This weekend’s announcement that a much-awaited bailout of Cyprus will include a levy on bank deposits of all sizes reminds us that the European policymakers still know how to shoot themselves in the collective foot. For the citizens of Cyprus this creates a level of chaos that we haven’t seen since the island country was divided in 1974. For the rest of the Eurozone, bank deposits are now in question. But for U.S. investors, not much has changed.
Before you start panicking that bank lines in the streets of Athens, Madrid and Rome are going to crush your portfolio, let’s remember that Cyprus is a unique case. It is unlikely that the so-called troika—European Commission, European Central Bank and International Monetary Fund—would impose this solution more broadly to the other countries of Europe. First, the European troika is planning to lend €10 billion to Cyprus, a small amount in absolute terms but a value which is close to 50% of the country’s GDP. Second, the country’s total bank deposits are about four times the size of the total economy. Short of a bigger check from the troika, there was no other way of bailing out the banks without hitting bank depositors. Third, a large chunk of bank depositors are Russians using Cyprus as a tax haven. It would be very difficult for the troika to bail out a bunch of oligarchs in the middle of a German election with no Russian contribution.
Still, bank depositors in peripheral Europe are no doubt paying attention. Greece is next in line and the country will ultimately require another round of debt restructuring. Even in the unlikely event that a future bailout of Greece would be funded in part by a tax on bank depositors, a bank run, while rational, might not necessarily be in the cards. Non-domestic bank deposits have already largely fled the Greek banking system. Greek depositors don’t have a lot of options, either; it is just not that easy to open a bank account in a foreign country. For much larger countries such as Spain and Italy, external assistance is currently not required; current accounts are improving, and the European Central Bank is available, albeit with conditions, as a lender of last resort.
I believe this “making depositors suffer” deal will be rescinded. Banks will be closed in Cyprus until at least Thursday as European policymakers debate the application of the unprecedented bank tax. Potential proposals include shifting the burden away from smaller depositors or adding sweeteners such as giving depositors some equity ownership in banks.
For investors, I believe the events in Cyprus illustrate that there will be negative events and corrections in markets. A risk-off trade would have all of the usual trappings of perceived safe haven assets like treasuries and gold rallying while “riskier” assets like equities fall under pressure. I do not, however, view the events in Cyprus as a credible excuse for investors to stay on the sidelines or to head for the exits unless they have the rare foresight to know when to get back into the markets. Regardless of what the next couple of days may bring, investors will be better served focusing on the long term. I maintain that equities continue to be attractive to most other asset classes. It is time for a bank run of a different sort. Cyprus notwithstanding, it is well past the time for U.S. investors to transfer some of that $10 trillion sitting in bank deposits into the equity markets.