Bank deposits, especially those that are accompanied by deposit insurance, are generally regarded by everyday people as being risk-free. If you put your money in a savings or checking account at a bank, you do so under the assumption that you will be able to access and spend that money, in whole, when the money is needed. What happened in Europe over the weekend challenges that assumption.
To see a list of high yielding CDs go here.
On Saturday, Eurozone finance ministers and the IMF reached a deal to bailout the country of Cyprus, yet another European country in the midst of a financial crisis. I am sure many investors have bailout fatigue and can’t imagine why a bailout of Cyprus is even newsworthy. Here’s why: This bailout is different. During the bailouts of recent years, depositors in Eurozone banks have always been protected—until now.
The reason this bailout is different is because the terms of Cyprus’ bailout include the following: Depositors with less than 100,000 euros in Cypriot banks will have to pay a “stability levy” of 6.75%. Any deposits over 100,000 euros will have to pay a levy of 9.90%. If you thought bank deposits in the European Union were off-limits during bailouts, think again.
According to the co-CEO of Saxo Bank, Lars Seier Christensen, what happened in Cyprus over the weekend is a game changer. In an opinion piece published on TradingFloor.com, he says that the decision to confiscate bank deposits “must make every bank depositor in Europe shiver.” Christensen continued, “Depositors in other prospective bailout countries must be running scared—is it safe to keep money in an Italian, Spanish or Greek bank anymore? I don’t know, must be the answer.”
Before the bailout becomes official, Cyprus’ parliament must vote to pass the measure. That vote, which was scheduled for Sunday, was delayed to Monday due to insufficient votes to pass the measure. If parliament does not vote in favor of the bailout terms, the President of Cyprus warns that the country’s two biggest banks will collapse on Tuesday. Whether or not Cyprus chooses the terms of the bailout or to allow its banking system to collapse, over the coming days, there will likely be much debate among financial pundits about whether seizing bank deposits is the appropriate thing to do when bailing out a sovereign nation. If you are curious as to what the President of Cyprus has to say about this (as it relates to Cyprus), read the March 16 “Statement by the President of the Republic Mr. Nicos Anastasiades.” At this time, whether or not it is the right decision for Europe to apply a haircut to bank deposits in Cyprus will be determined by the reaction of everyday people around the continent.
Citizens of Spain, who are likely well aware of the dire straits their economy is in, will surely feel some level of discomfort from the events in Cyprus. As Mr. Christensen put it in his aforementioned piece, “If you can do this once, you can do it again.” Many people in Italy, Greece, and elsewhere will also likely be concerned by the happenings in Cyprus. How they, as a collective group, react to their feelings will be an important thing to follow over the coming days and weeks. Should people in various European countries decide to pull their money out of local banks en masse, there will be far-reaching consequences for investors around the globe.
The fact that the IMF and European finance ministers have now shown the willingness (whether or not they succeed) to confiscate bank deposits when bailing out a member of the EU should not be overlooked by investors. That, indeed, is a game changer. The world’s financial system is one in which stability depends on the confidence of those who participate in it. By showing the willingness to apply haircuts to bank deposits, European officials have increased the likelihood of future European bank runs and have added more uncertainty to the lives of everyday people in European countries with struggling economies. Even if the likelihood of widespread bank runs in countries such as Spain and Italy is still small, Europe now has this problem: By taking an asset (bank deposits) that people expect to be able to access in full and demonstrating that the asset can simply be taken from them overnight (and how ATMs can stop working in a flash), the psychology of how people deal with their money will change.
Put yourself in the shoes of those people in Cyprus who suddenly discover they’ve lost 6.75% or 9.90% of their bank deposits. How would that make you feel? How would that change your behavior going forward? Now put yourself in the shoes of someone in Spain. You realize your economy is mired in a very difficult economic situation, and you fear (whether rightly or wrongly) that in the future, what happened in Cyprus might happen in Spain. How would you react?
All of a sudden, Europeans have learned there is a difference between cash held at a bank and cash hidden “under the mattress.” That difference amounts to 6.75% to 9.90% of one’s so-called “cash.” Even if European officials truly have no intention of ever repeating the terms of the Cyprus bailout, now that haircuts on bank deposits have crossed the boundary of being an idea to something actually included as terms for a bailout, the game has changed. If the citizens of troubled European countries decide to take Europe back into crisis mode by pulling money from banks, then equity investors around the world should be on guard—that goes for bondholders of European corporate and sovereign debt as well. What investment might do well in a European crisis situation? Let’s just say that the new bond king would probably make a lot of money.
More from The Financial Lexicon:Get our free guide to income investing here.