Capital on Ice

Cypriot bank accounts are frozen. Can the markets unfreeze them?

Efforts are underway to build a parallel market in Cypriot euros, currently frozen in Cypriot bank accounts (hat tip to Tyler Cowen):

Is your cash stuck in a Cypriot bank? Someone might be willing to take it off your hands.

Distressed-debt investors and brokers are circling Cyprus, the Mediterranean island that last month plunged its two main banks into an emergency restructuring and blocked thousands of depositors from touching all their money.

The idea: investors buy frozen bank deposits, at a discount. Depositors who need access to their money get a payoff immediately, instead of waiting months or years for the bank restructuring to be completed. Investors get a shot at a big payoff down the line.

This is not a novel idea. It happened all over during the Great Depression, when banks were shut down for months or even years. James Ledbetter of Reuters described it in the editor's notes on Benjamin Roth's diary of the Great Depression.

A market for buying bank “passbooks” also cropped up in places like Youngstown. If you were desperate enough in 1931 for money to buy the basic necessities, you could get 60 to 70 cents on the dollar for your passbooks’ value. Local newspapers even printed the weekly rates for buying and selling these passbooks as they became a commodity; Roth pasted one such rate chart into his diary.

Many people managed to use the passbooks to buy mortgages from the shuttered banks. In this way they were able to acquire quite a lot of real estate for about 50 cents on the dollar. (Though Roth notes, with perhaps a trace of satisfaction, that the joke was on them--after World War II, real estate in downtown Youngstown suffered a precipitous decline in value.)

And of course, Ayn Rand described a less salubrious version of this sort of market in Atlas Shrugged:

Nobody professed to understand the question of the frozen railroad bonds, perhaps, because everybody understood it too well. At first, there had been signs of a panic among the bondholders and of a dangerous indignation among the public. Then, Wesley Mouch had issued another directive, which ruled that people could get their bonds “defrozen” upon a plea of “essential need”: the government would purchase the bonds, if it found proof of the need satisfactory. there were three questions that no one answered or asked: “What constituted proof?” “What constituted need?” “Essential-to whom?” …One was not supposed to speak about the men who, having been refused, sold their bonds for one-third of the value to other men who possessed needs which, miraculously, made thirty-three frozen cents melt into a whole dollar, or about a new profession practiced by bright young boys just out of college, who called themselves “defreezers” and offered their services “to help you draft your application in the proper modern terms.” The boys had friends in Washington.

Whatever you think of Atlas Shrugged, the market descriptions like this are quite true to life--because they were based on things she'd witnessed during the birth of the Soviet Union.

The problem is that these sorts of markets--particularly when coupled with special government deals--create broad classes of haves and have nots. People with a bit of ready cash emerge much richer, while people who can't afford to wait are basically impoverished. It's hard to see what choice Cyprus had. But it's worth bearing the costs in mind.