Greek Debt Negotiations to Muddle Along, But Things Actually Looking Up for Syriza

It is Monday morning which must mean that there is a meeting in Brussels between eurozone finance ministers and Yanis Varoufakis' Greek negotiating team. Tomorrow is the deadline for repayment of 750 million euros to the IMF. Last week Varoufakis said Greece would make the repayment. The ever-skeptical Yves Smith of Naked Capitalism is not so sure. As she argues in her post today, "Greece Finally Threatens Default as Deal with Creditors Remains Remote,"

The ruling Greek coalition appears to have finally woken up to the fact that it it cornered. As we indicated, the longer the creditors keep Greece in the sweatbox, the more its popularity is destined to decline. 

While the latest polls still show Syriza as the most popular party, its support is now at 36%, a round trip from a huge surge after the government took office to back to where it stood when it was voted into office. Approval ratings of the government’s strategy have dropped precipitously from the very high levels reached shortly after the new government took office. As e pointed out early on, the best strategy for the creditors was simply to remain non-negotiable. Either Syriza would capitulate to their demands, or the government would lose support, paving the way for the return of a more complaint coalition. Syriza appears to realize that following the inertial path of trying to extend its negotiating runway does not work in its favor. Even if Greece were to pull a rabbit out of the hat and make the €750 million IMF payment, it has a total of €1.5 billion coming due to the IMF in June, which it almost certainly can’t satisfy if it fails to unlock the bailout funds.

Yves Smith seems to think that Syriza can either make the IMF payment tomorrow and risk having to issue scrip to pensioners and government workers at the end of the month, or it can stiff the IMF, a course of action that would not immediately precipitate default and Grexit. As Smith explains:

The situation is more fluid than it appears. The odds are high that blame game political calculations will win over sound policy. We’re already seeing jockeying starting to take place. Notice Schauble’s “justifiable conditions” caveat. He’s made clear repeatedly that he’d just as soon see Greece leave the Eurozone, but no one, particularly Merkel, wants to be seen to have pushed Greece out. Thus if Greece plays its cards so it can be depicted to have brought the default (and if it comes to that, an exit), that works to the advantage of the hardliners who see Greece as disposable and believe a default/possible exit can be made painful enough for the Greek people so as to make any other country that might contemplate leaving the Eurozone to see that alternative as too costly.

Despite the continued impasse, and virtual certainty of a default on Tuesday [!], the creditors have quite a lot of choices and options. For instance, despite the IMF’s tough talk about not giving Greece any grace period on a default, an IMF default is not as fine a trigger event at a private sector bond default. As the Financial Times explains:

But that hard line masks a little wiggle room created by the IMF’s own procedures. Under the official timeline plan, it is not until a month after a missed payment that the managing director formally notifies the board and not until three months afterwards that a formal statement to the outside world is expected to be made.

In other words, even if Greece defaults on the loan repayment to the IMF, things can continue to muddle along as they have. The June repayments are larger than this month's. But if missed payments can play out over months before a default is officially declared, there is no reason why this can't repeat itself next month.

In the Business section of today's "newspaper of record" is a slightly more sanguine treatment of the Brussels negotiations. Peter Eavis, Jack Ewing and Landon Thomas, "I.M.F. and Central Bank Loom Large Over Greece’s Debt Talks," see a chink in the troika's armor, and it is not the wiggle room on IMF repayments; it is the risk aversion of the European Central Bank:

It would of course also be a high-stakes gamble for Greece to do anything that could undermine relations with the central bank, which is shoring up Greece’s banking system. It has lent Greek banks more than €110 billion, cash the lenders need to operate but would have trouble raising on international money markets. 

The support to the banks is not the debt that the officials in the Greek government would consider for default. Instead, the idea would be to not repay Greek government bonds held by the central bank. Greece is scheduled to repay nearly €7 billion on those this summer. 

