Cyprus, Fight Club & Capital Controls

20 Mar

The first rule of capital controls is: you don’t talk about capital controls. (cracking story by Matina Stevis). For obvious reasons – if you think the gate is going to slam shut on you, all the more reason to make a dash for it. Even the architects of the current dog’s breakfast must know this, so the fact that controls are known to be under discussion shows that they are preparing for the worst. Worse yet, this looks more and more like a “ringfenced” Cypriot problem, as markets continue to refuse to sell off (-1.25% on EuroStoxx? a 0.1% rise in BTP (Italian govt) yields? really?) And controls are entirely legal.

There was a chance – probably overestimated in hindsight – that Cyprus could pull this off and keep at least part of its financial industry. Pass the deal on Monday, banks reopen Tuesday on schedule with foreign depositors duly decimated but possibly reassured by the country’s suicidal willingness to hurt its electorate to protect them, the ECB stepping into place as a backstop -hey, stranger things have happened. Instead, it’s Tuesday night, we’ve just had a 36-0 defeat of a more merciful version of the agreed programme with the ruling party abstaining, preceded by lengthy preening speeches describing the terms under which Cyprus will accept a bailout still worth 60% of GDP. The finance minister may or may not be in Moscow, may or may not have tried to resign, and noisy demonstrators are in the street. Meanwhile it looks highly unlikely that the banks will open this week. David Zervos of Jeffries said in a client note that “there will be a collapse of the Cypriot financial system no matter how they vote”. Mass evacuation of deposits – both Cypriot and foriegn looks like an urgent priority to deal with. The central bank chief Panicos Demetriades has raised concerns that 10% of deposits – that’s 80% of GDP – could flee. The ECB will undoubtedly be there, given a deal acceptable to the Troika. So empty banks are not the threat. What is the threat is a sector even thirstier for capital than it is now. And remember the driver for Friday’s deal was the steady leakage of deposits this year (chart @reutersflasseur).

Hence the talk of capital controls – a short-term palliative. Capital controls – done right – can be part of a recovery package – as in Iceland or Malaysia, or even Argentina. But they’re particularly hard on a financial sector. Already risk managers in London are sending internal mails quietly suspending Cypriot counterparties from acceptable trading lists. As go the deposits, and the trading entities so go the jobs in law and accountancy. Even if the system survives, the sector looks very vulnerable. No, Cyprus The Financial Centre is not resting, it’s shuffled off this mortal coil, run down the curtain and joined the bleeding choir invisible.

So, the rules have changed. Why bother to protect foriegn deposits if they’re on their way out already? A redesigned package may well go “the full Iceland”; look after the locals and shaft the foreigners. To work, plan A had to be implemented cleanly.

Felix Salmon links to an intriguing new paper (only three pages!) by the Crown Prince of Financial Repression, Lee Buchheit, and his trusty sidekick, Mitu Gulati. Buchheit is a Titan in my profession (sovereign debt management), having overseen the screwing of creditors debt restructurings across the world, most recently in Greece. The heart of their plan is leave the EUR100k (insured) deposits intact, thus leaving at least one contract unbreached. Instead of formally haircutting the rest, you replace them with 5 or 10 year securities, possibly enhanced with (Nigeria/Venezuelan style) gas warrants. And that’s it. If you had EUR150k of deposits, you now have EUR100k and a bond with a face value of EUR50k. It’s anyone’s guess what the price of such a bond might be on open, but my guess is that it’s less than the 90.1% you’d be left with under the current plan. I thought this was inferior to the original plan’s treatment of large depositors for 3 reasons: it didn’t provide EUR5.8bn to recapitalise the banks; it would terminate the financial sector forever; and the hit to consumption via wealth effects would likely be bigger. In new circumstances the first two points drop out – EUR5.8 bn is unlikely to be enough to recapitalise flight-ravaged banks; the financial ship has already hit the iceberg. The genius of this plan is that deposit flight ceases to matter. The only way of getting rid of a deposit is to sell it to someone else, not call on the bank’s cash. So I think it likely that Plan B will be newly tough on foreigners, and might conceivably contain some element of replacing deposits with bonds. Joseph Cotterill slapped me down magisterially -and accurately – today on Twitter for doubting Buchheit:

And please, please stop talking about the Russians. The current Russian authorities have a cold eye for value for money. They have bailed out both Belarus and Ukraine – but on terms which are giving the Russian central economic powers (such as Gazprom) which are in tight sync with the ruling political caste – the commanding heights of the economies. The Russian White Knight actually behaves the way their more aggressive opponents say the IMF and Troika do. The Russians talk a lot about loans – anyone remember $4bn for Iceland? – which never actually materialise.

Note: No fund in which I have any involvement has, or to the best of my knowledge has ever had, any exposure – long or short – to Cypriot sovereign or corporate debt, nor do I have any personal positions at all. In general, if I’m discussing it on social media, we’re not involved.

15 Responses to “Cyprus, Fight Club & Capital Controls”

  1. E.L. Wisty March 20, 2013 at 9:18 am #

    Reblogged this on Pink Iguana.

