposits, that would most likely give control over the banking system to non-residents (some would say money-launderers) – and nobody in the Eurozone would be happy about that.”

  9. Gravatar of mbk mbk
    17. March 2013 at 08:57

    You don’t even have to go to NGDP targeting or cultural affinities or the Euro or what have you. Breaking a legal (and governmental) promise for the sake of short term expediency is making a mockery of the rule of law, and with that, makes all and any future promise worthless. That the broken promise was made to small savers, to the vast majority of the population in other words, is just the icing on the cake of political incompetency. The consequences in terms of a precedent are unimaginable, if this is let to pass. But since this cat is out of the bag now there is no more good alternative either, it seems it’s either this or wholesale bank insolvency in Cyprus. Well, bank runs are pretty much assured at this point.

  10. Gravatar of ssumner ssumner
    17. March 2013 at 09:02

    Patrick, Now where have I heard that before?

    Marcus. Yes, that’s the underlying problem–but not the only one.

    Nick, It seems like cultural differences are the Achilles heel of the eurozone. The giant free trade zone for goods, services, and labor works tolerably well, but as soon as you start getting fiscal links the problem of culture rears its ugly head.

  11. Gravatar of TallDave TallDave
    17. March 2013 at 09:04

    I’m surprised no one has talked about the similarities to what Argentina did, which amounted to seizing private savings by a different mechanism.

    What really should have happened is that Cyprus balanced its budget and paid off its debt, whatever cuts that required. Since that was apparently unthinkable, the government leveraged the specter of default to get the Eurozone involved, and then after swearing up and down they wouldn’t seize deposits, they seized deposits.

    I think they are creating some very, very dangerous expectations with this very sudden and dishonest expropriation — as someone at Cowen’s observed, the perceived return on keeping money under your mattress just went way up. This kind of kleptocracy is why poor countries are poor.

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    17. March 2013 at 09:14

    The plot thickens;

    The proposed levies on deposits are 9.9 percent for those exceeding 100,000 euros and 6.7 percent on anything below that.

    They would be compensated with shares in the banks. A political source told Reuters that, as a sweetener, Anastasiades would offer depositors equity returns, guaranteed by future natural gas revenues.

    “Half of the value of the haircut will be guaranteed by natural gas proceeds,” the source told Reuters.

    Cyprus is expecting the results of an offshore appraisal drilling this year to confirm the island is sitting on vast amounts of natural gas worth billions.

  13. Gravatar of Morgan Warstler Morgan Warstler
    17. March 2013 at 09:38

    Its very hard to not see Cypress as a step towards using simplified tax structures and favoring digital transactions to reduce tax avoidance.

    I understand people will hoard cash if they feel like deflation is happening, or if it helps them avoid bank grabs, etc.

    But the reality is the southern European states have to actually collect taxes that pay for their services.

    This means:

    1. To reduce cost of services: Get serious about ending cronyism, fraud, corruption, but even more FAVORING the raising the status of the guys who can actually deliver productivity gains. The euro means the south states have to let their entrepreneurs drive the car, while the bureaucrats ride in back, and serve their masters. Productivity gains everywhere!

    2. To capture real new revenue, since #1 will increase growth: This means a simplified tax plan towards land or consumption taxes. MORE IMPORTANTLY, towards #1, it means moving to digital transactions, it means FAVORING the online stores, it means, using online banking, it may even mean reducing use of cash by law.

    Trading away privacy is acceptable, but it must occur in conjunction with a weakened public sector.

    Cypress is ALLOWED to drop their tax rates, liberalize their regulations, and invite in businesses to grow their economy. But they still have to LIVE on tex revenues.

    But what they did this week, wasn’t because they can’t print money.

    They did this because they aren’t good at living on tax revenues.

  14. Gravatar of chris mahoney chris mahoney
    17. March 2013 at 09:52

    If there was ever any doubt, it is now clear that the eurozone is not a single monetary area. A Cypriot euro does not equal a German euro.