If the Greek banks could not repay their central bank loans, the losses would be passed on to other eurozone countries. An outcry would come from Germany and other countries already fed up with what they regard as Greece’s misbehavior. The central bank’s credibility — probably a central bank’s most important asset — could be damaged. 

Still, the central bank’s deep caution about financial stability would most likely limit how hard it pressed Greece. As the guardian of the single currency, the central bank may not want to do anything that could set off a chain of catastrophic events in Greece’s banking sector that could lead the country to quit the euro. 

“The E.C.B. does not want to be responsible for precipitating a crisis,” said Mujtaba Rahman, practice head for the European Union at Eurasia Group, a political consultancy. “They are very, very concerned about having blood on their hands.”

I know at the end of April when last I wrote about this I said climax was near. Then it looked impossibile that Varoufakis could scrape together the 750 million euros due the IMF on May 12. At the time there was the brouhaha over Varoufakis' obstreperousness; things seemed to be at an unbridgeable impasse and something was going to fracture. But then Tsipras organized a deft cosmetic reshuffling of the bargaining team, with Varoufakis nominally sent to the sidelines, and that seemed to cool things down. Also, I had no idea just how wide the nonpayment wiggle room to the IMF is. Things can continue to go on as they have for months.

Syriza will get some rhetorical help from the Scottish National Party blasting away at austerity. And there is evidence that the U.S. is extremely jealous of Russian pipeline overtures to Greece. So all in all I am more hopeful of some sort of resolution that favors Greece than I have been in months.

Portuguese Judiciary Deals a Blow to Austerity

Portugal is in the news because its constitutional court tossed out part of its austerity package. This from a story today by Raphael Minder, "Portuguese Debt Crisis Brings New Trouble for Euro":

In an address to his beleaguered nation on Sunday, Prime Minister Pedro Passos Coelho warned that his government would be forced to cut spending more and that lives “will become more difficult” after a court on Friday struck down some of the austerity measures put in place after a bailout package two years ago. 

The renewed tension in Portugal raised the threat of further trouble elsewhere in the euro zone, where ailing members have struggled to rebuild economic growth after enduring wrenching spending cuts. 

“The risks in the euro zone have increased markedly over the past six weeks or so,” wrote Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London-based consultancy that assesses risk on sovereign debt. 

A critical moment for the latest trouble took place on Friday, when Portugal’s Constitutional Court struck down four of nine contested austerity measures that the government introduced as part of a 2013 budget that included about 5 billion euros, or $6.5 billion, of tax increases and spending cuts. The ruling left the government short about 1.4 billion euros of expected revenue, or more than one-fifth of the 2013 austerity package. 

Specifically, the court, which began reviewing the legality of the government’s austerity measures in January, ruled as unconstitutional and discriminatory the government’s plans to cut holiday bonuses for civil servants and pensioners, as well as to reduce sick leave and unemployment benefits.

Minder also quotes Jens Weidmann, the head of Bundesbank, saying Cyprus may need an additional bailout:

Cyprus received a bailout of 10 billion euros from international creditors last month. It may need even more to save its banks, a top German policy maker said on Sunday. 

“The situation in Cyprus has stabilized in the last few days,” Jens Weidmann, president of the Bundesbank, the German central bank, told Deutschlandfunk radio. “However, I wouldn’t rule out that the need for liquidity in Cyprus could increase.” 

The crisis in Cyprus reflects how urgent it is for the euro zone to establish a means to shut down failed banks without burdening taxpayers or endangering the financial system, Mr. Weidmann said. 

“There continues to be a problem with banks that may be too connected and too big to wind down without creating a danger for the financial system,” he said.

