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The Cyprus Bank Bail Out: Hard to Think of a *More* Politically Costly Option

- March 18, 2013

This weekend, the Eurozone was greeted with the specter of a something it had hoped was behind it: the dreaded bank run. Cyprus, a small Eurozone state, agreed to terms on a 10 billion Euro bailout that included an immediate tax on all bank deposits (a smaller but non-negligible tax on accounts under 100,000 Euros and a larger one on accounts above that threshold). That means when banks next open – if the plan goes through – everyone is going to have less money in their bank account than they did on Friday. To facilitate the plan banks are closed and electronic money transfers have been suspended, although in an interesting technological twist of fate ATMs are open, thus allowing the specter of a bank run to hover over Cyprus (and be photographed) without actually allowing people to get most of their money.

I will let the economists sort out whether financially this sort of approach makes sense, but from a political perspective it would appear to be the worst of all possible options. To make a great simplification, it would seem that there are three ways to deal with a failing bank:

  1. Use taxpayer money to save the bank
  2. Let people who loaned money to the bank (“bondholders”) lose money
  3. Let the people who have put their money in the bank (“depositors”) lose money

All of these approaches have economic costs.  But from a political perspective, we’re interested in who pays the cost, how large a proportion of the population that is, and how aware they are of paying the costs.

So let’s start with bondholders.  This is usually a fairly small group of people – many of whom are often not even citizens – who pay a large cost.  Due to this dynamic, we might think bondholders could be a powerful lobby – they have both the interest and the ability to organize – to try to forestall this sort of action.  But politically, if bondholders pay the price for bailing out a bank, we would not expect this kind of a decision to generate much backlash among the citizens of a country.  (Again, this is not to say it won’t cause all sort of economic problems accessing international markets in the first place down the road.)

At the other end of the spectrum is a government bailout (or a government loan to fund a bailout).  Here, all the citizens of a country will eventually pay a cost, but unless the government bailout comes with explicitly conditional austerity measures (think Greece, not the United States) citizens don’t know what the cost is or when they are paying it.  It may be ominous and feared, but it had the advantage for the government implementing it of at least being vague.

What the Cypriot government did seems politically to be the worst of both worlds.  By announcing an immediate tax on all bank deposits, every Cypriot citizen with money in the bank knows exactly how much money they have just lost.  But unlike the bondholder scenario, we’re talking about a significantly large proportion of the population. Moreover, since the act of responding to this impending tax has been made public by the fact that wire transfers are prohibited, every citizen of Cyprus gets to see just how upset/worried her fellow citizens are.  Again, there may be an economic rationale for this form of bailout (but even that I assume will be swamped by negative side effects if the bank runs spread to other European countries), politically it seems hard to come up with something more likely to generate immediate and relevant ill will. (It does remind me of a Doonesbury cartoon from the 1984 presidential election campaign, when Mondale is asked to elaborate on his plan for raising taxes and he gladly begins to name all the people who will pay higher taxes under his plan…)

The only political rationale I could think of for this sort of policy is if you only had a small proportion of citizens with money in the bank, and/or if your power base lay in the poorer segments of society that were unlikely to have bank accounts.  So there are some places in the world where you might expect this type of policy to potentially pay off politically, but I doubt Cyprus is one of them.  (I couldn’t find this figure from an admittedly quick Google search – if anyone knows it, please put in comments below). However, my guess is that if you exempted all accounts under 100,000 Euros, then you quickly move from a situation where the tax only affects “the rich” as opposed to “everyone”.  I put “the rich” in parentheses because of course everyone has different definitions of who is “rich”, but at least the deal could be sold in that manner.  Ironically, it may turn out that the rich are more likely to have diversified assets and thus a smaller proportion of their wealth in Cypriot banks than the simply “well off”, but again there are others who know more about such facts than I do.

Therefore if the actual version of the deal that ends up getting implemented exempts all accounts under 100,000 Euros, you can be pretty confident that the basis of that arrangement is as much political as it is economic.  And to be clear, while economically it might be just as as consequential (does Italy really want everyone with over 100,000 Euros in savings in an Italian bank wiring that money to Geneva or London this week?), politically such a change will ensure the Cypriot government that it suddenly has many, many fewer citizens suffering an immediate loss from the bailout (and Spain and Italy could have many fewer citizens worried about the export of such a tax, although now that the full fledged tax is on the table it remains to be seen whether a Cypriot retreat would banish the specter of such a tax from the minds of other European citizens).  Thus we may be watching a policy designed without politics in mind coming face to face with political reality.