  2. Michael Thomaides March 20, 2013 at 11:06 am #

    Yes Cyprus is small, we do not want to be “Jack against the Giant” but the options we were given were 1. Die now or 2. Die a slow death later.

    The Cyprus Banking sector was doing fine had its value of Greek Bonds not been slashed by the Euro Group.

    Cyprus is a net contributor to the EU.

    Our economy accounts for 0.2% of EU GDP, why so much fuss? Are we the experiment?

    Had there been a Euro Bond then many a problems would have been solved ( the USA is living proof). Who rejected it?

    Obviously there is a group leader and that leader has a specific agenda of domination and gain via a lending policy.


    After WW2 the Group leaders (GERMAN) national debt was slashed by the lenders (US, BRITAIN ETC) and favourable interest rates and terms bestowed upon it.

    It came out very well after hard work. No one tried to Humiliate or discredit Germany, so why are they doing this to Cyprus by continually suggesting that Russian deposits, they would love to have themselves are BLACK.

    Please do the same & nothing more for Cyprus, Greece, Spain, Portugal & Italy.

    Give us a fighting chance & nothing more.

    Cyprus does not want to shake up anything (markets etc) but we and bank depositors Worldwide believe our PRINCIPLE is justifiable & fair.

    The existing Euro Group policy on Cyprus has been criticized by experts worldwide.

  3. richard jenkins (@dreamofthought) March 20, 2013 at 12:01 pm #

    Forget the Russians? Are you crazy? They engineered this way back when Cyrpus joined the EU and offered 6% interest.! they saw the opportunity offered by Cyrus as a way to control Europe.Cyprus has a veto in Europe! and its government is a Russiaphile one which refused to act on international laws and prevent a Russian cargo ship which docked in Cyprus loaded with weapons for Syria from unloading them in Syria. Russia owns Cyprus.

    • Michael Thomaides March 20, 2013 at 4:27 pm #

      No Richard Jenkins, the Cypriots own Cyprus.

      The ship was confiscated and the ammunition exploded 2 years ago in storage in Cyprus. No one got the ammo and we had the casualties, 13 dead at the naval base in Zigi, Limassol. Check it out it is on the net.

      It is the British who think they still own Cyprus with 2 military bases (ex colonial) that are also Guarantors of Cyprus, yet owed over Euros 200 million in rent for the bases

      Britain did not even twitch to help us out in the Euro Group. I sincerely hope they reconsider; it would be benefit both Countries.

      Cyprus has never used its Veto, and knows of the consequences of doing so. It is not that easy Richard.

      The truth is that everyone wants the Russian Funds and the Russians know this, they also know there is also a great deal of resentment towards them. I do not know why the Cold War is over and a great chunk of Russia is in Europe.

      Cyprus is a small Island within the EU divided in two (much like Germany was) by 45,000 Turkish army Troops and two British Bases ( over 100 sq miles in size) a number of other NATO surveillance stations which had the misfortune to try bail out Greece another EU member and got burnt.

      It has over the years become an International Business Centre, similar to those existing in Guernsey, Jersey, Island of Man, Andorra, Monaco, Liechtenstein, Luxemburg, Malta, and recently Lithuania, Campione (all within Europe) etc.

      Cyprus has not hurt anyone financially, it has facilitated everyone who has requested help from it (within its means and political condition over the years) and yet we find few friends in our hour of need. Other Nations within the EU by their actions are trying to take our business away from us and destroy our lively hood. Why so much fuss over Cyprus – other financial issues are at stake.

      Apart from the service sector we only have Tourism, what do you expect us to do?

      We will accept friendly help from wherever it comes, and manage ourselves.

      We have been occupied by others for centuries and have prevailed as a people; we will act in our national interest, standing by the Ethos of the European Union and International law.

      The Cypriots have made mistakes in the past, like everyone else but rest assured the Cypriots are no longer owned by anyone and never shall be again.

  4. Call me John March 20, 2013 at 1:33 pm #

    “Cyprus The Financial Centre is not resting, it’s shuffled off this mortal coil, run down the curtain and joined the bleeding choir invisible.”

    Nice one. And spot on with your post. Cyprus should have taken the deal. Not because it was a great one, but because it was much better than the alternatives. Now the window is closing. I hope they will either take the deal or a (Buchheit or other) variant of it soon.

    Buchheit is on to something but although I get his point about he benefit of bank-issued CD’s vs deposits, I think he is making things perhaps too complicated and a big disadvantage of this plan is that is doesn’t exactly tame the Cypriot banking sector. Also, I just don’t think it is necessary to go that far (converting all deposits above 100k to CD’s goes a lot further than the current proposal in my opinion).

    Enter my preferred variant, which holds the middle ground between plan A and B(uchheit).

    1. Honour the EUR 100k guarantee. Ignore the overdone contagion concerns, but there is something here about Cypriots trust in their own government. And a broken government guarantee is a form of default, although probably not legally so. Also, although things should be cleaned up radically, it would be nice if Cyprus could maintain a shred of creditibility as a financial sector.