Last Friday Landon Thomas Jr. had a story, "Ex-Bank Officials Named in Cyprus Inquiry," about the findings of an investigative report commissioned by the central bank of Cyprus. Known as the Alvarez report after the financial consulting firm Alvarez & Marsal that the central bank hired to look into why the Bank of Cyprus doubled down on risky Greek bonds, it establishes what has already been widely reported. According to Thomas,

The Bank of Cyprus, long considered the better run of the two large banks that have been at the center of the Cypriot bailout debacle, decided to speculate in high-yielding Greek bonds by accumulating a 2.4 billion euro position from late December 2009 until June 2010, just as the Greece government was running out of money. 

That decision resulted in a loss of 1.9 billion euros, or about $2.4 billion, when bond investors were eventually forced to take a 75 percent haircut under the final terms of the Greek bailout, worked out last year. 

That loss and a larger one at the other big Cypriot bank, Laiki Bank, on a similarly misguided investment foray, totaled 4.5 billion euros. That was more than Cyprus, with a gross domestic product of 18 billion euros, was able to sustain. And the losses resulted in a near-collapse of the Cypriot banking sector, leading the country’s government to seek a 10 billion euro bailout from the troika of international lenders: the International Monetary Fund, the European Commission and the European Central Bank.

The Alvarez report provides new details on the extent to which Bank of Cyprus officials were hoping that the high yields generated by the Greek bonds would cover the bank’s imploding loan book. 

Alvarez investigators said that, according to the records they were able to secure from the bank, the decision to buy the bonds was based on a last gasp effort by the bank to generate profits as their loan book began to sour in late 2009 and through the spring of 2010. 

Investigators also said that the bank, like others in Europe at the time, made use of cheap financing from the European Central Bank to make these bets. As a result, executives in the bank’s treasury department bought the riskiest high-yielding bonds available and found willing sellers in banks eager to reduce their exposure to Greece. 

When it became clear not long after the Greek bailout in May 2010 that some form of debt restructuring would have to take place, the Bank of Cyprus found itself stuck with a 2.4 billion euro portfolio of Greek bonds.

Annie Lowrey has a story today, "Lew to Press for Growth in Europe," about Treasury secretary Jacob Lew's trip this week to Europe to ostensibly jawbone leaders there to dial back on austerity. What's interesting about the story is that the normally excellent Lowrey undercuts her lead halfway through the article:

But countries like Germany have shown little willingness to ease the constraints of austerity for peripheral European countries, or to engage in stimulus spending themselves. And for years, European officials have bridled at being lectured by officials from Washington — particularly because many feel that their financial crisis was largely caused by American financial products exported around the world by American banks. 

Though Mr. Lew will travel to Europe with a familiar message from Washington, it may not be delivered as urgently as in the past. The European crisis continues to weigh on American growth, cutting into exports, but many economists believe that the United States has entered a cycle of self-sustaining economic growth driven by a turnaround in housing and improving household budgets. 

Moreover, American companies have over the last few years steeled themselves against Europe’s financial woes, and the risk of contagion is perceived to be relatively low. 

Europe was the primary international concern for Timothy F. Geithner, Mr. Lew’s predecessor as Treasury secretary and a familiar face on the Continent. But perhaps as a sign of Europe’s diminishing threat to United States economic stability, Mr. Lew’s first overseas trip as Treasury secretary, last month, was not to Paris or Berlin or Brussels, but to Beijing.

Apparently what Lew is really in Europe to do is continue negotiations on a free trade agreement between the United States and the European Union. In other words, it is neoliberalism full speed ahead. Talk up stimulus, continue with austerity, and finalize the free trade agreement.

Destruction of the Economy in Cyprus

One small Cyprus story this morning by Landon Thomas Jr., "Some Savers in Cyprus May Lose 60 Percent," buried on page B7 of the New York Times Busines section belies its importance. Deposits above 100,000 euros at the nation's largest bank, the Bank of Cyprus, will be confiscated to the tune of 60% to 77.5%. According to Thomas,

Over the past week, government officials have been saying that depositor losses would not exceed 40 percent — even though bankers and lawyers involved in the negotiations have been warning for some time that the final figure would need to be higher if the bank was to re emerge as a viable entity. 

