Charles Wyplosz presents Scenarios how Cyprus crisis might pan out

On voxEU Charles Wyplosz presents three scenarios of how the crisis in Cyprus could evolve. A benign one, a less benign one and total disaster.

• The benign scenario is that depositors in Cypriot banks will accept the tax and keep their remaining money where it is. Depositors in other troubled countries will accept that Cyprus is special and remain unmoved.
• A less benign scenario is that depositors in Cypriot banks come to fear another round of optimal, time-inconsistent levies. This is what theory predicts. After all, if policymakers found it optimal once, why not twice, or more?
• The really worrisome scenario is that the Cypriot bailout becomes euro-systemic – in which case the collapse of the Cypriot economy will be a sideshow. This will happen when and if depositors in troubled countries, say Italy or Spain, take notice of how fellow depositors were treated in Cyprus.

 It is a must read. Some aspects are somewhat unlikely in my opinion, though. The benign scenario will just not happen because the foreigners will just look for a safer tax haven. So as I have mentioned this is the first time that it makes sense to stage a bank run for every one, even though it will as always bankrupt the finacial sector. In my worst case scenario there will be worry in Italy and Spain but not a full fledged bank run. More a walk. Something that is controllable. But Greece will possibly face a bank run.

But I think there is a new scenario emerging. One that seems more likely by the hour. The parliament will vote against the bail out and the banks will not reopen ever again, well at least not in their current form. From here on I see two paths forward 1. Having stopped all banking activity might actually prove invaluable. There is a chance to now restructure the banks. Create bad banks, were they put say all the European and Russian deposits and good banks with Greek and Cypriot money. Gazprom might be the entity that makes a orderly restructuring possible.  The problem is that even though as Mr. Wyplosz rightly states, this just cannot be described as an emergency measure NO ONE is prepared. The Cypriot government has only been around a few weeks now. There just isn't any way they made any plans.

Which leads us to 2. Cyprus banks will default disorderly, the hits on deposits will be immense, the government will fail and the island will be forced to leave the Euro without a new currency. Still even in this scenario Gazprom might just be the "white knight" the guy who gets Cyprus's natural gas at a bargain and the island will be scared (There will be a Depression - there are just too many people working in banking) . Should this happen I think a bank run in Greece is pretty likely.

Schäuble and the Blame Game

One of the favorite games of the German government is blaming outside entities (usually the EU) for decisions made even though the German government government is deeply involved. Here is how it is played. Schäuble answered questions about Cyprus on the State TV news (ARD Tagesthemen) yesterday evening:

He answered to the question: "was it Your idea to take money from the private deposits of the Cypriots?" (my translation)

No it was the position of the Bundesregierung and the IMF that the major part of the funds needed to stabilize the banks should be taken from the owners and creditors, those are the investors, of the banks. But of course we would have honoured the desposit insurance of up to 100,000 €. But those who did not want a bail in, the Cyprus government, the European Commission and the ECB chose this solution and now they have to explain it to the Cypriot people.

Yes if you have a deposit at a bank you are now an investor in the eyes of the German government it is your own fault that you trusted in the deposit insurance and Germany also pledges to uphold the law IF everybody does as we say. He then said, that to reach the needed amount he wanted to achieve a large base to not overburden the rich, so he might not have been the one who came up with the tax but he was deeply involved in how the plan was carried out.

The Merkel government has a bad habit of using language not to explain something but to defend the indefensible. They use words that sound similar to something which was proposed but mean something toally different. Thursday last week a bank customer was not an investor. The finance minister changed that now. It is extremely annoying that one has to listen to every word exactly because the phrases used just don't mean what one thinks when listening for the first time. The interviewer helped by asking the wrong question. Who cares if it was Schäuble's idea. What matters is was this a plan that the German government proposed? I think it was.

