The Cyprus Shell Game

20. March 2013 by Herman Brodie


Given the number of prominent voices that have been raised against the controversial Cyprus bank levy, it was a wonder it found so much support among the troika – the ECB, EU and IMF. Dmitry Medvedev cried foul, Lawrence Summers saw it as an error, and even former Eurogroup chief Jean-Claude Juncker criticised it.  With the exception of the Russian prime minister, however, the element that disturbed most commentators was the application of the levy to supposedly guaranteed bank deposits. The ‘little guy’, they implored, shouldn’t have to suffer in the restructuring of Cypriot bank debts. 

Where does this sudden concern for the little guy come from? From the start of the crisis, it has been the little guy that has borne the brunt of the necessary debt write-downs, and to a far greater degree than just single-digit percentages. When the civil service is hit with a pay freeze while inflation rises to five percent, as has been the case in the UK, is this not some kind of haircut? If pension pay-outs are cut and retirement dates are extended, does the little guy not suffer? If public services are scrapped, who is hurt if not the least wealthy, the people who actually use them? Finally, if interest rates are cut to near zero, who is penalised if not the small savers? As contemptible as the Cypriot levy is, the difference between this and other restructuring measures is not economic.

There is a difference, though – a psychological difference. For instance, most people are loss averse which means that it is less painful to be denied a gain than it is to incur a loss. As a result, the missing pay rise, interest or public service ‘hurts’ less than any reduction in the bank balance even if the euro amount is identical. People also have a tendency to overly discount the future – a tendency known as hyperbolic discounting. This means that news of a delayed or diminished pension pay-out weighs less heavily because it lies in the distant future. Even if the traditionally-discounted (exponential) present value of that future income is equivalent to any reduction in the one’s bank balance today, it is less likely to provoke the ire of a hyperbolic discounter.

The resolution of a debt crisis will require that creditors incur a loss, be it via austerity, inflation, low yields, haircuts, shrinking pensions, levies on bank deposits, or all of the above. To pretend that the little guy has been somehow spared up until now, and to feign outrage, is as lamentable as the EU’s latest measure.


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vposted on 20. March 2013 at 9:59 am

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