They called it a ‘stability levy’, when they meant a tax on Cypriot depositors (including the savings of poor widows and small children) so that they spare holders of Cypriot government bonds (including hedge funds who are now having a party in Mayfair and New York) as well as minimise potential long-term losses by the European taxpayers. In effect, faced with the prospect of lending to Cyprus a sum equal to its GDP, so as to bail out its banks Ireland-style, the Eurozone balked. They realised, post-Greece and post-Ireland, that something has to give (beyond the minimum working conditions and social welfare provisions of common folk) in order to minimise the size of the aggregate loan. And they chose to hit depositors directly (at a rate of 9.9% if their deposits exceed 100 thousand euros and 6.75% for smaller deposits) before the oncoming austerity-driven plague eats into them instead (as it did in Greece, Ireland and Portugal were savings were used up by stressed household in the daily struggle to survive after jobs and benefits disappeared).
What was astonishing is that, while the peoples of Europe are sick and tired of the gross inequities and regressivity of austerity-fuelled bailouts, they did not set a threshold below which poorer depositors would be untouched. And that they left unaffected the banks’ bondholders (even though the sums involved in these bonds were small, it was utterly unprincipled to spare them). I have no doubt that this decision will haunt them/us for decades.
What alternatives did the Eurogroup ministers have? Several, is the answer. In the context of their own accounting-like logic (i.e. of ‘hitting’ depositors) they could discriminate between bank accounts that are insured by Cypriot law and those which are not: So, any account by a citizen of an EU-member state with less than 100 thousand euros (the maximum account insured by the Cypriot state; the equivalent of the FDIC deposit insurance protection) should be left alone. All the other accounts could then be hit by a percentage that would deliver the sum of six to seven billions EU finance ministers wanted to reduce the bailout loan sum by. If Berlin was serious about its willingness to curtail Cyprus’ banks money laundering activities, while avoiding a tax on the hard earned savings of the poorer Cypriots (that a Lutheran German should see as an ally in restoring puritan ethics), that is what they would have done. But, it is now clear, they were not serious about their own ethics (indeed, had they been serious about Russian money laundering, they would have raised questions about Latvia’s banks, which are awash with mafia funds).
Of course, while hitting uninsured deposits only (as suggested by the previous paragraph) would have been preferable, it would still not be a solution to the Cypriot drama. The Cypriot economy is in the familiar tail spin that we witnessed in Greece, Portugal, Spain, Ireland and now unfolding in Italy. Even if the bank levy, or bail in, were fairer, the recession would still be fuelled by large scale public expenditure cuts and substantial tax hikes which, taken together, will most certainly lead Cyprus to a dead end. But none of this is specific to Cyprus. In this sense, an alternative strategy for dealing with the island’s fall from grace must involve a Gestalt Shift that will allow Europe a different approach throughout the monetary union. Precisely the Shift that Europe seems unwilling to contemplate, thus resorting to ill-conceived decisions like the recent one on Cyprus.
The Cyprus deal, although marginally better than forcing (Greece/Ireland-style) all of the burden willy nilly on the taxpayers, is highly destabilising in the medium term. The notion that one sacrifices Cyprus depositors in order to save the depositors in, say, Spain, is of questionable purchase. Moreover, despite the reduction in Cyprus’ new debt (achieved by bailing in depositors), its debt-recessionary cycle will proceed with increasing ferocity as austerity strings (with which the bailout comes attached) begins to bite.
Europe seems to have only partly learnt its lessons from Greece and Ireland. Europe’s leaders at least understood that they cannot pile a gigantic loan on an insolvent entity (i.e. an insolvent state that is intertwined with an insolvent banking sector) and expect, through austerity, to stabilise its debt-deflationary spiral. Some haircuts are necessary (although never sufficient) ex ante. What they have not understood is that limiting the bailout loan’s size is insufficient to prevent the free-fall, even if it buys them some extra time in the short run especially when the ‘limiting’ is achieved through sacrificing what bonds of trust remain between the EU and its citizens. That they will have to learn the hard way in the months to come.
In short, the recent decision on Cyprus is a touch more realistic than that which was imposed upon Greece, Ireland and Portugal, in the sense that Europe took some (however unfair and inefficient) steps to reduce the loan’s size. However, by remaining in denial about the true causes of the Eurozone’s (and Cyprus’) instability, and by resorting to euphemisms involving the word ‘stability’, they are giving the Crisis another vicious spin.
Last time Europe invoked ‘stability’ in one of its summit decisions was when it created the European Stability Mechanism (ESM). It proved anything but stabilising (as without Mr Draghi’s ECB and its LTRO-OMT interventions, there would be no Eurozone today). Now we have a ‘stability’ levy in Cyprus. Its effect will prove equally destabilising in the medium term. It is high time we take another look at stability in the Eurozone and to do so in terms of a closer look at the ESM and how it should be reconfigured. My next post will address the ESM and how to put the S-for-genuine-stability into it for the first time!