Damage to Cyprus Already Done

Once again the news coming out of Cyprus is not encouraging. Yesterday Cyprus' Parliament came up with a new bailout plan to present to the troika Sunday evening, though it still has to vote on one proposal to confiscate a quarter of all bank deposits above the insured amount of 100,000 euros for Laiki Bank account holders. Parts of the plan that passed, as Liz Alderman and James Kanter report today, include capital controls to prevent withdrawals and account closings as well as the shutting down of Laiki, creating a bad bank for the non-performing accounts and rolling its good accounts into the Bank of Cyprus. Parliament also voted to confiscate the pension funds of state-run companies.

I've seen reports that this might not satisfy the troika. The troika wants the legislation to apply to all Cypriot banks not just Laiki. Cypriot president Anastasiasdes jets to Brussels tomorrow to take his lumps.

The message from all of this -- banks have been closed for over a week now in Cyprus -- is that the damage has already been done. Even if the new bailout plan is accepted by the ECB, the IMF and the European Commission, Cyprus' days as a financial hub are over and capital flight from eurozone countries with vulnerable banks like Spain will likely commence posthaste. As naked capitalism opines in "Cyprus Capitulates to Eurozone (Updated)":

The imposition of capital controls has the potential to alarm depositors in periphery countries even more than deposit seizure. While the Eurocrats can try claiming that the deposit grab is a one-off, the result of Cyprus having a huge financial sector that was heavily deposit funded, it was already troubling that they didn’t go after equity or bondholders. But the imposition of capital controls effectively creates another currency without the benefit of allowing the currency to revalue.

As we’ve indicated, the big risk coming out of the cramdown of Cyprus is a resumption of the flow of deposits out of periphery countries, which had been underway last year but was arrested by the introduction of the OMT. You’d be nuts to keep your money in a Spanish bank after the brutal treatment of Cypriot depositors. Expect Swiss, German, American, and, as Dizard put it, “banco de Mattress” to be the beneficiaries.

So far U.S. markets have dismissed Cyprus as inconsequential. Let's see what the prevailing wisdom is next week. The 17-nation eurozone appears about to shrink.