The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

A man reads a newspaper at a cafe in the Cypriot capital Nicosia on March 17, 2013. (Photo by BARBARA LABORDE/AFP/Getty Images).

The world learned Saturday that the small Mediterranean country of Cyprus had agreed to a deal with European Union creditors that would impose a financial transaction tax as high as 9.9 percent on all depositors.

Depending on whether the Cypriot government finalizes the deal, which is still pending, this means that every depositor will have a portion of his money confiscated by the government when the banks reopen Tuesday morning.

“Accounts under 100,000 euros will have 6.75% of the funds seized. Accounts over 100,000 euros will have 9.9% seized,” Business Insider’s Henry Blodget explains.

After these funds are seized, the EU’s emergency lending facility and the International Monetary Fund, headed by Christine LaGarde, will drop €10 billion on keeping the banks in Cyprus running.

Unsurprisingly, after Cypriots learned of the surprise deal, many rushed to empty their bank accounts. However, according to various reports, ATMs have not been functioning properly and the government has made it impossible to transfer money outside of the country’s borders.

Obviously, the EU’s bailout conditions (and the fact that Cyprus seems willing to go along with them) are unprecedented.

You see, most bank bailout efforts in the past have put the burden on bondholders — not the actual depositors. Furthermore, it has usually been the goal to protect depositors to keep them withdrawing their funds en masse, creating a “run on the bank.”

But all that seems to have changed this weekend, which raises some obvious questions: Where does this go from here? What will this mean for the U.S. and the rest of the world? Will this actually help Cyprus’ banks or will it create a spreading panic and crash?

The Associated Press offers these thoughts:

Cyprus may be on holiday Monday, but the rest of the world will go back to work. [Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics in Washington ] says that the decision to tax tap depositors indicates that the European Central Bank is confident that the risk of a bank run elsewhere in the eurozone is low – and by excluding Greek branches of Cypriot banks, they have reduced the possibility even further.

Bond markets may react a little since bondholders were also tapped. Bank stocks will probably fall and they’ll see their borrowing costs rise since this deal signals that other eurozone countries may call on bondholders if their banks run into trouble.

But Heather Conley, director of Europe program for the Center for Strategic and International Studies, says it’s hard to know the far-reaching implications of this one-off deal. The “exceptions” created to solve Europe’s debt crisis are adding up, she said. And some investors may look at this late-night, three-day-weekend deal and see what she saw: a dress rehearsal for a country dropping out of the euro.

But Blodget raises some really interesting points:

Depositors in Cyprus banks will lose some of their deposits.

They will be furious about this.

And they will, rightly, feel that it is grossly unfair — because depositors in the bailed-out banks in Ireland, Greece, etc. didn’t lose their money. And they will feel like fools for not having taken their money out.

Indeed, as we noted in June 2012 when Spain — unlike Ireland and Greece — was awarded its no-austerity bailout, the “EU is like a family. And as anyone with siblings can tell you, when one kid gets special treatment, all the kids want special treatment.”

We have a feeling that Cypriots (as well as Russians and other non-residents who have stashed massive amounts of cash in Cyprus banks) are not going to be happy if the country goes forward with the proposed bailout deal.

The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

German Chancellor Angela Merkel chats with Cyprus’s President Nicos Anastasiades on March 15, 2013 in Brussels. (Bertrand Langlois/AFP via Getty Images).

Blodget continues:

And … here’s the important part …

Other depositors at weak banks all over Europe, in places like Spain, Italy, and Greece, will rightly wonder whether this is the beginning of a new era of bank bailouts, an era in which bank depositors are going lose some of their money.

What do you think those other depositors in Spain, Italy, Greece, etc., are going to feel like doing when they realize that, if their banks ever need a bailout, they might have their deposits seized?

That’s right. They’re going to feel like yanking their money out of their banks.

And if some of them yank their money out of their banks, well — then the financial condition of those banks will go from weak to insolvent. And the banks will go rushing to their governments and the Eurozone for help.

And if, god forbid, the Eurozone decides to seize the deposits of more bank depositors …

Well, then, a good portion of Europe is going to suddenly experience a good old-fashioned bank run. That, to put it mildly, could be a disaster.

The destruction of its banking sector would be a disaster for the EU economy, and a disaster for the EU economy would translate into a disaster for anyone who does business with them: The U.S., China, Japan, etc.

Considering that the U.S. did roughly $265 billion in exports and $380 billion in imports with the European Union in 2012, a crippling EU banking crisis would most certainly send shockwaves through the U.S.

Furthermore, should Cyprus agree to the deal, it’s not just the economic ramifications of a possible EU-wide run on the bank that should have everyone yelling, “Stop!” It’s the fact that Cyprus and European Union creditors are telling the rest of the world that targeting depositors is an apparently legitimate strategy.

Could this happen in the U.S.? Would Congress ever enact a financial transaction tax on U.S. depositors? To answer that question, let’s take a look at the following thoughts from Zero Hedge.

First, here’s a summary of the consolidated U.S. depository system, which, “according to the Fed’s December 31, 2012 Flow of Funds report had a grand total of $15 trillion in assets, and a matched number of liabilities, of which 72%, or a total of $10.9 trillion was in the form of deposits (checkable, small and large time, and savings).”

This is what it looks like:

The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

Courtesy Zero Hedge

“So, if the US was to go the Cyprus route, and begin impairing balance sheet liabilities to remark assets, there would be precious little space (with just $4.3 trillion in total other funding liabilities), before one would need to start eating into the deposit base,” Zero Hedge explains.

But would Congress ever go the Cypress route?

Obviously, we can’t really answer that question, but “it was ‘absolutely certain’ as recently as 48 hours ago that Cyprus too would see no depositor ‘bail in’ either,” the Hedge points out.

“What is known,” the report continues, “is that…the necessary debt-reduction needed in the US to reach a sustainable debt level, was over $8.2 trillion using debt numbers as of 2009 … Since then consolidated US debt has risen by over $5 trillion.”

The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

Courtesy Zero Hedge

“Which means that if, indeed, the US proceeds with its own wealth tax, then deposits may well be one ‘wealth class’ that gets impaired,” it continues.

“Of course, since in the US other financial assets, namely the stock market, account for a far greater proportion of household net worth, it is quite possible that instead of impairing deposits at US banks, which already subsist solely due to the Fed’s $2 trillion in excess reserves, the government may instead choose to generously tax simple 30% of all of your stock holdings, and achieve the same ‘wealth transfer’ result,” the report adds

The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

Courtesy Zero Hedge

Hopefully, it never comes to this. Hopefully, the EU and Cyprus rethink their “tax the depositors” strategy — which they may be doing.

“Cyprus’ president said Sunday that he is trying to amend an unpopular euro zone bailout plan that would tax deposits in the country’s banks to reduce its effect on small savers,” the AP notes.

“But in a nationally televised speech, President Nicos Anastasiades also urged lawmakers to approve the tax in a vote Monday, saying it is essential to save the country from bankruptcy,” the report adds. “Some 25 lawmakers in the 56-seat Cypriot parliament said they wouldn’t vote for the tax amid deep resentment over a move some called disastrous.”

The Cyprus Bailout Could Have Major Ramifications For the Rest of the World

Cyprus’s President Nicos Anastasiades. (Getty Images).

“I completely share the unpleasant sentiment that this difficult and onerous decision has caused,” Anastasiades said. “That’s why I continue to give battle so that the decisions of the eurozone are amended in the next hours to limit the effect on small depositors.”

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