Under the terms of the transaction, large depositors would have 77.5 percent of their savings turned into different forms of equity. 37.5 percent would be direct equity, in the bank with the rest coming in the form of securities that may convert into shares at a certain period. The remaining 22.5 percent would be a frozen, non-interest-bearing deposit that they would be able to access in the future. 

As a result of this arrangement, the bank’s largest depositors will initially become its major shareholders. 

If the bank does well, depositors would be able to sell their stock. But even in the best case, in which the bank thrives on the back of a quickly recovering economy — a long shot most economists believe — the loss is likely to exceed 60 percent and could well be much more than that. 

Lawyers and bankers who have analyzed the transaction believe the ultimate loss to the depositor could be anywhere between 60 and 77.5 percent.

To get a sense of the implications of this latest development check out today's must-read post by Yves Smith on naked capitalism, "Destruction of Cyprus Economy Proceeding Ahead of Schedule,"  which concludes as follows:

Now remember, Laiki and Bank of Cyprus were the core of the payments system in Cyprus. And it would be very difficult for a business of meaningful size not to have over €100,000 in deposits. If you freeze a significant majority of the commercial balances, how can you operate? How can these businesses even survive and pay each other? By e-mail, Antonis Polemitis of Ledra Capital teased out the implications:

If the Reuters story is correct, for the purposes of liquidity on Tuesday morning, that is a 100% haircut. 

If that is what they do, I am not sure how Cyprus can engage in economic activity on Tuesday without going to barter or scrips. 

I mean, that basically will mean 100% of the large deposits (all the business accounts) at Laiki and BoC are lost or not available as of next week. The Laiki wipe out may have been survivable. If you wipe (for liquidity purposes at least), both Laiki and BoC, then we are not talking about whether or not GDP drops X%, we are talking about ‘how do you actually engage in commerce?’ 

If they do this, there is little chance it can last more than a month — the economy will simply fail at even basic functions…

And if the plan has been accurately reported and plays out as Polemitis fears, it will undermine the “Cyprus is a special case” narrative. This Eurozone fiasco is making Geithner look good. The former Treasury secretary used the need to keep the confidence fairy alive as the excuse for any and every sop to the banks, from coddling miscreant executives to foaming the runway with mortgage borrowers to stealth bailouts. But the Eurocrats have completely ignored the impact of undermining confidence in the banking system. The fact that Cyprus has a decent-sized population of English retirees means that the British media will report on the Cyprus meltdown, which will be a stark contrast with Greece, where the economic devastation has not gotten the coverage it warrants. Grim accounts of the destruction wrought by the tender ministrations of the Troika should strengthen the position of the growing Euroskeptic sentiment in Italy, borne out by the success of Berlusconi and Grillo in the recent elections. Playing into the hands of Italian refuseniks should be the last thing Brussels and Berlin want. The cost of getting tough with Cyprus is likely to be far greater than they anticipate.

It's hard to find fault with this analysis, unless some sort of exception is made for business accounts, which is probably illegal (but capital controls in the eurozone were supposed to be illegal too). Bersani can't form a government in Italy. The next month should be a momentous one for Europe. Get those sell orders in.

Cyprus Temporary Capital Controls Likely To Last a Long Time

Cyprus' capital controls, only to last for one week, will now be in effect for at least a month. This from a story today by Andrew Higgins and Liz Alderman, "Long Lines as Banks Reopen in Cyprus After Freeze":

Not since the introduction of the euro in January 1999 has a European country blocked bank depositors from having full access to their own cash. Under European Union treaties, such restrictions are normally forbidden. But the European Commission, the union’s administrative arm, issued a statement Thursday morning that the Cyprus controls were legal — though urging that they be rescinded as soon as possible. Originally, the controls were to be in place for one week. But on Thursday, the Cypriot foreign minister, Ioannis Kasoulides, said that restrictions on financial transactions would not be lifted for a month.

