There was panic in Cyprus today as ordinary citizens learned that the government was about to take nearly seven percent (6.75 percent) of the money in their bank accounts as part of a package to bail out reckless banks.
The outrage was justified, predictable, and immediate. Then, in a move reminiscent of the Great Depression, banks were closed in a government-mandated ‘holiday’ while lawmakers and financial authorities scrambled and tried to figure out what to do next.
Putin’s mad. Observers like Paul Krugman are predicting bank runs in other troubled European countries. There’s only one saving grace for American observers:
It Can’t Happen Here
… Or can it?
The dollar’s still the global currency. The Federal Reserve has an extremely broad set of tools at its disposal (although it’s choosy about where and how to use them). A Cyprus-like incursion on people's savings seems unlikely here. But if the past several years have taught us anything, it’s to “never say never.”
Whatever happens, the Cyprus story holds important lessons for every economy, including our own: Austerity has failed. So has bank deregulation. The ‘fair share’ principle of progressive taxation, which has guided the tax policies of Western nations for generations, is under assault.
And this may be the most important lesson of all: The people who led us into this mess are the wrong ones to lead us out of it. In fact, they’re beginning to look downright scary.
The Story
The tiny nation of Cyprus "liberalized" its banking laws and became a haven for offshore money, including money from Russian oligarchs. Its banks lent money to other European Union nations, especially Greece, and were especially hard-hit by the Eurozone financial crisis and Greece’s fiscal meltdown.
That hit the economy and government of Cyprus hard. A German-dominated EU imposed strict austerity measures on the Cypriot people. The nation continued to struggle, and last week it was announced that a ‘tax’ would be imposed on all deposits. (We’re using parentheses because, unlike any other tax we know of, people are being given bank ‘shares’ in return for this levy.)
That’s the story. Now for the lessons.
We don’t understand the people who run the global economy.
We need to know much more about the mindset - the anthropology, if you like - of the financial elites that govern our economic destinies. That’s why Mitt Romney’s “47 percent” video was so important. It offered us a glimpse into the psychology and group dynamics at work among some of our richest citizens. (See “The Radical Rich” for more on this topic.)
The decision to hit ordinary people’s savings violates norms, expectations, and values that have guided Western democracies for a very long time. That alone makes this move a shocker. Why did they do it? Mohammad A. El-Erian says it’s partly the result of “a feeling among European officials that Cyprus could be a lax offshore jurisdiction that intermediates funds of dubious origins.”
Funny. They didn’t feel that way a few years ago. The International Monetary Fund, which is helping in the Cyprus move, conducted an audit of Cyprus’ banking regulations in 2006, just before the global financial crisis struck. Back then it concluded that “Supervision of international banks and domestic commercial banks, already found to be very competent in the assessment of 2001, has progressed to reach high standards.”
That was then, this is now. Because international financial organizations miscalculated, choosing to promote the theology of deregulation rather than the wisdom of oversight, the people of Cyprus are now expected to pay for their ideologically-driven blunder.
Apparently there’s no penalty for being horribly, massively wrong … as long as you’re part of the global financial elite.
Austerity’s a failure. Period.
This attempt to ‘rescue the Cyprus economy’ comes after long years in which the EU, the International Monetary Fund, and other organizations imposed harsh austerity measures on the Cypriot people.
The latest moves, implemented in November of 2012, included an across-the-board salary cut for government workers, a retirement age hike, government downsizing, a set-aside of future profits from newly-discovered natural gas deposits, and regressive tax increases for property, beer, spirits and tobacco.
They came on the heels of earlier austerity measures - measures which the ever-reliable EU Economic and Financial Affairs Council deemed fully adequate at the time. EU Commission Vice President Olli Rehn boasted that new measures “will reduce the deficit to 2.7% by the end of 2012,” adding: “This shows Cyprus’ strong commitment and ability to ensure sustainability of its public finances.”
As we were saying: Among the financial elites there’s no penalty for being wrong. You just make your next move – which always includes doubling down on the austerity.
Speaking of which: What was the projected impact of past austerity measures and those recently imposed? As of December 2012, the Cyprus economy was “predicted to shrink by 2.4 per cent in 2012, falling deeper into recession at 3.5 per cent in 2013 and slow down to -1.3 per cent in 2014.” Projections showed that unemployment would “reach 12 per cent in 2012, jump to 13.8 per cent next year and 14.2 per cent in 2014,” while “the public debt will increase to a minimum 92 per cent of GDP in 2013 from 85.8 per cent this year.”
Economy worse after austerity Debt going up. Hmm … Let’s impose more austerity!
Deregulation means disaster.
We’ve already discussed that enthusiastic IMF review of Cyprus’ regulatory environment. Now, of course, they’re lecturing Cyprus about the lax way it oversaw the banking system.
Guess what? Apparently bankers will do very risky things to make money if nobody's watching them.
As Mohammed El-Erian noted, depositors’ money was used to fund the banks' bad investments. That’s another lesson for the US: We need the Volcker rule. We knew we needed it to keep our money safe. Apparently we also need it to protect us from levies like this one.
