EUROPEAN UNION: by Patrick J. ByrneNews Weekly
Depositors will bail out failed banks: eurozone chief
, April 13, 2013
Confiscating the savings of depositors to bail out banks, as is being done in Cyprus, is to become the preferred method of dealing with future bank failures in the European Union.
Jeroen Dijsselbloem, president of the board of governors of the European Stability Mechanism (ESM), has announced that the EU’s Cyprus policy would be a template for bailing our failing banks across Europe.
The eurozone chief, who is also the Dutch Minister of Finance, said that if a European bank is failing, the EU will be asking it to recapitalise itself by issuing bonds.
If the bank can’t raise funds, “we’ll talk to the shareholders and the bondholders,” he said. “We’ll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit-holders.”
Mr Dijsselbloem’s announcement signals the mothballing of the ESM — that is, the EU’s US$861 billion bailout fund — which Spain and Ireland want to use to recapitalise their banks.
Germany’s central bank, the Bundesbank, has reinforced Mr Dijsselbloem’s statement by publicising the results from a recent study by the European Central Bank, which purports to show that the average wealth of Germans is lower than that of the inhabitants of the troubled Mediterranean states. Why? Because fewer Germans own houses.
By using this argument, Germany is signalling that it is no longer prepared to fund the bailouts of troubled banks.
Instead, the conditions for the $12.3 billion Cyprus bailout — by the European Central Bank, the International Monetary Fund and the European Union — include converting 37.5 per cent of all deposits above $120,000 into a special class of shares and freezing a further 22.5 per cent in non-interest bearing accounts.
It will be much worse for people with deposits in the troubled Laiki Bank, the second largest bank in Cyprus. It will be wound down and depositors with more than $120,000, will lose 80 per cent of their savings.
In order to stop a run on Cypriot banks, strict limits are being imposed on cash withdrawals. Further limits will apply on how much individuals can take abroad, despite the Euro having been built on the principle of free flow of capital between EU member-states.
This policy could see depositors elsewhere in Europe moving their savings out of the already weakened banks in Portugal, Italy, Ireland, Greece, Spain and Slovenia (the so-called PIIGSS), preferring the safer and stronger banks in countries such as Germany. (Banks in stronger economies can raise funds from the markets and governments can bail them out by raising taxes.)
Alternatively, worried depositors in troubled European economies may decide to shift their savings out of the EU altogether.
Banks and beaches
It used to be said of Cyprus that it has only banks and beaches.
This tiny island-state of only 840,000 people has a banking sector grossly disproportionate to its domestic economy.
Its banks ballooned in the wake of the global financial crisis (GFC).
When the Irish banking system was imploding, Cyprus became the new European destination for hot money. It was paying higher interest rates.
According to a McKinsey Global Institute study, $40.7 billion was funnelled into Cyprus through loans and bank deposits in 2008. This was small in the context of world capital flows, but huge when compared to the $24 billion Cyprus economy.
Eventually, bank deposits peaked at $120 billion, of which $60 billion came from Russia.
In October 2011, the fate of Cyprus was sealed by decisions made in Brussels at an emergency meeting of EU leaders and the International Monetary Fund (IMF), as they sought to deal with the Greek debt crisis.
According to a report in the New York Times (March 26), they “engineered a 50 per cent write-down of Greek government bonds. This meant that those holding the bonds — notably the then-cash-rich banks of the Greek-speaking Republic of Cyprus — would lose at least half the money they thought they had. Eventual losses came close to 75 per cent of the bonds’ face value.”
Altogether, the Cypriot banks lost about $4.2 billion. This came on top of losses from a Cyprus property bubble that burst.
Then, in March 2012, when Cypriot bonds were reduced to junk-bond status by Moody’s rating agency, the banks were unable to raise capital from the international financial markets.
Hence, in attempting to deal with the Greek crisis, the EU and the IMF precipitated a further crisis in Cyprus.
Harold James is professor of history and international affairs at Princeton University and author of Making the European Monetary Union. He argues that the EU’s ongoing crisis is further evidence of what most economists and commentators on Europe have long argued: a monetary union is impossible to sustain in the absence of a political union.
Professor James says: “A state, especially in the modern form of the European welfare state, depends on effective mechanisms for arbitrating and resolving social disputes — mechanisms that, as the turmoil surrounding Cyprus has shown, the EU lacks.
“As long as that remains true, European integration may be doomed by the time the music stops.”
Patrick J. Byrne is national vice-president of the National Civic Council.
 Harold James, op. cit.