Keep an Eye on Cyprus

Fisher Investments  |

If you haven’t paid much attention to Cyprus’s bailout negotiations, I suggest you start: There’s a plan afoot that could, if enacted, set a dangerous precedent for private property rights in the eurozone.

I refer to an idea tabled by eurozone finance ministers: Forcing foreign depositors in Cypriot banks to take a haircut.

Yes, you read that right—forced losses on cash deposits.

Here’s how it would work. Deposits would be seized (at least in part) and replaced with bank debt securities—a “bail-in” bond, in industry lingo (similar to the “bail-in” bonds eurozone bank execs may be forced to take in the event of any future bank failures in the currency union under the forthcoming regulatory scheme). Those bail-in bonds would almost immediately be subject to a giant haircut. Domestic depositors would be exempt, but foreigners would get whacked.

You see, other nations aren’t very keen to bail out Cyprus’s banks—in their view, Cypriot banks function first and foremost as Russian laundry machines. Cyprus, with its communist regime (until-now—right-wing, pro-European Nicos Anastasiades won the February 24 presidential election) and favorable tax code, is seemingly a financial safe haven for Russian oligarchs, who allegedly send dirty money to the island for easy laundering. Eurozone leaders, citing the controversy, reckon their taxpayers’ money should go to more noble ends.

Hence why Cyprus went to Russia the last time it needed a handout, bypassing the troika and getting a €2.5 billion loan. Now, however, Cyprus needs €17.5 billion, and Russia seems unwilling to throw good money after bad, so the island nation’s deep in troika negotiations. And as ever, the troika wants to do what’s needed to shore up the currency union and keep a disorderly unwinding a distant possibility. So it’s open to a bailout, but with huge conditions—including a debt haircut for private sector creditors and a forced rise to its 10% corporate tax rate (ostensibly to deter the Russians, but more likely to prevent allegedly unfair competition with other countries’ higher rates). And, that deposit for bail-in bonds swap.

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Which, frankly, is a ghastly proposition. Deposits—assets in an individual’s name—are private property, and strong private property rights are paramount to any well-functioning capitalistic (oops, redundant) society. On the surface, it might seem easy to sympathize with its supporters—any money getting laundered in Cyprus is likely ill-gotten anyway, so what’s the harm in seizing it? Well, consider this: Legitimate foreign account holders, to the extent there are any, would get hurt too. Cyprus’s financial system may be a mess, but it’s not unreasonable to suspect at least some Greeks, Turks or perhaps others have parked savings there, expecting risk-free storage. Most eurozone leaders support ring-fencing retail and investment banking to protect depositors in this very situation—that they’d support a plan that does the opposite, forcing depositors to be liable for a bank’s troubles, is flat out odd.

But more problematic is the precedent it would set: No longer would private deposits be considered vouchsafed, which would weaken private property rights throughout the eurozone. If another peripheral eurozone nation needed financial assistance for its troubled banking sector, folks may fear private account seizures could theoretically be on the table. This mere possibility could cause a loss in confidence in European banks, potentially fueling capital flight—not just from troubled countries, but from the currency union itself, which would cause some distortions in the Target2 system. Not what the eurozone needs. Mind you, that likely wouldn’t be enough to raise the probability of a sudden disorderly collapse of the currency union, but it would be a negative.

To be clear: At the moment, this plan is just talk—good sense could very well prevail. At the same time, it’s important for investors to be aware of all possibilities and potential risks, however improbable.

This constitutes the views, opinions and commentary of the author as of February, 2013 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. No assurances are made regarding the accuracy of any forecast made. Past performance is no guarantee of future results. Investing in stock markets involves the risk of loss.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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