Oy, Cyprus. Here’s a brief history of the Mediterranean island that’s trying its best to tank the markets: In the 1980s, Cyprus largely got out of the export business that had sustained it and retooled around services, especially the financial variety. Over the next few decades, foreign money began pouring in, specifically from Russia, which was minting billionaires at a rate that only a huge kleptocracy could manage.1 Today, Cypriot banks house around 70 billion euros worth of deposits, a breathtaking sum given that the country’s entire GDP is only 18 billion.2
With all that money sloshing around, the Cypriots naturally got careless. (Quick: try to summon an image of an anal-retentive banker. My guess is he or she won’t live in the eastern Mediterranean.) They piled into Greek government bonds—in retrospect, not the world’s safest investment. They diversified into real estate, inflating a housing bubble that recently popped. (Who could have foreseen it?) The country’s two main banks are now drowning in losses. They need a bailout the size of the country’s entire economy to stay afloat, a sum that would translate to about $16 trillion in the United States.
Even so, Cyprus didn’t truly go off the rails until a little over a week ago, when it petitioned its fellow Euro-using countries for the cash it needs to save its banks. The Europeans were only willing to pony up about two-thirds of the money, insisting that Cyprus bank depositors provide the rest. This was a semi-reasonable condition, since it was all that hot foreign money that fueled the country’s lending binge in the first place. Except that Cyprus’s political class wasn’t quite willing to alienate the Russians who stashed their money in the country.
So, rather than hitting up the oligarchs for the 6 billion euros they needed, the Cypriot government decided to split the burden roughly 60-40 between the oligarchs and ordinary citizens.3 That’s right: Thanks to the accident of their residency, Cypriot teachers and cops and doctors would see their hard-earned savings confiscated—savings that were supposedly insured—in order to lighten the load on a bunch of dodgy Russian moneymen. If it seemed like the most cartoonish caricature of an unfair bailout, well, that’s because it basically was.4
It’s all pretty hilarious in a dark sort of way. But it turns out there’s a final twist. As you reflect on precisely how backward and dysfunctional a government would have to be to screw its average citizens in order to shield its banking elite and their gangster-state patrons,5 consider this: It’s actually pretty damn similar to the way we bailed out our own banks.
Recall that in October of 2008, about two weeks after Lehman Brothers collapsed, Congress passed the Troubled Asset Relief Program (TARP), which took $700 billion in taxpayer money and set it aside for the banks. In theory, at least, there were other options. For example, the government could have foisted a few hundred billion in losses (known as “haircuts”) onto the failing banks’ investors—specifically their unsecured bondholders, which are roughly analogous to wealthy depositors in the case of Cyprus—so that taxpayers didn’t have to put up the cash.
Now, let’s not overstate the point. Big U.S. banks are a wee bit more important to the global economy than the two major banks in Cyprus. And, at the time, the entire U.S. financial system was on the ropes. Had the government decided against a big bailout and chosen to haircut the bank’s bondholders instead, it would have accelerated the panic and likely triggered a financial apocalypse. I’m not suggesting this was the way to go. There’s no justice in kneecapping bankers and bondholders if you end up destroying the economy for everyone else.6
But even after the initial system-wide panic passed, a few massive firms—such as Citigroup and AIG—looked like they’d need ever-greater piles of cash to soak up their red ink. At that point, a growing number of economists (and even some top administration officials) thought the best way to deal with their losses wasn’t to keep hitting up taxpayers. It was to squeeze the companies’ bondholders. But the government—namely Treasury secretary Tim Geithner, who had the final say here—disagreed. “We’re not going to do it,” he told an aide. “It would hurt our credibility deeply.” Instead, in late February 2009, he effectively put the taxpayers on the hook for additional bailouts, releasing a joint statement with the Fed pledging to “preserve the viability of systemically important financial institutions.”7 Translation: We’ll do what it takes to protect the bondholders.
