"All The Conditions For A Total Disaster Are In Place"

Tyler Durden's picture

Authored by Charles Wyplosz, originally posted at VOXeu,

Cyprus: The Next Blunder

The Cyprus bailout package contains a tax on bank deposits. This column argues that the tax is a deeply dangerous policy that creates a new situation, more perilous than ever. It is a radical change that potentially undermines a perfectly reasonable deposit guarantee and the euro itself. Historians will one day explore the dark political motives behind this move. Meanwhile, we can only hope that the bad equilibrium that has just been created will not be chosen by anguished depositors in Spain and Italy.

The decision to tax all Cypriot bank deposits has attracted massive attention (Spiegel 2013) – and rightly so. It is a huge blunder:

  • In the unlikely event that all goes well, the government will receive a bit of cash – but not enough to cover the loan generously offered by its European partners – and the Cypriot banking system will be history.
  • The alternative is a massive bank crisis in many Eurozone countries – a huge blow to the euro, maybe even a fatal one.

Not an emergency measure

Policymakers have been debating the Cyprus bailout for nearly a year; this cannot be classified an 'emergency action'. They engaged in a lively debate whether Cyprus is 'systemic' or not, the answer to which can only be 'it depends'. It depends not on the size of Cypriot banks but on the way the Eurozone acts. They also debated the Russian deposits that apparently represent a sizeable proportion of bank liabilities. The debate turned around the issues of how dirty this money is and how to do the laundry. They also debated on the size of a possible loan to the Cypriot government. The government itself requested something to the tune of 100% of its GDP, why not? After all this amounts to 0.2% of Eurozone GDP.

Eurozone’s help: Suffocating solidarity

From what is known:

  • Cyprus will receive a loan of about half the requested size under the usual austerity conditions.
  • The gross public debt of Cyprus will rise from its current level of some 90% of GDP to about 140%, a level that is unsustainable and will eventually require some deep restructuring.

This debt trajectory is a forecast, of course, but well in line with experience.

The effects of this Eurozone austerity programme are now well known. Cyprus joins a distinguished list of countries that benefit from suffocating Eurozone solidarity (Wyplosz, 2011).

  • The programme will impose tough austerity;
  • Its public-debt-to-GDP ratio will grow because deficits will not go away and because GDP will decline.
  • There will the need for more loans as economic predictions will be found to be 'disappointing' over and over again.
  • Unemployment will skyrocket, spreading intense economic and social suffering.

Who knows, populist parties could well be on the rise, adding political drama to economic pain. This technology is now well oiled.

The bank deposit ‘confiscation’

What is new is that bank deposits will be 'taxed'. The proper term is 'confiscated'. Like everywhere in the EU, bank deposits in Cyprus are guaranteed up to €100,000. Depositors have arranged their wealth accordingly, only to be told that the guarantee has been changed ex post.

Taxing stocks is optimally time-inconsistent (Kydland and Prescott, 1977). It is a great way of raising money but it has deep incentive effects as it destroys property rights. What is at stake is the credibility of the bank deposit guarantee system throughout Europe.

The system was shaken in 2008 but in the opposite direction. Followed by all other countries, Ireland offered a full guarantee in a successful effort to stem an impending bank run. The cost to the government was such that it triggered a run on the public debt that led to the second bailout after the Greek 'unique and exceptional' one.

That move has now been recognised as a mistake, which may explain how Cyprus is now being treated.

The Eurozone’s ‘corralito’

Because it is time-inconsistent, the decision to tax deposits has been preceded by a freezing of bank deposits. This is remindful of the Argentinean corralito of 2001, which led to economic dislocation, immense suffering and such anger that two governments fell (Cavallo 2011). Hopefully, the Cypriot corralito will not last too long.

The question is: how bank depositors will react in Cyprus and elsewhere? The short answer is that we don’t know but we can build scenarios:

  • 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?

Under the less benign scenario:

  • We will have a full-fledged bank run as soon as the corralito is lifted. Since bank assets amount to some 900% of GDP, there is no hope of any bailout by the Cypriot government.
  • Any new European loan would immediately translate into a run on the public debt.

Enter ECB, stage right

At this point in the scenario script, the ECB enters the play. Being the only lender of last resort, the ECB will have to decide what to do.

