Reflections on Cyprus
1) A rare event: Since the crisis started in 2007, Cyprus is the first country to resort to bank holiday. A bank holiday is a rare event. According to Nomura Economist Jacques Cailloux, only 17 cases out of 147 crises in a count back to 1970 were found. Country wide banking holidays are even more exotic. Nomura also shows that a deposit levy (as it is considered in the case of Cyprus) is almost an exception, especially when considering the size of the initally proposed levy. Past experiences in Hungary (in 1920 Finance Minister Hegedus imposed a 20% deposit levy) are rare.
2) Uncertainty is a fact: A new phase of uncertainty has started. Negotiations will involve Russia. The period of uncertainty is likely to last for 6 months or more. No quick solution possible. The bank holiday will be extended as authorities need to resume negotiations to find a solution. EU officials, as reported by Bloomberg, were already in the process of discussing an extension of the bank holiday.
3) A reopening could lead to a massive run on the banks: A bank forced holiday is an extremely dangerous measure and last resource. Cyprus has become the first country to use such a measure since the crisis started in 2007. We can now say that we have seen it all: Nationalizations, Bank recaps with public funds, deposit freexes, additional guarantees, asset guarantees, swaping toxic assets for clean T-bills and now, bank holidays. The reason why governments consider this measure to be a last resource is because it is very hard to exit succesfully such a measure. Runs will not stop until total confidence is restored and this is definitely not a matter of days. A strong positive (external) shock to confidence seems like the only plausible way to reset expectations in tha banking sector in Cyprus.
4) A clear past reference relies in the U.S. 1932-1933 experience and Latinamerica: The most symbolic episode of a way spread bank holiday relies in the bank holiday that lasted between March 6th and March 12th of 1933. Few banks were allowed to cash checks. Latin America, on the other hand, has a vast experience with bank holidays and restrictions, in the 80s and 90s.
5) Cyprus should not be irrelevant to the global investor: We are referring to the article by Andre Ross Sorkin on Deal Book (http://dealbook.nytimes.com/2013/03/18/a-bank-levy-in-cyprus-and-why/) "A Bank Levy in Cyprus, and Why Not to Worry", specifically to:
While the bailout of Cyprus is a fascinating case study and raises interesting theoretical questions about moral hazard for policy wonks and talking heads, here is the reality: It is largely irrelevant to the global economy. Cyprus is tiny; its economy is smaller than Vermont’s. And the bailout is worth a paltry $13 billion, the equivalent of pocket lint for those in the bailout game.
Even the larger issue about bailing out a country by taking money from depositors — which quickly created outrage around the world — seems overblown.
The worry is that the European Union and I.M.F. have created a dangerous precedent by making depositors share in the pain of the bailout. Historically, the goal of bailouts has been to raise confidence in banks so depositors don’t flee. The approach in Cyprus is at odds with that notion, raising questions about whether future bailouts in countries like Spain and Italy — if they are needed — could affect depositors.
The alarmist thinking is that depositors will move their money from troubled banks, creating a death spiral.
Even in the United States, some commentators used the Cyprus bailout as a scare tactic about what they speculated could eventually happen here.
There are 2 reasons to believe Cyprus will be relevant (though not extremely important) without becoming a macro catalyst: 1) Uncertainty and 2) The fact that, unlike Vermont, Cyprus is in the EU and thus any failure or success that the country generates will be translated in a failure or success that EU can obtain, economically speaking.
6) There are alternatives: There are, of course, alternatives to accepting a levy tax. You can rescue the economy with better measures. An example, the Waking Back from Cyprus article by Buchheit and Mitu Gulati (Duke University) propose leaving deposits under €100,000 untouched and terming out verybody else by 5 years. If you have bank deposits of more than 100 thousand euros, they could be converted into CDs that lhave a maturity of 5-10 years. You can access the paper here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2235359