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Cyprus Depositor Bail-In Set At 47.5

Op-ed - Cyprus Depositor Bail-In Set At 47.5%

According to the latest news from Reuters, the government of Cyprus, the Bank of Cyprus and international lenders have come to an agreement that will recapitalize the bank and allow it to remain solvent: all depositors at the bank will have 47.5 of all funds above the deposit insurance threshold of $100,000 seized to pay for the bank’s bad debts. Originally, 37.5 of all funds above the threshold were deducted and an additional 22.5 temporarily frozen in case of additional emergencies; now, if this agreement goes as planned an extra 10 coming from the frozen funds will go towards bank recapitalization and the remaining 12.5 will be unfrozen for its owners’ free use. The “additional emergency” in this case might be the fact that the BoC realized that it would not be able to get off lightly by holding on to its real estate for a few years until it could sell it at higher prices after a hypothetical market recovery; rather, the bank needs money now, even if it means selling off land at rock-bottom prices to get it.

Since the original depositor bail-in plan was announced in March, the idea has been very warmly received by governments around the world. The governments of Japan, Canada, the European Union, Switzerland, Australia and New Zealand have all endorsed or taken preliminary steps toward potentially implementing similar plans if necessary in their own countries. The economic logic behind the proposal is this: rather than banks imposing their fiscal irresponsibility onto the public at large through taxpayer-funded bailouts, depositor bail-ins would keep each bank’s problems confined to its own customers. Bank clients gain the ability to avoid facing any losses by deliberately choosing banks for their responsibility and solvency, and politicians concerned about inflicting severe shocks on the financial system through banks outright collapsing gain the ability to allow banks to only collapse partially, the financial equivalent of a prescribed burn.

Thus, depositors with funds in their bank exceeding the deposit insurance threshold (usually between $100,000 and $500,000) now have an increased incentive to turn to alternative ways of storing and protecting their wealth. The more popular alternatives include credit unions, “ethical banking” providers like Triodos Bank in Europe, peer-to-peer lending sites like Prosper and precious metals. Now, we are seeing a new category of asset emerge: cryptocurrencies. Bitcoin is by far the oldest and largest, but Ripple credits, litecoins and primecoins have already come up as significant alternatives.

Cryptocurrencies as a form of wealth protection is a highly controversial topic, the main reason being that, especially over the last six months, Bitcoin has been far more volatile than the fiat currencies that its proponents often rail against. Depending on the specific time that they bought in and cashed out, some Bitcoin users have lost even more of what they invested than the 47.5 haircut taken by Cyprus depositors – and Bitcoin has no depositor insurance threshold. However, as a small part of a toolbox Bitcoin is certainly a very valuable tool. The best analogy here comes from the world of electricity. If you have a circuit with current passing through a number of resistors in parallel, what happens if you add another resistor, one with extremely high resistance, into the mix? The answer is, only a small amount of current will pass through the new resistor and, all in all, despite the extremely high resistance that the new resistor brings the total resistance of the system will go down. Similarly, adding a highly volatile asset to your portfolio can still reduce your portfolio’s volatility as long as you only add a small amount of it – especially given how disconnected cryptocurrencies are from the economy of the outside world. Arguably, Bitcoin even hedges against the world economy – if more banks start to collapse, capital controls will increase, people will further lose faith in traditional institutions as a way of protecting themselves, and Bitcoin may become considerably more popular. The fact that Bitcoin’s price started to rise super-exponentially from $50 just two days after the news of the Cyprus bail-in first broke in March may be a coincidence, but is may also have been the primary trigger that set the largest part of the Bitcoin bubble off.

What will the bank account of the twenty-first century look like? Simply put, we don’t know. All we can tell for now is that we are seeing a large outgrowth of new alternatives, and any of them could become the dominant form of long-term wealth storage in the years to come. Treat your money carefully; don’t invest more into any single source than you can afford to lose.