More on Cyprus

Furgeson Wellman by Brad Houle, CFA Senior Vice President

With the bond market closing early and the capital markets closed on Friday, Brad Houle, CFA, gives a brief update on Cyprus for this week’s Weekly Market Makers entry.

The S&P 500 closed today at a new record, surpassing its previous closing high from October of 2007 and resulting in a 10-percent gain for the first quarter of 2013. Over on the other side of the Atlantic, the news was less celebratory, with focus on developments in the relatively small, but significant sovereign state of Cyprus.

Banks in Cyprus started reopening after two weeks during which a bailout was being negotiated with the European Central Bank. The reopening of the banks was less dramatic than feared as only small crowds of depositors lined up to withdraw the limit of €300 limit per day. The government has temporarily put in place strict capital controls on removing cash from Cyprus to limit the damage of a wider run on the banks.

Ordinarily, this story would be receiving little international attention due to the small size of the Cyprus economy; however, the news coverage we are seeing is a by-product of the nature of the bailout. Depositors’ funds in banks are thought to be sacred as the financial system runs largely on trust. Because this bailout involved the “taxing” of depositor’s money in order to assist in funding the bailout, it is seen as a taboo in the financial world to not give bank depositors their money back. Although these depositors are receiving equity in their banks, it’s just not the “standard operating procedure” we have seen from both sides of the Atlantic.

Initially, the plan involved a deposit tax on all accounts— regardless of size. This week, we saw the Cyprus solution altered to tax only deposits over €100,000. This policy change was more politically feasible because it was perceived to be impacting wealthy Russians who were using Cyprus banks as a tax haven, as opposed to local senior citizens.  

While this crisis has not reignited the broader European financial market stress, it has potentially given pause to investors and depositors all over Europe. Europe lacks a central deposit insurance organization, such as the FDIC. As a result, their deposit insurance is a comparatively more fragmented infrastructure. Using depositors’ money to fund a bailout may cause investors in bank bonds to be wary. Senior debt holders have mostly been made whole in bank bailouts both in the United States and in Europe. If bond investors fear the jeopardy of holding these European assets has risen—confidence may be further eroded in a business that functions on trust.