Saturday, March 23, 2013

Plutocracy and “Ringfencing” at EU and Cyprus

There is something wrong with the banking system in Cyprus. The banks have been closed all week, and will not reopen Monday, so it is easy to say that now. It is also easy to say that nothing is being done about it and that the bone-headed approaches of both the EU and Cyprus to the problems will do more harm than good whether implemented or not. The fact that no one seems to have a good solution doesn’t mean we should be silent with our criticism. It is, after all, better to do nothing in a situation spiraling out of control than to take detonator in hand and blow up a whole country and perhaps a continent with it.

What is harder to say is why the people making the decisions are so far off the mark. At the risk of simplifying a complex situation, the answer in a word is plutocracy. The people making the policy decisions are so far removed from the situation on the ground that they seem unable to predict or even observe the reactions of the ordinary people involved.

By all accounts, the new president of Cyprus was caught off guard by the street protests that followed the EU-backed proposal to seize a fraction of all deposits in the country, between 1/15 and 1/10 depending on the size of the account. In a time when decisions have to be made to navigate through the most unexpected of consequences, we are ill served by being led by a man who cannot foresee the most obvious and predictable of reactions, who cannot hear the voices of those around him who can. One result is the late word that parliament will not meet today ahead of tomorrow’s international deadline. I must assume leaders have abandoned a problem-solving approach and are pinning their hopes on an all-or-nothing vote after tomorrow’s European huddle. For their part, EU leaders are not much more helpful. They are still in denial about this week’s deposit flight in their countries’ banks. The code of silence about deposit flight is a hindrance in this instance. There is too much talk about “ringfencing” Cyprus (is that really the word?) and no talk at all about action and reaction in Paris and Rome. Finance ministers and prime ministers alike seem to think their statements have no consequences in the cities where they say them, but only out in the four corners of the world.

Five days ago I hoped that Cyprus could take a deep breath and figure out what to do. The former came, but there has been too little of the latter, with half of this critical week wasted on a feel-good trip to Moscow.

What has to happen? Above all else, the government in Cyprus has to show that it will be measured and lawful in its actions. That is more important than the question of how many banks can reopen next week. One of the problems with the deposit forfeitures as originally proposed is that it inverted the bank resolution sequence. If there is not enough money at a bank, the sequence of forfeitures is common stock, then preferred stock, then bonds, then uninsured deposits, then the deposit insurance fund. Insured deposits are forfeited only after there is no deposit insurance fund left. In proposing to do this sequence in reverse, grabbing insured deposits first while protecting stockholders and bondholders from losses, the president of Cyprus was showing a willingness to prey on the most vulnerable people at home in order to protect the interests of anonymous billionaire-investors abroad.

This inversion did not happen out of ignorance or accident. It probably came about at the EU’s insistence, from the vain hope that by avoiding the smell of bankruptcy, ratings agencies might be persuaded that the EU is not in trouble. I don’t doubt that some ratings analysts might be fooled for a few weeks, but there are worse things in the world than ratings downgrades, and if ordinary people in the EU (and U.S., for that matter) hear that the financial situation has gotten so bad that the rule of law is breaking down, those consequences will follow.