UBS: Contagion Risks Are Alive And Well

Bloomberg TVLast night, euro zone leaders finally agreed on a deal to bail out Cyprus’ financial system.  Among other things, depositors with over 100,000 euros in their accounts will get slammed.

While an immediate and disorderly collapse of Cyprus’ banks may have been averted, this story clearly isn’t over yet.

In his daily comment on, economist Paul Donovan notes that Cyprus’ current financial system continues to be unsustainable.  Furthermore, he warns that the precedent set by deal regarding depositor haircuts could make depositors in other countries worried.

Here are Donovan’s four bullets verbatim from

  • A deal has been done on Cyprus, though probably not a “final” final deal. The agreement leaves Cyprus with debt:GDP over 140% and a very weak economic outlook. Most economists argue this is not sustainable. The Cypriot parliament will not vote on the terms of the deal. The German Bundestag will.
  • Limiting cash withdrawals and credit growth in Cyprus limits economic growth (of course). Contagion risks are alive and well – whenever a crisis comes along bank depositors are bound to ask “is my money safe?” (and the honest answer will probably have to be “no”).
  • Bank deposits below EUR100,000 are intact, as long as you don’t try to spend the money (bank withdrawal limits are in place). This is similar to the early stages of the US monetary union collapse 1932-33. Sadly Chancellor Merkel seems to admire President Hoover more than President Roosevelt.
  • The data calendar is almost non existent today. We do have Fed Chairman Bernanke speaking alongside Bank of England Governor King after European markets close, on the topic of “lessons from the last financial crisis.” In the wake of Euro events, one could question whether it should be “financial crises”.