Paul Krugman: Treasure Island Trauma

Despite the risks to financial stability, tax havens like Cyprus "are still operating pretty much the same way that they did before the global financial crisis":

Treasure Island Trauma, by Paul Krugman, Commentary, NY Times: A couple of years ago,... Nicholas Shaxson published a fascinating, chilling book titled “Treasure Islands,” which explained how international tax havens — which are also ... “secrecy jurisdictions” where many rules don’t apply — undermine economies around the world. Not only do they bleed revenues from cash-strapped governments and enable corruption; they distort the flow of capital, helping to feed ever-bigger financial crises.

One question Mr. Shaxson didn’t get into..., however, is what happens when a secrecy jurisdiction itself goes bust. That’s the story of Cyprus right now. ...

Now what? There are some strong similarities between Cyprus now and Iceland ... a few years back. Like Cyprus now, Iceland had a huge banking sector, swollen by foreign deposits, that was simply too big to bail out. Iceland’s response was essentially to let its banks go bust, wiping out those foreign investors, while protecting domestic depositors — and the results weren’t too bad. ...

Unfortunately, Cyprus’s response to its crisis has been a hopeless muddle. In part, this reflects the fact that it no longer has its own currency, which makes it dependent on decision makers in Brussels and Berlin — decision makers who haven’t been willing to let banks openly fail.

But it also reflects Cyprus’s own reluctance to accept the end of its money-laundering business; its leaders are still trying to limit losses to foreign depositors in the vain hope that business as usual can resume,... they ... tried to limit foreigners’ losses by expropriating small domestic depositors. As it turned out, however, ordinary Cypriots were outraged, the plan was rejected, and, at this point, nobody knows what will happen.

My guess is that, in the end, Cyprus will adopt something like the Icelandic solution... We’ll see.

But step back ... and consider the incredible fact that tax havens like Cyprus, the Cayman Islands, and many more are still operating pretty much the same way that they did before the global financial crisis. Everyone has seen the damage that runaway bankers can inflict, yet much of the world’s financial business is still routed through jurisdictions that let bankers sidestep even the mild regulations we’ve put in place. Everyone is crying about budget deficits, yet corporations and the wealthy are still freely using tax havens to avoid paying taxes like the little people.

So don’t cry for Cyprus; cry for all of us, living in a world whose leaders seem determined not to learn from disaster.