  • In principle, it could stabilise the situation at little cost as total Cypriot bank assets represent less than 0.2% of Eurozone GDP or 0.5% of the central bank’s own balance sheet.
  • But this would involve the risk that it could suffer losses – especially if the banks are badly resolved, i.e. the bankruptcies are badly handled.

This is not unlikely since the ECB does not control Cypriot bank resolution.

Remember that the current version of the banking union explicitly leaves resolution authority in national hands. In Cyprus, as almost everywhere else, national authorities are deeply conflicted when it comes to their banking systems. Powerful special-interest groups become engaged when banks go bust and governments decide who pays the price. Thus, it is a good bet that Cyprus’s bank resolution will be deeply flawed. The risk to the ECB is real.

Proper resolution under European control could have been part of the conditions for the loan just agreed. But this does not seem be the case. The omission most likely reflects a belief by policymakers that the Cyprus crisis has been solved successfully. The problem is that this belief is false: Cyprus’s predicament remains even under the benign scenario.

All the conditions for a total disaster are in place

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.

All the ingredients of a self-fulfilling crisis are now in place:

  • It will be individually rational to withdraw deposits from local banks to avoid the remote probability of a confiscatory tax.
  • As depositors learn what others do and proceed to withdraw funds, a bank run will occur.
  • The banking system will collapse, requiring a Cyprus-style programme that will tax whatever is left in deposits, thus justifying the withdrawals.

This would probably be the end of the euro.


The likelihoods of these three scenarios – benign, less benign, and total disaster – are difficult to assess.

  • What is clear is that the Cyprus bailout has created a new situation, more perilous than ever before.
  • Once more a deeply dangerous policy action is decided apparently without any awareness of its unintended consequences.

It is also another violation of sound existing arrangements. We have a no-bailout clause in the Maastricht Treaty – a clause that was essential to the Eurozone’s stability. Putting it aside in the case of Greece was the heart of the today’s problem – the reason the crisis spread (Wyplosz 2010). This no-bailout clause has once again been put aside summarily.

We are now witnessing another radical change as a perfectly reasonable deposit guarantee is being undermined. Historians will one day explore the dark political motives behind this move. Meanwhile, we can only hope that the bad equilibrium that has just been created will not be chosen by anguished depositors.

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LawsofPhysics's picture

When fraud is the status, quo, possession is the law.  Some things never change, time to get your tribe in order folks.

GetZeeGold's picture



Thanks for all the help CNBC.

Careless Whisper's picture

Personally, I'm getting sick and tired telling people of the virtues of buying gold, only to get a blank stare in return. Anyone who's still in paper fiatsco, well, efff 'em.


BLOTTO's picture

Wall Street Last Week: Jump in the water its piss warm and fine


Wall Street This Week: Stay out of the water because its the piss and shit making it warm...



ATM's picture

Nothing is fixed because nothing has been fixed. The sewers are still full of a tidal wave of more shit and piss and when that clog lets loose, look out below.

gmrpeabody's picture

That was a quick BTFD...

johnQpublic's picture

where is simon black hiding his money in foreign banks?


awaiting his next article where he complains of theft of 13% of his hard won cash(spread across accounts in cyprus, greece, italy, spain, switzerland , hong kong and china, venezuela and argentina)

Popo's picture

Oh please. He's a broke blogger. He's hiding his cash in the back pocket of his jeans and writing make-believe blog posts about being in the CIA.

Gordon Freeman's picture


Thank you for the note of sanity

CrazyCooter's picture

Simon laid a few turds along the way (i.e. articles with bad premise) at which point I realized how useless his posts really are. Charles Hugh Smith is a giant. Bruce Krasting has very unique insights, opinion, and shares his experience.

Sometimes I click on a Simon post and then feel cheated when I realize it was his. I mean, it wasn't clear from the front page what I was going to get.

Sometimes I wonder if he actually pays to be on ZH. He catches almost as much flak as Leo got before he and his solar stocks left the pages of ZH for good.



CIABS's picture

If he could afford to pay zerohedge, he probably would.

El Diablo Rojo's picture

Bruce and Simon are two peas in a pod. Read his at best remedial article about black accounts, and you will reconsider Bruce as credible.

