Consensus: Cyprus Crisis Won't Spread

A consensus seems to be forming that the debt crisis underway in Cyprus will not spread to vulnerable, big eurozone countries like Italy and Spain. The reason? Cyprus is unique because of the outsize role played by money-laundering Russians. Here's how Andrew Ross Sorkin, a reliable Wall Street mouthpiece, puts it in his DealBook column today:

Cyprus is unique. Besides being tiny, its banking system looks different from those in most other countries. Much of the big money deposited in its banks is from foreign investors, including Russians who have long been suspected of money laundering. Those investors had fair warning that Cypriot banks were troubled. The issue has been simmering for six months. But those investors left their money in the bank, in part because they were gambling that the banks would be bailed out at no cost to them. If the current plan is approved, depositors will have lost that bet. 

Worse, the strategy employed in the bailout of Greece — in which bondholders of its sovereign debt were paid less than face value — will not work in Cyprus. Cyprus’s banks own much of the country’s debt, so any effort to reduce that debt by forcing debt holders to accept less would only make the banks more troubled. 

Given the brutal history between Russia and so much of Europe — and speculation that so much of the money is ill gotten — it is clear why it would be so politically unpalatable to countries in the euro zone, Germany in particular, to bail out Russian depositors. And even if the move were to create a run on the banks in Cyprus, the contagion would be limited. 

There is very little chance that politicians would ever choose to use the model they developed in Cyprus in a country like Italy or Spain, where a run on the banks would have such profound implications. By the way, if you’re wondering why investors left so much money in troubled Cypriot banks, here’s a trivia question: Would you have been better off leaving your money in a bank in the United States or in Cyprus over the last five years? 

The answer: You would have been better off in Cyprus, even after the bailout, when your money was “confiscated.” If you had 100,000 euros in a Cypriot bank account over the last five years, where the interest rate has averaged about 5 percent, you would have about 127,600 euros today. Even after the bailout, which would require you to give up 10 percent of your deposit — 12,760 euros — you would be left with 114,840 euros. The American bank? The $100,000 you deposited at Bank of America five years ago is about $105,100, at the going rate of about 1 percent interest a year.

Dismissing the bank run in Cyprus as a one-off because nearly a quarter of its deposits are held by Russians seems too convenient to me, too redolent of the old cold war. The issue isn't the Russians. The issue is getting a bailout through parliament, whether in Cyprus or in other eurozone countries.

Jeroen Dijsselbloem, Labour Party member and Dutch Minister of Finance who is the current head of the Euro Group, nationalized SNS Reaal in February, wiping out its shareholders. If he can take a hard line in the Netherlands why can't he do the same to a tiny country like Cyprus? The push back came from Cypriot President Nicos Anastasiades -- as documented in today's frontpage story by James Kanter, Nicholas Kulish and Andrew Higgins -- who fought to keep confiscation on deposits of more than 100,000 euros below ten percent. This meant the small fry have to fork over more, which is the recipe for a bank run.

Contrary to Sorkin's dismissal of concern over Cyprus, it's unclear at this point that the contagion won't spread. This from today's story, "Second Thoughts in Europe as Anxiety Rises in Cyprus," by Liz Alderman and Landon Thomas Jr.:

While it is too early to tell if Italian, Spanish and Greek savers will pull out their deposits in response to the Cyprus tax, investors holding the bonds of banks in Spain and especially Italy are already taking action. 

In Italy, ravaged by a stagnating economy, banks are experiencing a steep increase in nonperforming loans — one of the highest rates in the euro zone — that worries regulators and has made an investment fad of betting against Italian bank bonds. 

For now, no one is predicting a European bailout of Italian banks. But just as problems with Spain’s smaller savings banks last year quickly escalated into a crisis requiring a European bank rescue, a growing number of analysts are warning that Italy’s most troubled banks could lead to a broader systemic threat to Italian banking.

Brooks on Health Care Spending

David Brooks' column this morning looks at the nomination of Chuck Hagel to lead the Department of Defense through the prism of budgetary battles to come.  Obama needs a Republican war hero to provide political cover for a Democratic administration to reduce the size of the Pentagon.  Brooks has been playing Cassandra when it comes to the dangers of ever-growing Medicare spending.  Soon it will blot out nearly all else that the government does:

As the federal government becomes a health care state, there will have to be a generation of defense cuts that overwhelm anything in recent history. Keep in mind how brutal the budget pressure is going to be. According to the Government Accountability Office, if we act on entitlements today, we will still have to cut federal spending by 32 percent and raise taxes by 46 percent over the next 75 years to meet current obligations. If we postpone action for another decade, then we have to cut all non-interest federal spending by 37 percent and raise all taxes by 54 percent.

As this sort of crunch gradually tightens, Medicare will be the last to go. Spending on things like Head Start, scientific research and defense will go quicker. These spending cuts will transform America’s stature in the world, making us look a lot more like Europe today. This is why Adm. Mike Mullen called the national debt the country’s biggest security threat.

This assumes that we will continue to provide and pay for health care in the manner that we do today.  We can't.  The math doesn't lie.  A shift to preventative medicine is going to have to take place.  This of course is easier said than done.  For each person to begin to take responsibility for his or her own health is akin to an Apollo program or a World-War-Two-type mobilization.  Infantile narcissism and the consumerism that makes it a defining characteristic of our culture will have to be put in check.

Andrew Ross Sorkin in a DealBook column this morning argues that the four-year delay in the implementation of the Basel III liquidity requirements was less a heinous capitulation on the part of bank regulators than an unavoidable acceptance of reality:

In truth, the reason that regulators ultimately chose to relax the rules was simple practicality: many banks in Europe and some in the United States would have never been able to meet the requirements without significantly reducing the amount of credit they were to extend to Main Street over the next two years, according to people involved in the Basel decision process.

My problem with this is it is a continuation of the Wall Street-bailout, Too-Big-to-Fail logic: Let's go easy on the banks because if we don't they'll hurt Main Street.  How is this different from calling the 1% "job creators"?