The Week That Was

What a fascinating week we just experienced within the world’s financial sphere!  Within the span of just four days, two news stories emerged that, under normal circumstances, would have never happened within days of one another:

1)      As so often occurs within the financial world, U.S. investors woke up Monday morning, March 25^th, to bad news from Europe.  The European Union’s “solution” to a long brewing banking crisis in Cyprus was to have the Cyprus government “collect” a certain percentage of the balance within every Cyprus bank depositor’s account (6-13%) as a way of funding a bailout of Cyprus banks. The bailout was needed because a shameless lack of risk management by those banks managed to make the J.P. Morgan Chase “London Whale” look like a success story in comparison. Those banks had managed to lose billions of dollars on now worthless Greek bonds, precipitating a crisis that emerged in 2012 and led to banks being closed two weeks ago.  The EU’s “solution” provoked a popular revolt, which forced Cyprus to go with “Plan B”  — steal just from accounts totaling over 100 Euros. After promising for several days that banks would re-open the following day, Cyprus banks finally did open on Thursday – but with a tight cap on how much can be withdrawn.

Although it has an economy as small as Vermont or Jackson, Mississippi, Cyprus  held the attention of the world’s financial markets this past week. (Map from commons.wikipedia.org)

1)      On that same Thursday, after hovering within 10 points of an all-time record closing high during the prior 13 sessions, the S&P 500 Index finally breached the old closing price record of 1,565.15 (set five and one-half years ago, on October 9, 2007) – settling at 1,569.19.

These events occurring in tandem created such a seeming paradox that I put on “hold” my original intended theme and shifted to a brief look at each of these events separately.

First, the Cyprus “event” is a paradox in and of itself. Cyprus managed to hold the world’s full attention all week long – despite the fact that its economy is only the size (relative to GDP) of the entire state of Vermont, or the city of Jackson, Mississippi! A quick look at Cyprus’ little economy shows another anomaly: its banking system holds capital that is at least seven times greater than the national GDP!  Cyprus banks obviously drew in billions of dollars from outside its borders – generally because Cypriot authorities “look the other way” with regard to the moral character of its foreign depositors and the legal propriety of the activities that generated the deposited funds!  Personally, I don’t feel sorry for Russian moguls and mobsters losing a good-sized slice of their deposits because of this crisis.

However, the overriding reason that the world’s focus this week was on Cyprus is simple – a telling fear that this so-called “solution” might become a “template” for European management of its ever deepening debt crisis as we move into the future – whether for future bank bailouts or for the bailout of a sovereign government. That prospect sent shivers of fear throughout the hearts and minds of citizens (and investors) everywhere!

The best analogy I heard regarding the initial proposal of (on average) taxing ten percent of all depositor funds in order to fund the bailout was this:

Imagine a father, who allowed his children to deposit all of their babysitting, lawn cutting, or birthday/holiday gift funds into a family savings account. Later, unilaterally and without warning, the father then proceeds to raid that account and empty it in order to pay off an out of control gambling debt. 

No matter how morally appalling and unfair that would be – that is what almost happened in Cyprus! The fact that it was even seriously proposed should “scare us straight” (to borrow a phrase) regarding how perilous a nation’s debt can become – be it big bank debt or the debt of a national government.

I have heard from some folks this week whose response to this is a dismissive shrug of the shoulder, saying: “It could never happen here!”   Unfortunately, such folks are very naïve. Within U.S. history, we have already seen something similar. In 1933, in the midst of the Great Depression, President Roosevelt issued Executive Order 6102, criminalizing the private holding of gold (“hoarding”) and requiring everyone to deliver to authorities, within a short 25 days, all but a very small amount of any gold they possessed. Violation of the order was punishable by a fine of up to $10,000 (over $180,000 in current U.S. dollars) or ten years in jail (or both). http://en.wikipedia.org/wiki/Executive_Order_6102

Yesterday morning, I was vainly trying to create one more analogy to these events, and their potential repercussions. To my surprise, I discovered such an analogy by mid-afternoon, as I headed out toward an appointment.  There, at the end of the driveway, just off the edge of the curb, was a blue plastic newspaper wrapper. I assumed it had blown over from a neighbor’s home, so I walked out to retrieve it. As I got closer and closer, I noticed the blue plastic had something in it. Without much thought, I picked it up so I could remove the unsightly trash to help maintain a litter-free neighborhood. I was halfway up the drive when I realized precisely what I had in my hand – through no fault of my own.  It was the droppings from a careless dog owner’s pet – meticulously stashed into the bag and then left for me to remove.

I realized in that moment what it might have felt like to be a Cypriot bank customer this past week: innocent, and yet left with responsibility to help clean up the smelly, rotten mess!

In the next installment, I will relate this Cyprus story to a 2013 Pew Research Center poll.

Submitted by Thomas Petty

Related Posts