A naked capitalism cross post from VoxEU today by Jon Danielsson, Director of the ESRC funded Systemic Risk Centre, London School of Economics, argues that the example of Iceland proves that temporary capital controls should, for all intents, be considered permanent:

Another European country was forced to implement `temporary’ capital controls in its crisis – Iceland, as discussed here on Vox (Danielsson and Arnason 2011). 

The Icelandic government, its central bank and the IMF considered the controls necessary because so many foreigners, and the occasional wealthy Icelander, had lost faith in the economy and only wanted to take their money out. While such individuals were considered misguided, their exit would have had disastrous consequences. Hence it was thought necessary to `temporarily’ prevent capital outflows. 

The authorities said at the time the controls would be temporary and limited in scope – lasting a few weeks or, at worst, a month or two. Half a decade later, the capital controls are still in place and getting more and more restrictive. 

This was the second time Iceland had implemented `temporary’ capital controls. The first time it did so, in the 1930s, led to the controls being in place until 1993. This is in line with the historical evidence; once capital controls are imposed, they are really hard to abolish, and a temporary arrangement usually ends up being permanent.

Reporting from Nicosia, Landon Thomas Jr. says the prevailing wisdom appears to be holding. Cyprus is a one-off and will not spread:

“People have lost all their money,” screamed a young financier Wednesday night, as he knocked back drink after drink at a local nightclub — which, despite the earsplitting din of Greek rap music, was half empty. “To me, that feels like war.” 

But on a global scale, investors have refused to panic, other than unloading the risky bonds of second-tier banks in Spain and Italy. 

And while the bond yields of Italian government debt have spiked in recent days, a signal of investor wariness, and the euro has traded down against the dollar, the view, for now, is that even though Europe’s handling of the crisis has been a mess, broader contagion has largely been avoided. 

“This does not worry us at all — Cyprus is just not systemic,” said a senior executive at a large sovereign wealth fund based in the Middle East, who was not authorized to speak publicly. 

Even Cypriot government bonds that are due to reach maturity this June are holding up fairly well, trading at 88 cents, not far from their recent high of 94 cents earlier this week, though a 12 percent discount from their face value.

But Floyd Norris in a High & Low Finance column that appears side by side with Thomas' piece sees signs of a spreading instability:

The fact the hot money stayed even after it became clear the Cypriot banks were in trouble — in large part because of all the Greek bonds they owned — is a testament to the false security the euro provided even after the Greek crisis erupted. That security has faded, at least a little. The cost of credit-default swaps on European banks has been rising since Cyprus got into trouble, suggesting the market thinks bank defaults have grown more likely. That cost continued to rise after the latest plan was announced. It does not help that European leaders seem unable to decide whether the Cypriot deal would set a precedent if banks in other countries get into trouble. It does, whatever they say, or at least it could. 

A few months ago, Europe was supposed to be on the way to a banking union, an arrangement that it was hoped would prevent what has now happened in Cyprus. What happens to those plans will be an indication of whether Europe can continue to hold the euro zone together. 

It may help that Cyprus is so insignificant. Its economy is about one-tenth the size of Ireland’s, which itself is among the smaller economies in the euro zone. It is even smaller than Vermont’s, which is smaller than that of any other state. We can only shudder at what might happen if banks in a big euro zone country got into a lot of trouble.

The next small eurozone country headed to the troika for a bailout, according to naked capitalism's Yves Smith, is Slovenia.

Cyprus: "The Money is Going to Stay There for a Very Long Time"

Banks are scheduled to open tomorrow in Cyprus and rules outlining how people can access their money are still being promulgated. This is from today's story, "In Cyprus, Big Losses Expected on Deposits," by Landon Thomas Jr.:

The government is also struggling to come up with some form of capital controls in a bid to prevent too much money from draining from the banks and leaving the country. Given that more than 30 percent of the Bank of Cyprus’s 14 billion euros in long-term deposits belongs to foreigners — mostly Russians and Greeks — who would not hesitate to take their money out of the country, the restrictions on those funds are likely to be onerous, bankers say. 

