Although Medvedev fulminated at the injustice of the Badinov Bank solution, subsequent Russian reaction has been more accepting: the man who matters-Putin, not Medvedev-”has decided to support it.”
Perhaps Putin is just bowing to reality. I’m more interested in whether the deal makes economic sense, especially as compared to the levy scheme that went down in flames.
The fundamental fact is that the two big Cypriot banks are insolvent. Assets are less than liabilities. The resulting loss must be borne by someone or someones, specifically:
- Equity holders. (Ha!)
- Unsecured depositors.
- Secured (guaranteed) depositors.
With all due deference to Krugman, let’s rule out (6). With respect to (5): (a) Cypriot taxpayers-uhm, Cyprus is bankrupt (which is why it needs 10 billion euros in bailout funds), so Cypriot taxpayers aren’t a realistic alternative, and (b) bowing to political pressure and an impending election, Merkel has ruled out German taxpayers.
So that means that the loss must be borne by those with claims on the insolvent banks. The proper way to do it is to work through those claimants in order of seniority from junior (equity) to senior (insured deposits). That’s what has been done now. That’s the right way to do it. It’s what should have been done at the outset, given the economic and political realities.
The problem with the solution that went down in flames is that it violated the priority of claims. Apparently in an attempt to appease the Russians, Cyprus’s president Nicos Anastasiades decided to reduce the losses imposed on uninsured depositors-who include many Russians-by imposing losses on insured depositors, most of whom are the countrymen he was actually elected to represent. Moreover, the levy was imposed equally across claims on Cypriot banks, regardless of the severity of their insolvency. This was also highly objectionable, because it meant that depositors at banks that were truly egregious in their risk taking were treated identically to those who were less egregious. Under that rule, no depositor has any incentive to avoid especially risky and reckless banks, or to monitor bank riskiness.
The Badinov Bank alternative is therefore defensible on rule-of-law grounds, whereas the levy alternative was not: moreover, the Badinov bank alternative is economically more sensible, especially in terms of giving depositors better incentives.
The irony, of course, is that Russia would have been better under the Anastasiades alternative. Russian depositors at the Popular Bank of Cyprus will be especially hammered under the Badinov bank alternative, because that was the baddest bank of them all. Whereas they were looking at a 10 percent loss under the levy scheme, they are now looking at losses upwards of 30 percent.
Oh well. That’s the way the seniority cookie crumbles. And that’s how it should be. Let the crumbs fall where they may.