The Cyprus Bailout Is Turning Into a Jerry Bruckheimer Movie

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Photo: Image Source/Corbis, iStockphoto

So, that weird and controversial Cyprus bailout we discussed yesterday? Yeah, not really happening as planned.

What was supposed to happen: a relatively orderly process whereby ordinary Cypriots would get a fraction of their bank deposits seized from them in a onetime tax to help Cyprus satisfy the terms of an EU bailout and put the island nation's undercapitalized banks back on stable ground.

What actually happened: a doomed Parliament vote, riots in the streets, a finance minister who may or may not be resigning, a bunch of nervous Russians, and a British plane stuffed with 1 million Euros headed to Cyprus to give emergency money to soldiers. In short, this thing is quickly turning into an Armageddon-style disaster movie.

Cypriots are upset — as they have a right to be — about the part of the bailout package that would subject their bank deposits to a significant onetime tax levy. And faced with the prospect of a mass uprising, politicians in Cyprus did the only thing they could and voted the package down.

So, what's next? The one thing we know is that Cyprus's president will head back to the bargaining table with the Troika, to look for a solution that will (a) not get him killed in the streets, and (b) avoid a huge bank run in Cyprus. (A medium-size bank run is already kind of a given.) Dylan Matthews has a good rundown of Cyprus's other options, including leaving the Euro (which would be a disaster) and trying to bail out its own banks (which would be an even bigger disaster).

Felix Salmon, with backing from sovereign-debt guru Lee Buchheit, thinks the right answer is to leave ordinary Cypriots' money alone, while converting deposits of over 100,000 Euros into five- or ten-year CDs, to give Cyprus's banks some time to pull it together. Buchheit anticipates one objection to this plan, which is that terming out big deposits for five or ten years is basically just buying more time and doesn't recapitalize the banks.

But the bigger objection to plans like these is that it doesn't really do anything for depositor psychology. As Matthew Klein and others have pointed out, the outrage in Cyprus is more optical than anything else. We've learned that while ordinary people don't like negative real interest rates, high taxes, austerity measures, and other unpleasant economic realities, they will tolerate them. But if you threaten their bank deposits — their savings and checking accounts — they will freak the hell out. 

Savers, whether they're Russian oligarchs or Cypriot fishermen, don't like having their deposits messed with. And for that reason, Buchheit's plan — which would involve tinkering with the form and liquidity of deposits, even if the amounts are not strictly being reduced — would likely be greeted with the same scorn and backlash as the old tax-all-depositors plan, and big depositors would still line up on Thursday to pull their money out.

As Cullen Roche writes, the lesson of the Cyprus conflict thus far is that "money is built around trust." Now that trust in Cypriot banks is dwindling by the hour, it's unclear what, if anything, Cyprus's parliament can do to prevent total financial and political chaos in the next few weeks. Which is good if you're a Hollywood producer looking for a script concept, but bad if you're a Cypriot or anyone who does business with one.