Totentänzerlied's picture

"Charles Hugh Smith is a giant"

Please. A giant among midgets.

aint no fortunate son's picture

opened stocks at LoD and killing the VIX - prolly gonna be an up day in Bernanke land - is there a POMO today?

aint no fortunate son's picture

textbook manipulation of capital markets - spot VIX opened right at it's 50 DMA and they've been selling it ever since, aapl up, classic short squeeze coming in today compliments of the world's central banks

Awakened Sheeple's picture

Noone was short before today, hence no short squeeze.


FrozenOut's picture

I disagree. The solution is real assets, that is true, but your gold can be stolen. I say consumable assets. Let's drink it all. Cheers ;)

Meat Hammer's picture

Yup, as I sit there being a good sport and the butt of goldbug jokes (Scrooge McDuck is my favorite) I think "joke's on you, bitchez".

freewolf7's picture

"benign" = asleep

"less benign" = less asleep

"total disaster" = fully awake

Super Broccoli's picture

you retard, it's not the Rothchilds that are getting fucked here

Jim in MN's picture

Really....the Russians let themselves get pushed around by that space rock, and now the horse is out of the fucking barn....

toys for tits's picture



Forget the ECB, this is the Fed's second Lehman Bros. moment.  If it doesn't totally fund Cyprus, then the Euro is done.

ATM's picture

We might all be realizing that counterparties in a fiat scheme are all that matter. when we know they can't pay it's run for the hills.

kaiserhoff's picture

Once you begin Soviet Central Planning, there is rarely a convenient off ramp.

fightthepower's picture

Fuck you Rothschilds!

kito's picture

they make wine now........its called the "fruits" of their labor..............



Edward Fiatski's picture

It's a leisurey-cover operation. :)

Tinky's picture

Finally we have a post on this topic written by someone with a European-sounding name.

gratefultraveller's picture

Did you guys know this?

"Industrial Note" and "Equity Strategy Note" of Citigroup Corp., N.Y. (2006) "Plutonomy, Plutocracy, Plutocrats" http://cryptome.org/0005/rich-pander.pdf


btw, Citi has tried (invain) to keep this off the web with their lawyers ever since it was first leaked. that should tell you something

swissaustrian's picture

Great stuff. Thanks for posting!

CrazyCooter's picture

Charles Hugh Smith and the Pareto Economy (Zh guest post from back in Feb).



i_fly_me's picture

Good stuff, I missed that one.  Thanks.

Jim in MN's picture

I wonder how HFT algos would react to being pounded with a rock, over and over and over again?  Maybe someone should find out.

q99x2's picture

I had one of those crawl out of the dvd drive slot one day. I ran outside and flipped the breaker. When I came back in it had disappeared. Got an algo problem; cut the power.

CrazyCooter's picture

Hah! Didn't work for Knight Capital!



firstdivision's picture

Shorting some UNG now.  Natty seems to be in a whole other world today.

kito's picture

dig deep and think ahead, there is a tremendous amount of capital being pumped into nat gas transportation infrastructure.......

CrazyCooter's picture

I have no money in this trade, but I am generally of the opinion that Nat Gas production based on shale fracturing is only floating because of all the free money. Further, I think the shale oil boom in the Dakota's also relies quite a bit on the "free money" as it is very capital intensive to keep production up.

Both are going to take a real turn when the free money is gone or inflation takes off. Both are *expensive* compared to conventional sources and that will shine through with time.



kito's picture

input costs are dropping. they are working on the demand side. within 10 years you will see a different world with nat gas and transportation. i would gather 40% of all commercial trucking will have switched.....

Downtoolong's picture

"Yes we can" just became "Because we can".

post turtle saver's picture

Best post of the day, sums it up succinctly - I'd give you +1000 if I could.

Truther's picture

The roosters are coming home....you know the rest, right?

kito's picture

...and the bankers get tarred and feathered?????????

swissaustrian's picture

"Once more a deeply dangerous policy action is decided apparently without any awareness of its unintended consequences."

I don't think they're that stupid. This has to be intentionally done to make the crisis worse. They know that they can't get away with all the reforms they want, so they're creating a crisis to offer a "solution":

problem -> reaction -> solution.