“That money is going to stay there for a very long time,” said one person who has been involved in the discussions, but who requested anonymity because he was not authorized to speak publicly.

Beyond the challenge of dealing with the large depositors is the question of what to do with about 27 billion euros in deposits in accounts under 100,000 euros that now carry the Cypriot government’s full backing, following last weekend’s reversal of the decision to tax those deposits, too. That figure alone exceeds Cyprus’s annual gross domestic product of 18 billion euros. 

If the banks reopen on Thursday, as planned, Cyprus’s shellshocked citizens will have access to their insured deposits for the first time in more than a week. With their bills and fears mounting, it is widely expected that many will immediately seek to remove these funds from the banks. 

For now, officials say, it is likely that uninsured depositors will face stiff restrictions when it comes to withdrawing money from an automated teller machine or sending money abroad. But if a depositor at Bank of Cyprus wanted to transfer funds to, say, Hellenic Bank, a smaller institution that is in better shape, the controls would be less severe because that money would remain within the Cypriot banking system. Such arcane mechanisms are now being thrashed out in Brussels and Frankfurt.

With more time to consider the bailout an assessment has gone from bad to worse. The low end of the haircut, 30%, for uninsured depositors at the Bank of Cyprus has given way to the high end, 40%, because the bailout estimate of a 3% contraction of Cyprus' economy is being reassessed as too modest; now, according to Thomas' story, economists are predicting a shrinkage of 5%-10% within a year.

Andrew Higgins and Liz Alderman have a good "how we got here" story today, "Europeans Planted Seeds of Crisis in Cyprus." The Eurogroup's decision in October 2011 to make private-sector investors take a 50% write-down on Greek government bonds doomed Laiki Bank. Higgins and Alderman conclude their story with seven paragraphs that pretty much sum up the whole story heretofore. And the gist of it is that the eurozone is finished:

After the Greek write-down, Cyprus compounded its problems by dithering on whether to seek a bailout from the European Union. At first, it appealed to Russia, which provided a 2.5 billion-euro loan in December 2011. But this money quickly ran out, and when Cyprus did finally go cap-in-hand to its European partners for a lifeline, it received a rude shock: Germany, already gearing up for an election this year, wanted not just budget cuts and other conventional austerity measures but a complete overhaul of Cyprus’s economic model, built around financial services for foreigners seeking ways to dodge taxes and, Berlin suspected, launder dirty money. 

“They did not want the Cypriot model to exist as it did — they wanted Cyprus to stop being a financial center,” said Pambos Papageorgiou, a former central bank board member who is now a member of parliament and on its finance committee. “It was very brutal, like warfare.” 

Mr. Papageorgiou complained that the European Union had shown “the opposite of solidarity” in its dealings with one of its weakest and most vulnerable members. 

In the three years since Europe’s rolling debt crisis first exploded in Greece, governments and citizens in the hardest-hit nations have fumed that decisions made in Brussels pay little heed to their interests and are dictated instead by the economic concerns and election cycles of Germany. Whether in Athens, Dublin, Rome, Madrid or Nicosia, people increasingly ask whether the European Union serves their own aspirations or those of remote institutions dominated by others, particularly Germans. 

Such questions have grown to a furious pitch in Cyprus, where terms set early Monday for a 10 billion-euro bailout will deepen an already painful recession and send unemployment — now at 15 percent — soaring. They require the dismantling of Laiki Bank, with the loss of around 2,500 jobs, and a significant reduction in the country’s role as an offshore financial center. 

“We are looking at a very grim future for Cyprus,” said Michael Olympios, chairman of the Cyprus Investor Association, a lobbying group. “Even firm believers in European project like myself see now that it was a bad idea and that we should have at least stayed out of the euro.” 