Essentially, the U.S. government, like Cyprus, took one look at the banks’ biggest creditors, and one look at the man on the street, and decided it would much prefer to screw the latter rather than the former.
In both cases, this decision had a lot to do with the conviction that the banks were key to the country’s economy. “Cyprus doesn't want to cripple its future as an offshore financial center,” wrote The Atlantic’s Matt O’Brien, explaining the reluctance to make the Russians take too much of a bath. Likewise, Geithner once told me that he didn’t “have any enthusiasm” for shrinking the U.S. financial sector because we wouldn’t want to cede all that lucrative banking business to other countries. In both cases, you have to assume the bankers themselves—and their, er, lobbyists—had a lot to do with bringing the government around to this view.8
Having said that, there is one way that Cyprus’s little-guys-bail-out-the-big-guys approach is shaping up to be radically different from ours: The Cypriots eventually rejected it! When the Cypriot government put the original plan to a vote in parliament, it lost 36-0, with 19 abstentions. The president promptly scrapped the idea. His government spent the next several days essentially offering up Cyprus as a Russian client state if Moscow would come to the rescue (no profile-in-courage that), and flirted with tapping the pension funds of state employees (arguably worse than confiscating bank deposits, as the Germans pointed out). Finally, the government took up a proposal that puts the entire onus on the Russians and other fat-cat depositors.9 The Europeans and IMF tentatively signed off on the plan early this morning.
The leaders of Cyprus may be comically inept. They may be willing to sell their children to Vladimir Putin if it’ll save their banking boondoggle. But, unlike our own government, they apparently grasped the need to stand up to wealthy bank creditors before all was said and done.
Some wealthy Brits also stash their money in Cyprus, but the volume is considerably smaller.
By comparison, a similar ratio of deposits to GDP would mean about $63 trillion worth of deposits in the United States; in fact, there are less than $1 trillion in U.S. banks.
As a practical matter, that meant taxing deposits below 100,000 euros at a rate of 6.75 percent and those above 100,000 euros at a rate of 9.9 percent, instead of only taxing the 100,000-plus accounts—the fat cats—at upward of 15.5 percent.
I say “basically” because, given the Cypriot economy’s enormous reliance on the banking industry, losing its status as an offshore banking hub would clearly hurt ordinary Cypriots as well. So there was some rationale for trying to preserve this business model. The problem was that it was ultimatley hopeless—no one is going to stash money in an offshore haven whose biggest claim to fame is massive insolvency. The government should have realized as much rather than offer up its citizens’ savings in a hopeless attempt to maintain the status quo.
In fairness, the banker is not quite the scorned figure in Cyprus that he or she is in the United States, since the fraction of Cypriots employed by banks is so much higher than the fraction of Americans employed by banks. There is, as a result, more popular support for the banks in Cyprus than here, even amid the crisis. Still, the people most keen on saving the banks by taxing small-time deposits were almost certainly bank executives, not rank-and-file workers.
Another key difference: Unlike the Cypriots, the American central bank—the Federal Reserve—could simply buy up or insure a bunch of toxic banks assets, or make emergency loans, and then just print money to cover any resulting losses. Cyprus’s central bank has no such luxury because it doesn’t control its currency, the euro.
In theory, the Fed could have paid for future bailouts by printing additional money, at no direct cost to taxpayers. As a practical matter, future bailouts would almost certainly have had some additional costs for taxpayers. The unused money from TARP would surely have been spent if necessary. And Geithner had become expert at putting taxpayers on the hook using other federal agencies, like the FDIC.
As noted above, there’s some actual popular support for this view in Cyprus, where it turns out to be much more true than in the United States.
The other main point of contention was whether both major banks in Cyprus would be dismantled, as the Europeans wanted, or just the second largest, as the Cypriots hoped. The Europeans reluctantly agreed to let the largest bank survive for the moment. The bank's bondholders will also apparently take a hit, though there simply aren't very many of them--that's why deposits had to get whacked.