  15. Gravatar of Bill Woolsey Bill Woolsey
    17. March 2013 at 10:07

    I think it sounds like a great idea. If the Cypriot banks are insolvent, then the depositors get lower deposits and an equity stake.

    Yes, I will grant that people will hold more money in banks if you promise them that they can never take a loss.


    Is there any reason to believe that the Euro zone won’t issue however much currency people want to hold?

    Now, a haircut just big enough to save the banks is a bad idea. Make it big enough so that banks are well capitalized and sound.

    Why pull your deposit from your bank that now has 40% capital?

    You might need to sell your stock.

    Of course, if there is an increase in the demand for currency in Cyprus, this will cause some problems.

    The solution for Cypress is to leave the Eurozone and targing Nominal GDP in Cypress. Issue all the Cypress Euro currency people want to hold, and let the Cypress Euro drop in value relative to the Euro Euro (:).) Yes, the Cypriots might wisely decide to hold more foreign exchange. And their exports will get cheaper to the foreigners sufficient that they can get all of that foreign exchange.

    What is the alternative? Have the taxpayer protect the depositors from loss so that they will keep more money at home.

  16. Gravatar of The Nordics | Historinhas The Nordics | Historinhas
    17. March 2013 at 11:08

    […] this post Scott Sumner […]

  17. Gravatar of James in London James in London
    17. March 2013 at 12:54

    Cypriot banks really aren’t any worse run than most banks. They are mostly just victims of circumstance. The banks and economy are closely tied to Greece, and have suffered as Greece has gone down. The bulk of their losses are coming from very ordinary retail and commercial loans.

    It is just proving that banking is a rotten business in a declining NGDP environment: your liabilities stay the same in nominal terms, but the value of your assets (loans and debt) shrink in nominal terms as the cash flows that support them shrink and the real assets that collateralise them fall in nominal value. It is pure tragedy.

    Cyprus has a long tradition of being a safe offshore financial centre, based on the traditions of a largely British-based rule of law, backed up with high quality professional services. As a longtime colony of Britain it is a sort of mini-City of London in the sun.

    It has never been considered particularly corrupt, unlike Greece. For the current German political leaders to now decide to force a punishment for this long tradition of financial and professional services is a bit rich. If they didn’t like the offshore banking industry they could always have taken action earlier. Punishing small Cypriot and expatriate depositors now is grossly unfair.

    The banks have suffered from losses on Greek government debt, probably too high a concentration of their liquid assets. But modern banking has to hold a lot of liquid assets against deposits, and as an offshore centre they had a lot of liquid deposits to reinvest.

    There was a lot of Russian money in the banks, but only about 30% of total deposits. That money was legitimate, deriving from the long-standing but somewhat unique tax treaty between Russia and Cyprus. The often aggressively sharp Russian tax authorities had raised no issues about the headquartering of large numbers of Russian corporates in Cyprus. It is hardly different to the way many US and European corporations organise their tax affairs.

    The only real corruption in this story is of the political and intellectual leaders, on both the right and the left, bought off with goodies provided by the European Union, and who have betrayed their people. Being a Euro MP or Euro civil servant is a marvellous life for these elites, and they cease to think what is in the best interest of their people back home. The same intellectual betrayal and corruption has been played out in Greece, Spain and Italy. There are at least popular movements in Greece and Italy who may, in their haphazard way, lead those countries out of the Euro. We are still waiting for Spain.

  18. Gravatar of Lars Christensen Lars Christensen
    17. March 2013 at 15:32


    Spot on!

  19. Gravatar of Morgan Warstler Morgan Warstler
    17. March 2013 at 15:36

    “It is pure tragedy.”

    No it’s not.

    Its teh awesome.

    Sumner once argued that the best and brightest should get paid well to figure out where to place capital.

    Thats of course is total and utter BS. Placing capital is easy when the capital requirements are good and high.

    Bankers are step above Government employees, but they are still meant to to sit on the sidelines keeping score while the gladiator king entrepreneurs do battle. The government is the ref, and the rules are supposed to hardly ever change.

    Refs and scorekeepers get paid enough, and get investigated enough, to keep the players convinced they are happy with their second position lot in life.