    2. Work out whatever you need to take off the >100k depositors to get to your EUR 5.8bn. Because you need to get the Europe deal done. You need that ECB whatever-it-takes backing. You need the future credibility, access and goodwill from the Eurogroup if (when?) the sovereign needs a lifeline too. And no, really you don’t want to leave the Euro, believe me.

    3. Assuming that (2) is 15%, you pass a law that forces every depositor to buy a new IOU equal to the amount of 15% of deposits exceeding 100k. This new IOU will be open-ended but fully backed by the first gas revenues that ever come out of those gas reserves. And yes, it will be traceable. You can quibble about the details, like whether it should include a deferred coupon equal to inflation, and or whether these should rank park pass with sovereign, of not. Etc. And although such an IOU might well be worthless in the end (the gas is not exactly flowing yet…), it may also well mean that depositors will eventually see their money back if and when Cyprus can afford it. Also, a forced participation in an asset-backed debt issue seems a lot better than a tax in exchange for pretty much worthless equity.

    The benefits of this seem obvious to me, and it would appear to be a better deal for all than the Buchheit proposal, with the added benefit of reducing the size of the bloated banks, and getting a grip on them (the raised bail-out money for bank capitalisation will give the government a majority stake I assume), something which the Buchheit plan does not achieve.

    • Michael Thomaides March 20, 2013 at 4:34 pm #


      We will all know what will happen soon.

      • Unsympathetic March 20, 2013 at 5:51 pm #

        I hope Cyprus voters have the courage to throw out the EU dictators, take whatever banking pain is/was going to come, and be the next Iceland.. because being the next Greece isn’t very appealing.

    • Maximum Liberty March 20, 2013 at 5:09 pm #

      Why not just take the banks into a receivership that quickly imposes what a liquidation would impose? That would mean — for each bank individually and not as a sector –
      a. If they are insolvent, wipe out all equity interests.
      b. Start working your way up the debt structure (including deposits) according to applicable law. Issue new common equity to anyone who loses on the debt.
      c. Make sure to take enough debt (including deposits) that the resulting bank is clearly solvent. (This also means that the equity will be worth something, which is nice, but not necessary.)
      d. If, despite the clear solvency of the bank, it experiences a run, allow it to redeem deposits with debt. Yes, you can take out your deposit, but you get a 5-year note.
      e. Presumably, the government would have to find the funds to cover its deposit guarantee. But that is like any other government promise. Let the claimants have claims. If the government can’t pay them, you have the choices of “too bad” or “here’s a bond.”


      • Call me John March 21, 2013 at 2:47 am #

        Why not? Because of at least four very good reasons:

        (1) Precise estimates vary, but to get back to some reasonably degree of solvency, you’d have to crawl so far up the capital ladder that you’ll be wiping out some 40% if not more of deposits. They need the 10bn + 5.8bn EU + levy money for a reason you see. That is how badly capitalised the bloated, over-leveraged Cypriot banking sector is after the Greek debt restructuring. Equity by the way, is at the bottom of the capital ladder, so it will not be worth anything anymore in such a scenario. Also, after you do this – guess how long the remaining deposits will stay. 3… 2… 1…, and it’s gone.

        (2) By the time you’re done with this, you’d have all but completely destroyed the Cypriot banking system. There will be very little left of it. It is kinda hard to run an economy without a banking sector. Could it be rebuilt? Unlikely, or at least it would take many years. Investors are generally not keen to assist a bank raising capital after they have been wiped out once. Strange huh. A bank has zero chances of ever raising capital again after it has wiped out its equity and debt investors. And then we haven’t even thought about attracting deposits yet.

        (3) What you describe really amounts to nationalisation, since you can’t just let a bank hanging in receivership. It is not a car factory. A bank in receivership cannot function, won’t have access to funding markets, and has no future. Ie, it would need to be on a lifeline of capital and backing from the state. In a ‘normal’ nationalisation, you’d do this precisely to wipe out equity and bond-holders, but protect the depositors. The problem is however that even this is not an option here, because the Cypriot sovereign is not strong enough to carry the weight of such a nationalisation given the size of the banks’ deposits base and their weak capitalisation. If this was an option, it would top the list of course – this is by fat the easiest and most traditional way of dealing with a banking crisis.

        (4) Even without taking (3) into account, what you propose would lead to a default of the sovereign. Balance sheets must balance you see. If you burn down the equity and liability side by cutting down the capital until you have reached some kind of comfort level relative to assets, you will also face the consequences on the other side of the equation. Banks invest a significant portion of their capital (ie their liabilities: depots, debt, equity) in sovereign paper (part of their assets), partly because of regulatory obligations. In other words: the banks lend big-time money to the state. This is one of their key, although often taken for granted, functions: they basically finance the government by buying up big chunks of the government’s bond issues with savings placed in their care by the taxpayers. If you reduce the banks the way you propose overnight, the sovereign is done for too. It would loose its prime source of funding. Not to mention what it would do to the Cypriot economy in terms of bank lending to the non-government sector.


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