The Cypriot Bailout Hasn't Rocked Markets—Yetby
Could the tiny Cyprus banking system be the powder keg whose explosion reverberates around the planet? A bank run in Cyprus, a euro zone nation of 1.1 million, should be an island-contained crisis. But the entwinement of Cyprus and Russia, the world’s ninth-biggest economy, makes things complicated. Russia’s banks and companies have $31 billion parked in Cypriot banks, according to estimates by Moody’s Investor Services—on top of almost as much in Russian bank loans to Cypriot companies. The immediate question is: How confident are 145 million Russians that their money is safe at their Russian bank? By extension, how confident are global banking multinationals—in the U.S., Switzerland, London, Brazil, and China—that their Russian counterparties are good for their rubles if Cyprus rots up to their balance sheets? Will this all prompt a mass run on banks in weak links such as Italy, Greece, and Spain? And a bolt to the exits by equity investors the world over?
So far, so yawn. The Dow Jones and Standard & Poor’s 500 index largely shrugged off the news to start the week; that hit may have been dulled by St. Patrick’s Day libations. On Monday, Russian stocks slid, while gold surged and the euro fell to its lowest level of the year. German two-year bond yields dropped below zero, while Spanish and Italian debt costs jumped. No panic, to be sure. But the week is still young.
Some market watchers are predicting volatility. “What happened to Cyprus on Friday evening was one of the most significant developments in the Euro zone since the Greek election last summer,” wrote David Zervos, the chief market strategist at Jefferies in a Sunday note to clients. “To tax the bank deposits of savers sends an ominous message to the entire global investment community. … Such a move should send shock waves across the entire population of the developed world. This was not a Bernanke style slow moving financial repression against risk free savings that is meant to stir up animal spirits and force risk taking. This is a nuclear war on savings and wealth—something that will likely crush animal spirits. This is a policy move you expect from a dictatorial regime in sub-Saharan Africa, not in an EMU member state.”
Zervos writes that if the Cypriot parliament agrees to the tax, there could be “some serious instability” at peripheral banks. “Why keep your money at a Spanish or Italian bank when you can jump to Germany or France?” he asks. “And why even keep money in the Euroarea banking system at all. We should see huge outflows. Maybe I’m wrong and deposits stay sticky, but the risks here are HUGE and SCARY [his caps].”
Rabobank International, the Dutch financial institution, wrote in a Monday client note that investors need to regard the Cyprus episode at the very least as “an accelerant” to fear and big selloffs should the euro crisis start raging again: “We remain of the view that in the contagion stakes, Cyprus has clear potential to punch far above its weight (the country accounting for a mere 0.2 percent of Eurozone GDP). In fact, we are more confident of this view given the unexpected plan to implicate all Cypriot depositors (and not just those of the Russian Oligarchy). … In essence, Eurozone savers are being asked to believe that the sanctity of deposits has not been compromised, just the sanctity of Cypriot deposits.”
So the ball is in the hands of European savers—and the Cypriot parliament, which will debate and vote on the controversial bank fee on Tuesday. Do not underestimate politicians’ underestimation of markets.