Say hello to the mattress economy

Jack Peat finds that the Cyprus recession has hit the only people with any money left: the savers.

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By Jack Peat

Accountants would be the last people to advise you to keep your cash under the bed, but after a recent chat with a Cypriot finance director, the notion of becoming personally responsible over ones finances seems to have come back into vogue.

Buttonwood’s Notebook, produced by the Economist, responded to the Cyprus debt crisis with a feature that opened: “Savers will pay for the mess, they are the only ones that have any money left.” The fiscal dinosaurs who have roamed for longer than money itself have long advised never to trust the banks, and their primitive ways may be not be entirely unjustified.

A bailout in Cyprus has been on the cards for some time, but the unprecedented moves to impose losses on deposit holders under the private sector involvement (PSI) has caused significant controversy in the country. Under the proposed bailout, savers could be hit with a one-off charge that will depend on how much money you have stored away. This move sets aside decades of conventional laws protecting bank deposits, and will also significantly undermine the confidence both Cypriot people and savers in the wider EU region have in banks.

The outrage over the deal has been caused because people think a tax on deposits is theft, but unfortunately, this is nonsense. Banks, unlike the house safe, are not vaults. Rather, they are thinly capitalised asset managers that make a promise – to return depositors’ money on demand and at par – that cannot always be kept without the assistance of a solvent state. Banks will remain closed in the country until a deal has been struck, but the heavy hand of the EU won’t bail out without securities, and a solvent state is not something Cyprus can claim to be.

Tiptoeing on disaster

The wider ramifications of the Cyprus deal are not that our savings are under threat. For those unfamiliar with the country, Cyprus is a unique case and some charge on the equity it holds was inevitable for the bailout to be both affordable and achievable. Without taxing depositors, the proposed rescue package would have had to be €17.2 billion, instead of €10 billion, or close to 70 per cent of GDP. This would have brought sovereign debt to some 160 per cent of GDP.

Cyprus is no longer an offshore haven (as I was abruptly reminded by an angry accountant) but the banking sector still has assets over seven times GDP. Beyond a small amount of equity stands some €2.7 billion in unsecured bonds protecting €68 billion in deposits, mostly from countries from Russia and the UK – sounds pretty offshore to me!

The wider ramifications are not that tiny Cyprus got into trouble, but that it is a source of wider danger. Banking is dangerous everywhere. But it still threatens the eurozone’s survival. A deal on banking supervision legislation that will strengthen EU-level oversight of many EU banks has recently been struck by Parliament and Council negotiators, including provisions that will strengthen the system’s transparency and accountability, as well  carrying a European spirit and not reflecting just a sum of national interests. For this to be a success, the EU will need to sort out the loose ends first.

Offshore to onshore, under the bed into the bank

One of the more probable eventualities of the Cyprus deal is that savers will look for more security. This happens all the time in the investment markets – the price of gold rockets in times of uncertainty – and there is a wider trend starting to emerge.

I recently spoke to a professional in a global International Structuring business who said they had recently seen a move away from offshore to onshore jurisdictions in line with increasing attention from regulatory authorities. Countries such as the Netherlands; Luxembourg; Ireland; Switzerland, have become more favourable, and the recent developments in Cyprus are likely to further confirm and may even accelerate this trend.

As for you and I, our savings are safe. Cyprus is a unique case, and savers are being hit because of the unique fabric of its economy – Rich Russians were only going to get away with it for so long. But it does go to show the fragility of our economy, particularly one which is governed by risk taking financial institutions.

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