In one of a few early hints that Europe might surprise the world with its Cyprus bailout, on February 10th the Financial Times leaked the content of a secret EU memo.
In one of a few early hints that Europe might surprise the world with its Cyprus bailout, on February 10th the Financial Times leaked the contentof a secret EU memo. It reported that bank depositor haircuts were among three options being considered to reduce bailout costs. And the memo also warned ominously that "such drastic action could restart contagion in eurozone financial markets."
Clearly, policymakers decided to take their chances. And now we're living through the contagion that the memo's authors predicted. But what exactly does that mean? Sure, we can see volatility in asset prices, but how long will it last? Some pundits say it'll blow over like a late afternoon shower on an otherwise sunny day. I disagree.
I'll suggest there's more to it than rising market volatility and that we should take a closer look at the meaning of contagion. I'll argue there are three different types at work today: vanilla contagion, latent contagion and stealth contagion. And when you add up the three effects, Cyprus will have a bigger global impact than many expect.
This is the term I'll use for a rapid transmission of volatility from one region to another - what most people simply call contagion. We've seen vanilla contagion in financial markets since the announcement of the first bailout agreement on March 16th. We've also seen it in reports of bank customers in the European periphery rethinking their loyalties. Both effects should continue for awhile, especially as EU officials have warned uninsured depositors that their assets aren't protected in government bailouts. This is by far the most significant development of the past two weeks. And it'll play out slowly, since it takes depositors time to find a new home for their assets once they've decided their banks are too risky.