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The Bailout Of Cyprus Did Get One Thing Almost Right

Mar 17, 2013, 23:23 IST

In a few hours, when markets open, we'll get our first taste of how disruptive the controversial Cyprus bailout is.

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Remember, Cyprus has announced plans to tax bank depositors (6.5 percent of deposits for those with less than 100K eur in the bank; 9.9 percent for those with more than 100K in the bank).

Already there are fears that this will create contagion in the rest of Europe.

The announcement is also incredibly damaging to the public trust. Suddenly money in the bank is not money in the bank.

The announcement did get one thing right. The only way this can work is if there's an element of surprise. No one should be able to see or believe it's coming, or else you get a bank run in advance of the haircut.

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This depositor haircut had been rumored about for awhile, but this has clearly been a surprise to most people.

But the problem is, then you have to fulfill the tax and make it happen right away. Here's where it runs into problems. Cyprus banks are scheduled to open Tuesday, and the vote was to happen before then. So right away, you have a day of financial market activity on Monday. And then there might be delays in the actual vote, if it passes.

So they did one thing right. They made a surprise move on a Friday night/Saturday morning. But this advantage goes away if they can't actually pass the tax law before banks are scheduled to open.

This was actually all laid out in the winning entry to 2012's Wolfson Economics Prize (big thanks to Kelly Evans for the reminder on this), which explained how a country might go about leaving the Eurozone, and how important it was to do it in secret without any warning.

Here's the key part of the Wolfson press release:

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The paper proposes that key officials from the exiting country meet in secret one month before publicly announcing a day of exit or ‘D Day.’ Eurozone partners and other international monetary organisations would be notified of D Day three days before – preferably on a Friday – when a public announcement is made that the changeover to the new currency will take place at the start of the following week. Immediately after this announcement, domestic banks and financial markets should be closed to prevent capital flight.

So the Friday announcement part was done.

But markets will open Monday without anything set in stone.

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