Precis: The financial crisis in Cypress is a precursor to
what can happen in Europe and even here in America. The confiscation of Cypriot
bank deposits is a new tactic to enhance tax revenues. By freezing the bank
accounts,
citizens cannot access
their money, nor can they transfer it out of the country. The financial blitzkrieg
worked because it happened without warning. Overnight, Cypriots lost access to
all of their bank accounts.
The Cyprus Financial Crisis
The Republic of Cyprus takes up half of the island of
Cyprus, located in the eastern end of the Mediterranean Sea. Most of its
residents are of Greek origin and Cyprus has been historically plagued by power
struggles and other conflicts between Greek and Turkish residents.
The Republic of Cyprus joined the European Union in 2004 and
adopted the Euro in 2008. (http://en.wikipedia.org/wiki/Eurozone)
Not surprisingly, this has turned out to be a less than
ideal choice (though one required by members of the European Union once they
meet certain criteria) due to the financial crisis that started adversely
affecting both the financial stability of the region and the Euro itself around
that time.
For a while, Cyprus was riding out the crisis quite well- it
suffered less severe adverse effects than the rest of the euro-zone up until
2012 and grew faster than surrounding countries during that time.
Unfortunately, Cyprus shares not only strong cultural ties to Greece but strong
financial ties as well.
Specifically, Cyprus is a large holder of Greek government
and corporate bonds, so the sharp decline in the value of those assets had a
particularly severe negative impact on Cypriot banks. In fact, the fact that
the value of Greek debt was written down as part of the bailout deal for Greece
actually meant that Cyprus was essentially pushed towards needing a bailout
itself. Cyprus Popular Bank and the Bank of Cyprus, two of the main financial institutions
in the country, couldn't withstand their losses and requested assistance from
the Cypriot government.
The country's government, in turn, chose to nationalize
Cyprus Popular Bank. Unfortunately, this didn't solve the problem, since the
Cypriot government couldn't really afford the bailouts that it had enacted.
Financial markets also made it difficult for the Cypriot government to finance
the bailouts, since the interest rate on Cypriot government debt increased due
to the country's tenuous position. Therefore, the Cypriot government moved the problem
up the financial food chain by asking the European Central Bank, the European
Commission, and the International Monetary Fund for help.
(http://www.ecb.int/home/html/index.en.html)
(http://www.imf.org/)
Unlike a lot of previous bailouts, the original Cyprus
bailout plan involved having depositors in Cypriot banks fund the bailout. Not
surprisingly, this was quite a controversial provision, and there was a lot of
debate regarding how to allocate this "bailout tax" to accounts. In
fact, it was brought into question whether such a plan would even be feasible,
since Cypriot bank deposits are insured and thus implicitly guaranteed to not
be subject to loss of value. Such a plan would have, however, had the benefit
of getting matched by 10 billion euros in bailout funds from the International
Monetary Fund and the European Central Bank. The government
tried to move this plan forward, but a vote was delayed and depositors started
a run on the banks in order to avoid a potential bailout tax.
Taxing Cypriot bank accounts initially appeared preferable
to raising regular taxes in order to fund the bailout because a significant
fraction of depositors in Cypriot banks, especially high-value depositors, are
not residents of Cyprus. (In other
words, Cyprus was happy to have foreigners partially fund its bailout, even if
it made the country a less attractive financial center in the future.)
To make matters more interesting, Russia offered Cyprus a
loan with very generous terms in order to get its financial situation resolved.
(This is potentially not unrelated to the fact that a lot of the high-value
depositors in Cyprus are in fact Russian.) This loan was not as attractive as
it seemed on the surface, however, since it seems that the loan was offered in return
for the Cypriot government looking the other way regarding various tax evasion
and arms dealing practices. In any case, the Cypriot government was left
without an attractive solution to its problem, though possible
options are an austerity program similar to what has been enacted in Greece, a
new version of the bank deposit tax, or
Cyprus' exit from the euro-zone (so that it can use its own currency that is not pegged to the Euro to cover its
debts). Because the latter two of these options adversely affect the value of
bank deposits, the Cypriot government has put capital controls in place that
restrict the ability of depositors to withdraw their funds. As a result, some
residents of Cyprus are even turning to the virtual currency Bitcoin to conduct
business transactions. (http://bitcoin.org/en/)
At the time of writing, it appears that depositors in
Cypriot banks could lose up to 60
percent of their assets' value on deposits over 100,000 euros, with 37.5 percent of holdings over 100,000 euros
becoming shares and 22.5 percent earning
no interest and being subject to further write-offs. There is additional
concern that such a plan will have negative repercussions for other countries,
where depositors are concerned that such a bailout implementation could become
the norm.
Source: About.com, financial-markets. By Jodi Betts,
Economics Expert, 8/5/15
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