Cyprus Is Not a Problem; a Bank Run Is

NEW YORK (TheStreet) -- I'm hit by a double whammy over the weekend. First by the unprecedented bank robbery in Cyprus, by the troika and via the Cypriot government. Then again by the cry of wolf all over the Web.

For completeness' sake, here's the shock-and-awe Cypriot bank robbery: As a condition for ECB emergency assistance to Cyprus to bail out the deeply troubled banks, the Cyprus government announced a deposit-for-equity plan for all depositors. Details are still fluid at the time of writing, with conflicting reports. But the basic idea is small depositors are volunteered to buy equity of their bank with a smaller percentage of their deposits (say around 6% for deposits of less than 100,000 euros), and bigger ones are volunteered a bigger chunk (say around 10%).

I know. Quite a shock. Even Stalin would not have dared to pull such a barbaric act.

Speaking of Stalin, this is very much directed to rich Russians with lots of deposits in Cypriot banks for the purpose of running away from the oppression of Putin. Rich ironies aside, I guess the troika and Cypriot government wanted to avoid the embarrassing appearance of outright Russian-targeting by robbing small depositors along the way. Looks much more civilized, yes?

Since the Web is overflowing with outrage, I'll stop here and get to my point.

The problem with Cyprus is that the banks have little debt in the form of senior unsecured bonds. There are no bondholder heads to cut hair with, as was done in Ireland and Greece. This doesn't make it any less barbaric. (For example, a much more civilized way would be to impose more traditional taxes -- but why take the hard road when it's so much easier to rob the rich Russians.) But it does make it more likely that this will not be replicated in other countries, assuming the rest of the world would still like to remain civilized.

Despite the rampant hyperbole all over the Web regarding the Grand Cypriot Bank Robbery, and although Cypriots should by all means storm their banks on the first chance, I don't see any rational reason why others should worry about suffering the same fate.

But, as Sir Mervyn King, governor of Bank of England, once famously said: It is not rational to start a bank run but rational to participate once it has started. Bank runs are by definition emotional and panicked, mutually destructive reactions. If and when the fragile underlying trust is shaken, there's no telling when a bank run would begin. And often this uncertainty itself suffices to warrant a run.

To summarize, I don't think it's rational for other Europeans to be overly concerned about their deposits, yet cannot rule out such a possibility. Let's wait for daybreak and see whether there are long lines outside bank branches anywhere outside of Cyprus.

If there are, it could start a chain reaction or, if responded with swift, unified and strong action to assure the public, it might fizzle out. And if it does spread, this could very well be the long-anticipated end of euro.

Yes, there's an EU-wide insurance for deposits up to 100,000 euros, but the panic would be that the Grand Cypriot Bank Robbery renders it null and void. A typical fat-tail event, and one that OMT doesn't cover -- otherwise it wouldn't be a black swan, so at least we still have the logic perfectly working.

If there's no bank-run contagion, then the knee-jerk risk-off reaction in the markets (equities worldwide and EUR and industrial commodities tanking, USD and especially JPY surging, gold and treasuries up) would likely recover somewhat. The fact that Cyprus needs a bailout is not news. But as long as it's contained, it's too small to cause a eurozone crisis.

As to the news of Russia sending a permanent fleet to the Mediterranean, I appreciate the imagination and would otherwise write it off. Russians know better than sending a fleet into war without air cover.

Longer term, however, this is a perfect illustration of how lunatic the euro experiment has become. Although in the end analysis I doubt this will cause a systemic crisis, I fully expect more lunacy to come from eurozone. I do recommend panic, just not now.

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