Schäuble was very much against  a "rescue" of Cyprus less than two months ago. Both the coalition and the oposition parties wanted to punish the depositors, since they feared the backlash of the German voters in case that "Russian oligarchs" would be bailed out. So the minister basically did not explain a thing. He just blames Cyprus for choosing the pest over cholera. Even if it wasn't the Merkel government who pushed for this plan, which I find unlikey,  we are at least in part responsible for the outcome. We could have just said that the deposit insurance has to be honoured. We didn't.

Just a reminder, due to the way the ESM is set up Germany can veto any bail-out decision. At least 80 % of the votes are necessary for such a move and Germany controls 27 %. If we actually wanted to, we could have forced the protection of deposits up to 100.000 €. 

How is a "bail-in" different from a deposit tax? Not very. Goldman is not sure if the action in Cyprus wasn't also the former. "Bail-in" describes using deposits to finance the banks, by forcing the bank customers into bank ownership. So instead of just outright losing money, the happy new investors would have had shares of a broken financial system. An actual journalist would have asked the finance minister why "out" was chosen over "in".  Instead German state TV just accepted that some one else is to blame. Also the interviewer did not even ask what the exact plan was that Schäuble claimed to favor. German Quality Journalism For The WIN.

What Schäuble also does not seem to understand is that no matter how the Cypriot parliament votes the banks will be insolvent. Once the confidence in the banks is destroyed it cannot be fixed easily, so when if the banks reopen, the customers will try to get their money out. Worse still is that of course spill over effects cannot be avoided even though Schäuble claims otherwise ("special case" "wont happen again" yadayadayada). As Krugman put it:

It’s as if the Europeans are holding up a neon sign, written in Greek and Italian, saying “time to stage a run on your banks!”

I am looking forward to what the ECB has to say. In the end no one will be responsible. The deposit tax just happened. Every body wanted to uphold the law but other entities didn't. Sometimes I think they come up with "plans" by playing a drinking game and the proposal of the "winner" has to be accepted. That also explains why no one remembers his own involvement in bad solutions.

German Politics at the Core of Cyprus Decision

The excellent blog Wonkbook has a post about the "bail out" of Cyprus. I mostly agree but one thing caught my eye:

Those are the reasons the IMF has insisted on losses for depositors — those, and the fact that rescuing Cyprus’s finances without the 5.8 billion-euro contribution represented by depositors’ losses would have meant a bailout approximately equivalent to the country’s annual economic output, too much for the fund to stomach.

I disagree with this passage. The IMF is not the responsible party in this mess it has at least last year called to stand behind the deposit insurance, which is now being guttet. The decision to "tax" depositors was made due to German politics. Merkel has problems keeping her coalition together when votes are called for on "rescues". There are at several (up to 23) so called "Abweichler"  ("deviators")  primarily in the two smaller partners (CSU and FDP), who will vote against such packages. So Merkel needs the opposition to vote yes.

The Greens and the SPD, just like the coalition, said (for example SPD "expert" Carsten Schneider on Friday) that they would only vote for a rescue of Cyprus if the bank customers would be involved in the bail out. The only other party in the Bundestag- the left wing Die Linke - will most likely just say no to the rescue. All German "rescue" parties are scared that money will bail out Russian oligarchs. That is the primary reason why they want a tax on bank deposits.

Here is why the situation in Germany matters so much: the Constitutional Court made a vote on such packages mandatory, so Merkel's "governor" cannot agree to ESM money being pledged unless the parliament agrees. Here's the catch: Germany is one of two countries which always has a defacto veto in the ESM. Even if the ECB says a rescue is necessary at least 80 % must agree within the Board of Directors. The German "governor" controls 27 % of the votes, which equals the share of money Germany has contributed to the ESM. Making it impossible to "help" any country without Germany agreeing.


The party responsible for the unimaginably stupid "bail out" is Germany not the IMF.  What makes this even worse is that no matter who is elected in September, the next German government will consist of the very people who caused the already happening and the ensuing mess. Specifically, the destruction of the European deposit guarantee might just prove the last drop necessary to cause a breakup of the Euro area.