Over the weekend the European Union agreed to a 10 Billion euro bailout of member country Cyprus’ banking sector, but imposed as a condition of the bailout a 9.9% tax on all bank deposits above 100K Euros.
On its face and in the abstract, this proposal is a horrible way to bail out a bank and an ailing economy, as it violates rule #1 of financial bailouts, namely “avoid bank runs.”
Not only does the proposal guarantee every Cypriot bank will suffer a run by all its depositors as soon as they open on Thursday, but every bank in Southern/peripheral/wobbly Europe – Spain, Portugal, Greece – has to wonder whether their depositors will do the same in anticipation of future similar bailout terms imposed by the European Union, and Germany in particular.
The fastest way to achieve a run on banks in weak countries is to suddenly punish depositors for leaving their money in the bank. Even to threaten to do so can create a self-fulfilling fear, one that leads quickly to bank runs.
The proposal also violates rule #1 of dealing with distressed banks, which is that depositors get treated better than bondholders. The European Union’s proposal to punish depositors – while bondholders suffer no losses – upends the traditional order of payment priority of bank liabilities.
On the other hand, I can see why the European Union made this odd deposit tax proposal, as the specific situation of Cyprus boils down to the European Union vs. Russian oligarchs.
Cyprus is the Cayman Islands of Russia, a hub for vast quantities of Russian banking deposits. Some may be savings of ‘ordinary’ Russians, but most people believe a combination of Russian Mafia, Russian oligarchs, and dirty money sloshes around the Cypriot financial sector. Bailing out Cypriot banks, without confiscating what is perceived to be largely illegitimate Russian money, was too much for the German leadership of the EU to swallow.
Which all reminds me that in a world of Plutocrats, in which huge aggregations of money are perceived to be illegitimate, it becomes much easier for policy-makers to engage in what would otherwise be horrible banking policy.
I don’t think it’s a stretch to wonder about the implications for the US.
The inequality here has reached a point where, if people actually knew how stratified we’ve become, the idea of a Cypriot bank tax in the US to confiscate wealth goes from being an Occupy Wall Street fantasy to becoming more normalized.
In the US we currently view our own plutocrats as superheroes. But if they instead become morally equated with Russian oligarchs, then a confiscatory tax like the Cyprus proposal starts to almost look ‘fair.’
I think this is a nightmare scenario, but I also think structural inequality in the US sets the scene for this kind of nightmare. It’s not unthinkable.
 Although the proposal keeps changing as of this morning. Maybe it’ll be 15% for depositors over 500K Euro, and 3% for depositors below 100K Euro, and no tax for depositors below 20K Euro. Also, maybe the Cypriot parliament will reject the whole deal and take their chances.
 The other interesting angle: If you’re a Cypriot parliamentarian, are you willing to vote for something that hurts the Russian mafia? I mean, admittedly everything I know about the Russian mafia comes from Hollywood, so I don’t really have real life experience here. But I’d be pretty nervous to vote for this bank tax and put a big fat Russian mafia target on my back.
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