So we should apparently all be panicked by the possibility that a bank deposit tax the Cypriot government has proposed as part of a broader EU “relief” package for that country will lead to a European and then a global financial meltdown.
Other than confirming the occasional impression that the world’s bankers and investment managers are (a) uncomfortably incestuous and (b) have the psychology of overcaffeinated adolescents, what’s actually going on here? Well, it’s complicated, but here are the basics from Matt Yglesias:
What happened, essentially, is that the Cypriot banking system needs a bailout. But the Cypriot banking system is large relative to the (small) size of the Cypriot economy. So a big government bailout would just create a public sector debt crisis. Consequently, Cyprus needs to tap the larger European Union (i.e., mostly German) bailout fund. And with an election coming up in Germany, Angela Merkel was feeling in a less generous mood. The most straightforward way to reduce the cost of a bank bailout is to simply not give people 100% of what they’re owed. In other words, make creditors take a “haircut.”
But formal haircutting of bank creditors is still considered too hot and too likely to provoke panics and runs. So what they’ve come up with is a de facto haircut.
The bailout will be paid for, in part, through new higher taxes in Cyprus—austerity, in other words. But the specific tax in question will be a one-off wealth tax. And not just any wealth tax, but a wealth tax specifically levvied on bank deposits. A tax of 9.9% on deposits over €100,000 and 6.75% on deposits below that level. This will raise €5.8b to help defray the costs. Is this in any real way different than depositors taking a haircut? No. But for whatever reason the relevant officials seem to prefer to phrase it this way. And now the question is how many Spanish and Italian people are going to look at this precedent and try to shift money out of local banks.
There’s a lot of sentiment in Cyprus for shifting the deposit tax fully onto larger depositers, in part because Cypriot banks seem to be a favored location for Russians interested in offshoring and/or money-launderering. In the meantime, there’s been a local bank run by regular folk. So the Cypriot government has temporarily closed the banks and postponed a referendum on the whole scheme, amidst rumors of what it might do next and how that might affect investors and bank-depositors in the countries most likely to take a similar route to avoid general public-sector austerity and/or to pressure the EU (or really, Germany) to get more flexible.
Yglesias half-seriously proposes that Ben Bernanke should defuse the whole crisis by paying off the 5.8 billion euros the deposit tax would raise, since the potential global (and thus, U.S.) financial damage of a European-wide panic dwarfs that sum many, many times over. Maybe the Germans will ease off and make fewer demands of the Cypriot government. Or maybe said government can come up with some formula that distributes the “haircut” in a more politically feasible way. But it’s another example of how Europe’s austerity policies, couched as they are in the moralistic language of justice and stability, often produce their opposite.
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