It is a must read. Some aspects are somewhat unlikely in my opinion, though. The benign scenario will just not happen because the foreigners will just look for a safer tax haven. So as I have mentioned this is the first time that it makes sense to stage a bank run for every one, even though it will as always bankrupt the finacial sector. In my worst case scenario there will be worry in Italy and Spain but not a full fledged bank run. More a walk. Something that is controllable. But Greece will possibly face a bank run.
- The benign scenario is that depositors in Cypriot banks will accept the tax and keep their remaining money where it is. Depositors in other troubled countries will accept that Cyprus is special and remain unmoved.
- A less benign scenario is that depositors in Cypriot banks come to fear another round of optimal, time-inconsistent levies. This is what theory predicts. After all, if policymakers found it optimal once, why not twice, or more?
- The really worrisome scenario is that the Cypriot bailout becomes euro-systemic – in which case the collapse of the Cypriot economy will be a sideshow. This will happen when and if depositors in troubled countries, say Italy or Spain, take notice of how fellow depositors were treated in Cyprus.
But I think there is a new scenario emerging. One that seems more likely by the hour. The parliament will vote against the bail out and the banks will not reopen ever again, well at least not in their current form. From here on I see two paths forward 1. Having stopped all banking activity might actually prove invaluable. There is a chance to now restructure the banks. Create bad banks, were they put say all the European and Russian deposits and good banks with Greek and Cypriot money. Gazprom might be the entity that makes a orderly restructuring possible. The problem is that even though as Mr. Wyplosz rightly states, this just cannot be described as an emergency measure NO ONE is prepared. The Cypriot government has only been around a few weeks now. There just isn't any way they made any plans.
Which leads us to 2. Cyprus banks will default disorderly, the hits on deposits will be immense, the government will fail and the island will be forced to leave the Euro without a new currency. Still even in this scenario Gazprom might just be the