As jobs disappear and the economy contracts, Mr. Olympios said, faith in Europe will wither. “I used to be a believer. Not anymore.”

The eurozone will continue on for some time of course. But this is the beginning of the end. Bigger is not always better. The idea has finally sunk in.

Cyprus Augurs End of Euro

Why is Cyprus so important? Because it marks the end of the euro as we know it. This from today's excellent offering from Liz Alderman and Landon Thomas Jr., "With or Without Bailout, Cypriots Lose Trust in Banks":

“For the first time, we have capital controls in the euro zone,” said Nicolas Véron, a senior fellow at Bruegel, a policy research group in Brussels, and a visiting fellow at the Peterson Institute for International Economics in Washington. “The next time there is a crisis somewhere else in the world, people will think of what happened in Cyprus and will try to get their money out much faster. These are the new rules of the game.”

My interest in and concern with Cyprus is what happens to markets once the realization sinks in that the eurozone is starting to disintegrate. Yesterday, after Eurogroup head Jeroen Dijsselbloem said that Cyprus would be a model going forward, European markets dropped. This from Alderman and Thomas:

Stocks were down broadly in Europe on Monday, after the head of the Eurogroup, Jeroen Dijsselbloem, suggested that the idea of skimming savers’ accounts to bail out banks could be considered a “template” for other countries. The borrowing costs of the financially shaky Spain and Italy surged upward as the markets digested the Cyprus news — and the broader implications for the euro currency union.

Dijsselbloem later disavowed this statement, saying that Cyprus was a one-off, and in this he was supported by officials from the ECB (for more, check out the story this morning by Liz Alderman and David Jolly, "Head of Cyprus's Biggest Bank Resigns"). But even if it's not true, and bail-ins are not the new normal, the impression created by the Cyprus bailout negotiations is one of chaos. As the New York Times sums up in an editorial this morning:

Though it is better than the initial plan, the new agreement does not inspire much hope. It represents the latest in a series of slapdash and last-minute European efforts to prevent financial Armageddon in one country or another. Many analysts have noted that this deal leaves the government of Cyprus with an impossibly high debt burden, about 140 percent of its gross domestic product, and will impose many years of hardship and pain on its people and its economy.

For Spain, Italy and other troubled euro zone countries, Cyprus is an unnerving example. Individuals and businesses in those countries will probably split up their savings into smaller accounts or move some of their money to another country. If a lot of depositors withdraw cash from the weakest banks in those countries, Europe could have another crisis on its hands. 

The way to prevent financial catastrophes like this is to impose strong centralized regulations on all banks and recapitalize or restructure weakened ones. Most important, the policy makers need to scrap austerity programs that are making it nearly impossible for the European economy and financial system to recover.

Suffering is certainly ahead for Cypriots as they go the way of Greece and Portugal and Ireland and Spain. The question is whether that pain finds its way to our shores. A scenario that has to be contemplated is one where U.S. markets react negatively as the eurozone's disintegration accelerates. We are not flush with economic health in this country; we cannot sustain another significant market drop. Yesterday at work I saw a Reuter's headline online, "Student loan write-offs hit $3 billion in first two months of year" -- up 36% from the same period last year. More people are going back to school. Why? Because there is nothing else to do. There is not enough work.

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.

Bank Run in Cyprus

A bank run has begun in Cyprus. This is important because Cyprus is a member of the eurozone. Cyprus is tiny; but if it goes down and scraps the euro, it could well be the beginning of the end. The issue is a decision by the Eurogroup to make a Cyprus bailout contingent on all depositors absorbing some losses. This is from today's Liz Alderman and Landon Thomas Jr. story, "Turmoil in Cyprus Over a Bailout Rattles Europe":

By size, Cyprus’s economy represents not even half a percent of the combined output of the 17 euro zone countries. Yet the impact of this weekend’s decision by European leaders to impose across-the-board losses on bank depositors — from the richest Russian oligarchs, who have increasingly deposited their money in Cyprus’s banks, to the poorest Cypriot pensioners — in return for 10 billion euros, or $13 billion, in bailout money could not be more far-reaching. 