    IF this is how bankers lived, then we’d have a tragedy.

    This however is a joy to behold. lets hope none of the best and brightest get the idea to be bankers for a long long time.

  20. Gravatar of mbk mbk
    17. March 2013 at 17:35

    James, good background info. But in general, not everything under the sun is the fault of the Euro and the Germans. Had Greece devalued a hypothetical Drachma under crisis, then what would have been foreign currency loans from Cyprus would have come under distress too. And from the Coppola quote at top of Scott’s post it seems the IMF and Schäuble wanted things differently and that it was the Cypriot government who came up with the brilliant idea to just toss out the small depositor’s insurance promise.

  21. Gravatar of Richard W Richard W
    17. March 2013 at 19:06

    The problem with deposit insurance as in any other insurance, is the insurance is only as solvent as the one doing the insuring. If the sovereign is insolvent then so are its insurance obligations. Haircutting depositors with a tax is effectively no different to raising any other taxes when the sovereign is faced with insolvency. Bank runs are much less likely than the hyperbole suggests because actually opening bank accounts in what would be a foreign country is not easy. Money laundering regulations has made opening a bank account without proof of residency a difficult process in most of Europe. Money under a mattress is always an option.

    Important to remember this is not a default on deposit insurance, they are being taxed to bail out the Cypriot state.

  22. Gravatar of ChargerCarl ChargerCarl
    17. March 2013 at 21:28

    Rich, I would add that deposit insurance is fine if you control the printing presses, but in a case like Cyprus it’s doomed to failure.

  23. Gravatar of Ritwik Ritwik
    18. March 2013 at 02:31

    C’mon what is all this talk of banking crisis and bailouts. Doesn’t suit. ECB just tightened monetary policy. That’s all there is to it.

  24. Gravatar of RebelEconomist RebelEconomist
    18. March 2013 at 04:37

    @James in London, so a mass dilution of holders of nominal claims by a switch to NGDP targeting as looks set to happen in the UK is OK, but an appropriation of depositors is not? I don’t see much difference.

  25. Gravatar of Rien Huizer Rien Huizer
    18. March 2013 at 05:02

    Taxing the Russians is a great idea. They may complain but Cyprus is still a great bargain. In the world of corruption, realism is king.

    What the Cypriot gvt did however was shameful. They could and should have avoided taxing their own citizens. The EU game is to do whatever you can for your own and too bad (or worse) for the rest, because they cannot kick you out. Why on earth be nice to the big depositors who have no better bargain elsewhere in the EU? Would the Russians be any help against the Turks? Would anyone in the EU care if those Russian deposits were expropriated? Maybe they were not all Russian, given the banks involved, probably a few Greeks too. Maybe we were given the wrong impression.

  26. Gravatar of ssumner ssumner
    18. March 2013 at 05:53

    Morgan, You said;

    “Its very hard to not see Cypress as a step towards using simplified tax structures and favoring digital transactions to reduce tax avoidance.”

    Actually it’s not that hard.

    Richard W. You said;

    “Important to remember this is not a default on deposit insurance, they are being taxed to bail out the Cypriot state.”

    That’s true of deposits about 100,000 euros, but it certainly is default for the small deposits.

  27. Gravatar of mbk mbk
    18. March 2013 at 06:07

    Well FWIW the BBC has this:

    “German Finance Minister Wolfgang Schaeuble said he and the International Monetary Fund had been in favour of “respecting the deposit guarantee for accounts up to 100,000” euros.

    He said it was the Cypriot government, the European Commission and the European Central Bank that had decided on the levy terms and that “they now must explain this to the Cypriot people”.”

    All of this is mighty inexplicable to me. The robust response we see now (from pretty much everyone, people, press, European MPs, you name it, plus the Russian government too of course) was pretty much a given. Who on Earth had this brilliant idea?

  28. Gravatar of TravisV TravisV
    18. March 2013 at 06:35

    Are there any good old posts where Prof. Sumner recounts the various monetary policy decisions the Fed made throughout 2008?

