BELIEVE it or not, but the Cyprus deal turned out not to be as bad as it could have been. In parts, it was actually quite good – and no, I haven’t actually gone mad, or drank any Europhile/IMF kool-aid. Of course, the rescue was miserably mismanaged, with endless u-turns, incompetence, bullying and stupidity. The Russians are angry, the local economy is set for a major collapse, cash shortages will cripple firms, many depositors have lost a fortune, the EU has been exposed for the two-faced, principle-less nightmare that it has always been, and the island now faces years of decline. So, of course, it is a giant, tragic mess, and there is bound to be to contagion to other Eurozone countries.
But out of it all, and perhaps even for bad reasons, a half-decent solution has emerged. The demented, immoral seizure of a chunk of all depositors at all Cypriot banks, regardless of viability, is not now happening. Bondholders are not now being protected. Instead, we are seeing something pretty close to a textbook bail-in, a proper bank resolution, for the first time since the crisis. Equity holders in Laiki are being wiped out (good, but not new; shareholders have always paid). Senior bondholders are being bailed-in, their bonds wiped out but replaced by equity (excellent, though in Cyprus the small number of bonds means that this wasn’t enough to recapitalise the institutions).
Small depositors – technically, lenders to the bank – are being protected up to €100,000, the insured limit. People who had more than the insured amount in bank accounts in Laiki and Bank of Cyprus will lose a chunk of their money.
While horrific, all other depositors at viable institutions are being protected. But while the losses at the two unsound banks are an awful outcome for many, not just Russian oligarchs, a key principle is being respected: in extremis, when a bank goes bust, people lose money – shareholders, bondholders and uninsured depositors. Losses are no longer being socialised. Taxpayers are no longer being seen to be liable for all losses. This is a major breakthrough.
There is one big problem, as economist Andrew Lilico points out. The insurance itself is not being triggered – instead, the smaller deposits are simply being exempted from haircuts. This is saving the state – which provides the insurance – a lot but means the bigger depositors are being made junior to smaller ones, messing up the system and penalising them disproportionately. It would have been better to have declared the bank bust, worked out what percentage of depositor losses was required (the same for all accounts), triggered the insurance and repaid insured amounts; and allowed those over €100,000 to face the loss, which would have been less than the 30 per cent or so discussed. For that, of course, one would have needed a solvent state.
Don’t get me wrong. There is lots to hate about this whole episode. We need reforms to allow the creation of secure storage accounts of unlimited size for those unwilling to take on risk; this could replace deposit insurance. Cyprus is in tatters. The free movement of people and capital is under existential threat. The single currency and the EU aren’t working.
But we are finally beginning to reintroduce capitalism into banking, with losses as well as gains. Moral hazard could finally be on the way out. Bondholders will end up bearing losses first; usually, that ought to be enough but depositors need to become much more vigilant. They need to read the fine print, and make sure they spread their money around.
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