In an announcement this weekend, the EU and the IMF have come to the rescue of Cyprus, at the request of the government, by offering Euro 10 billion in aid, in exchange for which the Cyprus government will impose a “one-off tax” on all private deposits in Cyprus banks. Depositors with Euro 100,000 or less in a bank account will be assessed a 6.75% tax, and deposits over this amount will be taxed at a rate of 9.9%
However politely this is described in press releases, this is nothing more than a confiscation of private property from people who did no wrong. The Cyprus banks prior to the 2008 financial collapse played a game similar to the Icelandic banks – offering lavish interest rates on deposits to attract hot money, and investing the money in a real estate bubble that has now collapsed and crippled the banks. Most of the money in Cyprus came from Russian business interests.
Iceland chose a different tack in dealing with its crisis. It essentially stiffed the IMF and the governments of the UK and The Netherlands, which were the source of hot money for Icelandic banks and which governments fully expected the Icelandic government to cover the losses. The Icelandic government refused, it allowed the banks to go under, it placed the losses on the the bank shareholders and bondholders, and it jailed the top bankers involved in the debacle. Iceland’s economy took a severe hit, but the pain was relatively short term and the economy has recovered nicely.
Elsewhere in Europe and the US, governments have chosen to protect bank management, bank shareholders, and bank bondholders, arguing that a “systemic crisis” will result if the banks are allowed to fail. The total deposits in the banking system of Cyprus account for less than 1% of total EU deposits, but nonetheless the EU is now arguing that a systemic crisis will engulf Europe if any bank in Cyprus is allowed to go under.
What is likely to happen after this decision is a systemic crisis of a different nature – bank runs throughout all the periphery countries, such as Spain and Italy, which have also asked for EU and IMF help for their banking industries. The citizens of Cyprus rushed to the ATM machines Saturday evening when this announcement hit the news wires, but the ATMs quickly ran out of cash. Cyprus is on holiday Monday – the announcement appeared to be timed to coincide with the holiday weekend – and the central bank of Cyprus is now going to impose a freeze on electronic transfers in the banking system until the “tax” is withdrawn from each account.
This development in Cyprus is getting very little press in the US and other countries, but it will. A basic doubt has been raised about the sanctity of private property in the banking system anywhere in the world. You can be assured that savvy investors will be paying attention to this development. You should too.