  29. Gravatar of Morgan Warstler Morgan Warstler
    18. March 2013 at 08:19

    Scott, if hiding your money in Cypress or other banks, isn’t hiding… it makes hiding money cost that much more elsewhere…

    If large purchases with cash are outlawed, where do you hide your money?

    If on the other side, your tax enforcement is trying to be efficient, you want to “expand the base” and limit deductions, target consumption, target land, etc. right?

    You don’t see this as step in right direction?

  30. Gravatar of Peter N Peter N
    18. March 2013 at 09:09


    This may possibly have increased the procedural difficulty of hiding money, but it has also considerably increased the incentive. It also destabilizes the other southern tier banking systems by increasing the likelihood of bank runs and capital flight.

    I can’t see this as a good trade-off.

    OTOH the idea of using future gas revenues as compensation may be a winner, but the compensation should 100% and with interest and some chance for a modest profit for the guaranteed deposits – a sort of forced good investment.

  31. Gravatar of Peter N Peter N
    18. March 2013 at 09:35

    All very ugly, but it’s more of the same.

    For political reasons, austerity has been applied least where it was needed most and most where it should have been applied least.

  32. Gravatar of Jeff Jeff
    18. March 2013 at 12:16

    Before this, Cyprus supposedly had deposit insurance on deposits up to 100,000 Euros. So most of the really big deposits were not insured. Everybody knew that, and everybody has known since at least 2008 that the Cyprus banks were underwater. So why not just let the banks go under and pay off the insured deposits out of bank assets? The uninsured depositors knew what they were getting into. Let them fight it out with other creditors in bankruptcy court after the insured depositors are paid off.

  33. Gravatar of ssumner ssumner
    19. March 2013 at 15:44

    mbk, I agree. And BTW, I reported the story before the BBC, in this very post.

    Morgan, I agree that the big depositors should take a hit.

    Peter, Why not just sell the Cyprus gas fields to Gazprom?

    Jeff, Exactly.

  34. Gravatar of James in london James in london
    20. March 2013 at 09:39

    Cyprus was hitting small depositors because it was trying, rather desperately, to keep its reputation as a on offshore financial centre. It wants to do the right thing to its customers, large and small, domestic and overseas. It is a worthy aim. And many local businesses will have large deposits too, penalising them really harshly could lead to more job losses. In fact job losses all round.

    The offshore banking business within the banks is largely segregated from the onshore business, so they could keep the offshore business in Euros and reintroduce Cypriot Pounds for the domestic accounts. It is maybe what they are planning for this weekend. We shall see.

  35. Gravatar of ssumner ssumner
    20. March 2013 at 19:29

    James, It will be interesting to follow. What about the idea of selling off some of the gas reserves.

  36. Gravatar of James in London James in London
    20. March 2013 at 23:57

    The gas reserves need to be “risked”, ie to a potential recovery rate allowing for the usual geological uncertainty. Often this means just 10% of the headline total until lots of exploratory wells and quite a lot of production is under way. And then they you need to risk for the geo-political uncertainty. The gas reserves are disputed by both Turkish-backed Northern-Cyprus, Turkey itself, Syria (!), Lebanon, Israel, Egypt and even the Gaza-strip Palestinians. All have coastline around the gas basin. And then there is Russia, and the US involved in various ways. And finally you have to do the normal financial discounting for NPV of the gas.

    Gas reserves are a minefield, geologically, politically and financially. That is why the British and Norwegian North Sea oil and gas reserves, despite their relative inaccessibility are so attractive, becuase Britian and Norway are stable, friendly, Northern European democracies with a strong tradition of the rule of law, and deep and wide capital markets.

  37. Gravatar of James in London James in London
    23. March 2013 at 00:48

    Obama yesterday got Israel to apologise to Turkey for killing nine Turkish activists back in 2010 who were trying to aid Palestinians in the Gaza Strip. A rapprochement that removes a barrier to cooperation over gas reserves in the region. Hard to know whether this is good or bad for Cyprus given the country’s fraught relationship with Turkey, but it does show that the gas reserves have leverage.

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