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Will the Banking Crisis in Cyprus Rock Other Markets?

March 18, 2013 at 12:00 AM EDT
Off the coast of Greece, the small nation of Cyprus is facing big economic problems. Judy Woodruff interviews Jacob Kirkegaard of the Peterson Institute for International Economics on the magnitude of the banking crisis in Cyprus and how it may be causing aftershock effects in others markets.
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JUDY WOODRUFF: For a closer look at the crisis in Cyprus and why it’s captured the attention of Europe and the U.S., we turn to Jacob Kirkegaard. He’s a senior fellow at the Peterson Institute for International Economics.

Welcome back to the program.

JACOB KIRKEGAARD, Peter G. Peterson Institute for International Economics: My pleasure.

JUDY WOODRUFF: So, why does tiny Cyprus, a population just over one million, have Europe, the markets, the governments so rattled?

JACOB KIRKEGAARD: I think there’s two main reasons, first of all, that Europe as a continent and the entire European economy is still kind of on the edge. It doesn’t take much to shatter the sort of recent lull of confidence that you have had in Europe in the last couple of months.

And, unfortunately, I think Cyprus is one such thing. And the other element is that what happens in Cyprus and with respect to the Cypriot banks have a large precedent-setting effect for how Europe going forward is going to deal with banking crises potentially in other European countries. And then it begins to matter a lot also for the rest of the world.

JUDY WOODRUFF: Remind us, Jacob Kirkegaard, why the banks in Cyprus got themselves into this mess.

JACOB KIRKEGAARD: Well, there’s basically two reasons.

One is that the banks in Cyprus are very, very large. There’s a total of 800 percent of GDP, which is eight times the size of the Cypriot economy as a whole, which means that if there is a small problem in these banks, then the government actually has a very big problem, because it will not be able to bail these banks out.

And then what happened after the restructuring of the Greek government bonds last year was that the Cypriot banks had taken a big bet basically on these bonds, and therefore took a lot of losses as a result. And therefore at least one of these banks is now bankrupt and the Cypriot government can’t afford to bail this bank out and therefore has had to approach the international community for assistance.

JUDY WOODRUFF: And right now this idea of taking money out of individual — from individual depositors, where did the idea come from?

JACOB KIRKEGAARD: Well, the idea is kind of unique.

I regard it as a sort of Willie Sutton rule, you know, named after the bank robber who once said, why did you rob the bank? Well, that’s where the money is, he said.

And the reason that the international community and the Cypriot government has decided to go after bank depositors in Cyprus is that really there aren’t any other valuables there. And the problem that Cyprus has had is or still has is that the financing needs that they have are so big. It’s 100 percent of GDP approximately. And they needed to bring down that number to about 60 percent of GDP, which is what they’re now perhaps going to get.

And by taxing depositors, they actually have the ability to also tax non-residents, as we saw in your clip just now. There’s a lot of British there, but there are even more Russian depositors. So, in that sense, you actually end up having the ability to bring in tax revenue from non-Cypriots. And that’s a big advantage for the government of Cyprus because these are — this is money that otherwise they would have had to raise by cutting pensions or other types of austerity measures.

JUDY WOODRUFF: So, the Russians and others stand to be hurt pretty badly by this.

JACOB KIRKEGAARD: Yes. Basically, that’s part of the strategy or the intent of both the euro area, the IMF and the Cypriot government.

JUDY WOODRUFF: But the signal that sends, what — I mean, what’s the message it sends to the rest of Europe? I mean, how worried should they be that what’s going on in Cyprus — and we don’t know how this is going to play out because the banks are closed for the next few days. How worried should the rest of the banks in Europe be?

JACOB KIRKEGAARD: Well, I don’t think that there’s an immediate risk of sort of contagious bank run in other European countries in Spain or Italy, because they are separate countries, first of all.

I think there’s a good reason to believe that the majority of the bank depositors in these countries probably don’t even know what’s going on in Cyprus. And then, secondly, the international community have ring-fenced the operations of Cypriot banks in Greece, so that depositors in Greece will actually not be affected by this new tax.

And then the third element is, as I said earlier, that the Cypriot banks are so big that they really don’t replicate the financial systems in any of the other European countries, which means that this isn’t something that can be used elsewhere, in my opinion.

JUDY WOODRUFF: But what does it say that the European Central Bank, which is akin to our Federal Reserve, had the power, the ability to force the banks in Cyprus to do this?

JACOB KIRKEGAARD: Well, it basically says that the ECB is not a normal central bank. It is a central bank that actually has real political coercive power.

And what they said to the Cypriot government, together with the Germans and others, the IMF, look, unless you accept this deal, we’re going to shut down your banks come Tuesday, and your government and your economy is going to collapse. So it certainly shows that the ECB is a very forceful and powerful central bank. But it also shows that the ECB has actually changed its strategy quite a bit from earlier in this crisis, because back when — when Ireland needed a bailout because of its banks getting into trouble, the ECB was actually very forceful in preventing bondholders and others from taking any losses.

So they have changed their behavior quite a bit.

JUDY WOODRUFF: So, finally, how do you see this playing out? When the banks reopen, what happens then? And what about here in the U.S.? How concerned should Americans be?

JACOB KIRKEGAARD: Well, I think, essentially, I view Cyprus as right now being between the first and the second TARP vote here in the United States. It basically takes a few days, unsurprisingly, for the sort of people’s representatives to realize that they really don’t have a choice.

It’s the choice between something terrible and something catastrophic. So I think this deal will pass the Cypriot parliament in the next couple of days. The banks are likely to reopen, probably at the end of the week. And at that point in time, I would expect that a lot of people would take their money out of the banks. It may be necessary to have further capital controls or restrictions on banks, but I think, beyond that, I don’t think we’re going to see any major effects across Europe or to the United States, for that matter.

JUDY WOODRUFF: Long term?

JACOB KIRKEGAARD: No. I think this is the sort of crisis of the week, if you like.

JUDY WOODRUFF: I guess that’s a relief.

Jacob Kirkegaard, thank you.

JACOB KIRKEGAARD: My pleasure.