Wherever you go, “Too big to fail” is too big to fail.
The Cyprus banking sector is dominated by three banks which by Cypriot standards were clearly “too big to fail.” A World Bank study noted that these three banks controlled 56 percent of domestic deposits and 48 percent of domestic loans. And, as we now know, they were also deeply involved in risky international loans.
The study notes that total banking assets in Cyprus total nearly 900 percent of that country’s entire Gross Domestic Product (GDP). That’s an enormous concentration, posing an existential threat to the national economy.]
Thank God we don’t have that problem in the US, right?
Not so fast. The total US risk exposure from derivatives is $250 trillion, according to the OCC. Conventional bank defenders will argue that this isn’t a valid concern because the system has in-built protections against massive failure. There’s a three-word – no, three letter response to that: A. I. G.
With risks so heavily concentrated - more than 95 percent of them held by our five biggest banks - TBTF should be a four-letter word in any language.
They don’t believe in progressive taxation.
Germany’s led the propaganda campaign which argues that the Cyprus depositor is aimed at Russian oligarchs who evade taxes and leave billions in these offshore accounts. But it targets ordinary Cypriots nearly as much as it does high depositors – 9.99 percent for deposits above €100,000 (roughly $129,500 US at current exchange rates), vs. the below-€100,000 rate of 6.75 percent.
It doesn’t matter whether it’s the life savings of a middle-class family, or billions from flashy fast-buck artists who party on Volga houseboats and circle the globe in private jets. Either way, it’s 9.99 percent.
This offers another frightening glimpse into the minds of the financial elite: They no longer believe in progressive taxation, a principle which helped postwar Western economies grow and prosper. Oligarchs and the upper-middle-class pay the same rate - even though they claim this move targets oligarchs.
The victims are expected to pay restitution to the wrongdoers.
El-Erian speculates that EU officials hit ordinary depositors with this “tax” because they felt they “could not ignore bank depositors all together,” since “it is their funds that inadvertently enabled the careless over-expansion of the Cypriot banking system.”
If true, that may be the most outrageous thought yet. Depositors had no say in how their funds were used, after all, and it was against their interests to allow banks to gamble with their savings.
Who did have influence? Many of the same officials who concluded that ordinary bank customers should pay for official errors in judgment – in allowing reckless under-regulation of Cypriot banks, in approving Cyprus’ EU membership, and in a variety of other foolish decisions.
And let’s be clear: Although we say they “allowed” Cyprus to loosen its banking regulations, they almost certainly encouraged it to do so as they’ve done in many other countries.
Winner takes all. Loser cleans up the mess.
The biggest hit to the Cyprus banking system, the one that precipitated this crisis in the first place, was the “haircut” (losses) imposed on Greece’s creditors. Who imposed that “haircut”? The “troika” of institutions behind this latest move.
This needs to be added to the list of “highly predictable events that caught the global financial community completely by surprise.” Sure, investors should be accountable for bad investments. But some thought should have been given to separating innocent depositors from greedy speculators.
Angela’s Ashes
Philip Aldrick, Economics Editor of Great Britain’s Daily Telegraph, asks: “Why is Berlin quibbling over the Cyprus bail-out? Germany has profited from the euro project for a decade.” The shortest answer? Because they can. ]
German Chancellor Angela Merkel is quick to berate the citizens of other countries for the actions of their government officials and bankers – actions which her country tolerated, and even encouraged, for years.
Germany has enjoyed a large market for its manufacturing products, while exerting enormous financial leverage over other EU countries. Germany’s economic missteps have gone unnoticed, and so has its profit-taking from the EU experiment. As Aldrick notes, “By locking itself into a foreign exchange union at a low rate, (Germany) enjoyed the advantages of a weak currency without the attendant dangers of spiralling inflation."
It’s also worth noting that more than 9 percent of shares in the Bank of Cyprus, that nation’s largest bank, are held by foreign investors. (Regulations on foreign portfolio investment were liberalized in 1997.)
It’s a small world, after all.
What does this all mean for the US? First, it’s a reminder that there’s no escaping the global economy anymore.
The Cyprus experience gives us even more evidence that austerity doesn’t work, and it offers a warning: Financial institutions may take extreme measures as austerity measures lead to cascading failures. We also need smarter, tougher regulation of the banking industry. And we urgently need to break up too-big-to-fail banks.]
It also teaches us that we need to watch our financial elites very, very closely – whether they’re Wall Street CEOs, government officials, or the leaders of multinational financial institutions. The theory's been broached that this is an experiment on a very small country to see how people react to this kind of fiscal incursion, which crosses previously-respected boundaries. Not so long ago I would have dismissed that kind of talk as paranoid. Now? Who knows.
We knew they misunderstood economics. We knew they had the wrong priorities. Now there’s reason to believe they’re capable of more extreme actions than we realized.
It can’t happen here … unless we let it.
