The EU agreement to bailout Cypress could turn out to be an incredibly important decision that could have far reaching effects on global financial markets. Why? Because the deal structure not only places much of the onus of the debt on the investors and ends the days where the small Mediterranean island acted as a tax haven for the wealthy - it stops the unrestricted movement of capital that has seen money fly in and out of Cypress with disastrous consequence.
For those of you frustrated with financial jargon, this basically means an end to the cowboy style capitalism that has created bubbles of extreme wealth, catastrophic amounts of debt, and too often complete financial collapse.
And that is damn important.
The Independent reported:
A top European official has said the Cyprus bailout, agreed in last-ditch negotiations over the weekend, should become the bloc's default approach for dealing with ailing lenders.
Jeroen Dijsselbloem, who chairs the Eurogroup gatherings of the 17 eurozone finance ministers, said in an interview today that banks' owners and investors must be held responsible "before looking at public money or any other instrument coming from the public side."
Dijsselbloem, who is also Dutch Finance minister, said the €10bn Cypriot rescue marked a watershed moment in how to deal with failing banks.
He commented that European leaders should be committed to “pushing back the risks” of paying for bank bailouts from taxpayers.
The notion that the public doesn't take all the fallout for incredibly risky investment schemes dreamt up by clever bankers is a big departure from the Wall St model. In 2008, big banks gambled trillions of dollars, lost big time, then passed the cost on to the tax payer. The Cypress Bailout has been structured to do the opposite. Notes the Guardian:
The deal has been structured so losses on large depositors will be achieved by restructuring Cyprus's two largest banks and not by levying a tax on its citizens....
Russian nationals are estimated to hold more than €20bn of the €68bn deposited in Cypriot banks and many are thought to have deposits of over €100,000.
But it is the end of unrestricted capital movement that should have anyone interested in real financial reform excited. The seamless flow of money from one end of the world to another was seen as a good thing by investors as they worked to destroy regulation set up after World War Two to bring balance to the world economy. As Paul Krugman writes, the free flow of capital, "reflected the rise of free-market ideology, the assumption that if financial markets want to move money across borders, there must be a good reason, and bureaucrats shouldn’t stand in their way."
The results of this unrestricted capital movement created the global super rich, and huge amounts of poverty and economic instability for everyone else. Writes Krugman:
It’s hard to imagine now, but for more than three decades after World War II financial crises of the kind we’ve lately become so familiar with hardly ever happened. Since 1980, however, the roster has been impressive: Mexico, Brazil, Argentina and Chile in 1982. Sweden and Finland in 1991. Mexico again in 1995. Thailand, Malaysia, Indonesia and Korea in 1998. Argentina again in 2002. And, of course, the more recent run of disasters: Iceland, Ireland, Greece, Portugal, Spain, Italy, Cyprus.....
The best predictor of crisis is large inflows of foreign money: in all but a couple of the cases I just mentioned, the foundation for crisis was laid by a rush of foreign investors into a country, followed by a sudden rush out.
Cypress will have to maintain very strict controls on capital flow for the coming years, and if that leads to sustained economic recovery, we'll know that it was the implementation of strict regulation rather than the genius of financial markets. While it's hard to say how easy the Cypress case would be to replicate around the world, it will at least provide rock solid proof that limiting the behavior of banks and the ultra wealthy works out a lot better for everyone.
And in the global battle to stop deregulated capitalism, it could prove to be an important victory.