After five years of bailouts financed largely by European taxpayers, wealthy European nations have decreed that when a bank or country goes broke, bond investors and perhaps even bank depositors will pay a significant portion of the bill.

This is how naked capitalism describes the situation today:

The cheery view that Europe had moves past its crisis now looks to have been a tad premature. The astonishing weekend revelation that Cyprus had struck a deal for a Eurozone rescue of the island nations banks that hinged on a deposit grab, um, tax, of 6.75% of deposits below €100,000 and 9.9% for those above €100,000, sends a message that anyone in a weak bank in a periphery country, particularly a large deposit holder, is at risk. The one thing that America learned in the Great Depression is that to prevent debilitating bank runs, depositors need to be sure their holdings are safe. And if you need to extend government guarantees to provide that reassurance, then government bloody well better keep the banks on a short leash to make sure you dont have to pay out on those guarantees all that often. The recklessness of letting financiers talk governments out of constraining bank activities is coming home to roost. 

But currently there aren't the votes in Cyprus' Parliament to accept the bailout terms. So Cypriot banks are closed until Friday and this morning markets are all down. The lengthy, detailed naked capitalism analysis concludes by saying that unless treated German schizophrenia -- wanting to maintain its huge trade surpluses without funding its eurozone partners -- will destroy the financial system:

Over the weekend, colleagues who are normally of the calm, cool and collected sort have been stunned by this development, although the Eurocrats had been muttering about a deposit haircut in Cyprus in recent months. And the message could not be clearer: you are at risk if you hold money in a shaky bank or country in the Eurozone. One reader’s reaction: “I thought I’d put a prediction on the record: starting tomorrow, the euro payment system really starts to unravel.” 

After the PR barrage that accompanied the launch of the OMT, which was a brilliant exercise in smoke and mirrors (all it did was repackage and rebrand existing ECB powers), the quiet deposit run out of periphery countries to banks in the core nations slowed and had even reversed in recent months. Expect it to pick up with renewed vigor. Even if we don’t see hot bank runs of people lined up trying to empty their accounts, anyone who has more than €100,000 on deposit in a periphery country, particularly Spain, has to recognize he is in danger. However, many of the people own businesses (a payroll of meaningful size means you’ll have large deposits at least when you are about to pay staff, and unless you manage cash very aggressively, much of the rest of the time too) will need some time to switch to safer (presumably German or maybe even Swiss) banks, since selecting a new bank and moving a large, multi-serivces account is a big undertaking. And this sort of hidden-to-the-public big deposit run has felled banks; it was the proximate cause of the resolution of WaMu. 

Now the EU officials could easily calm nervous depositors by announcing an ECB-backstopped deposit guarantee, instead of the current national system which depends on not-exactly-credible central banks. Germany and its fellow surplus countries have hesitated about proceeding with the necessary steps to further economic integration (notice how the plan to implement eurozone wide bank supervision, which Germany insisted was a precondition to Eurozone-level deposit guarantees, has languished?). Germany is trying to maintain policies that are contradictory: it wants to continue to have large trade surpluses, yet not fund its trade partners; its wants debtors to meet their obligations, yet refuses to allow either enough in the way of fiscal deficits or monetary easing to keep debtor countries from falling into deflationary spirals, which assure default. Germany’s failure to relent on any of these conditions means that what breaks will be the financial system.

Negotiations are underway no doubt to rejigger the tax formula for Cypriot depositors, reducing it for small fry. But, barring some authoritative pronouncement from Mario Draghi of the ECB that guarantees deposits at eurozone banks, the damage is done. Is this the beginning of the end for the euro?