Cyprus: Of Course It’s A Template

11 Apr

So we have the Troika’s Debt Sustainability report and the related financing document (kudos to the FT: others had it, only they posted it publicly. Worth reading Peter Spiegel’s post too) and what a shabby, despicable little document it is. The Cyprus negotiations started with a high-risk gamble – that depositors would bear part of the pain of restructuring; unfortunately, the Cypriot parliament then tried to bluff the Troika whilst declaring loudly that they didn’t have any cards at all, and a catastrophe was duly created.

Two-part post: greatest hits from the DSA/EFN; and a quick run-through the “Template” aspects of the solution.

1) the economic forecasts are worse than literally laughable (table) . The drops in consumption and investment look dementedly optimistic given the events of the past month. Exports to drop a mere 5% with the destruction of the banking industry and the introduction of capital controls. The wealth effect wiping deposit worth 60% of GDP will apparently barely register on consumption – the Troika must think the deposits are all Russian. Compare with Iceland (50% drop in investment) or Latvia (40%), the former boosted by devaluation the latter by an intact financial system. Public consumption drops 9% – Iceland held the line here, and we have bitter experience from Greece on how big fiscal multipliers are. These projections cross the line from wild optimism into contemptuously half-hearted fable. This table is a bare-faced lie.

DSA table

2. The attempts to haircut depositors have turned into a fullscale scalping. Aided and abetted by the Cypriot parliament, the bailout cost is EUR5bn higher than the original March 23rd plan envisaged – the pricetag for a mere 5 days. All of this falls on the depositors in the 2 big banks. As the FT notes, that’s 30% of GDP. Great job, Jeroen!

3. The fiscal projections suffer from the presistent Greek problem: undershoot fiscal targets – slaughter economy with new measures to get back to targets – undershoot revised targets. “Insanity is repeating the same mistakes and expecting different results” (Narcotics Anonymous Basic Text, not Einstein, apparently).

4. “Sale of Excess Gold Reserves” for EUR400m. My instant reaction to this is “WTF?”. May have an aim other than being a nifty piece of political humiliation, but buggered if I can see what it is.

It is envisaged to use the allocation of future central bank profits of approximately [EUR 0.4bn], subject to the principle of central bank independence (double WTF?)

5, The banking sector shrinks. The domestic banking industry shrinks at a stroke from 550% of GDP to 350% by a deft combination of taking people’s money and stripping the Greek operations (120% of Cypriot GDP) out and selling them to Pireaus. Given that the Greek operations were to a significant degree responsible for the disastrous GGB trades that wiped out the banks, and given that Pireaus stock rallied sharply afterwards, the Cypriots find themselves in the position of the Blackadder character who not only had a relative murdered, but had to pay to have the blood washed out of the murderer’s shirt. (excellent stuff here on how the Cypriot banks blew up, based on leaked documents).


A number of other policy steps will alleviate financing needs over the programme period, but with limited or no impact on the public debt trajectory: i) the Cypriot authorities will endeavour the roll-over of up to EUR [1.0] bn domestic law long-term debt maturing during the programme period. In order to implement this, the Cypriot authorities intend to undertake a voluntary sovereign bond exchange cover ing bonds maturing in 2013-15.

Tipping their hand a bit there with that “domestic law” stuff. Clearly they don’t see much hope in getting rollovers from foreign investors protected by foreign courts. “Voluntary” is as ever a term the EU seems to struggle with, confusing it with “doing what we want”. At best, moral suasion on banks and local institutions, at worst more Greek-style ex-post re-writing of bond covenants.

This brings us to the question of why the programme looks like this. The (admittedly laughable) debt estimates in the DSA top out at around 65% of peak Greek debt:GDP and below where non-programme Italy is this year. Note that carefully: the Troika felt a path that took Debt:GDP above Italian levels was so dramatic that it required scalping bank depositors. “Sustainability” is a flexible thing. The priorities of the EU have shifted over the years.

The EU is recognising moving towards a new regime of bailing in banks – reducing the size of and protecting core contributions to ESM et al has become a major priority. While what happens will not be identical to Cyprus because Cyprus” banking system was unusual in size and structure. For a non-Template, the Cyprus solution drops some cracking clues as to EU priorities. At present, the capital structure is equity, subordinated debt, then senior debt and depositors together. The new hierarchy will be: equity, sub debt, senior debt, uninsured depositors, and then at the top of the mountain as the floodwaters rise, voters insured depositors (remember that while a very big chunk of deposits are uninsured, almost all depositors are) the ECB and the Eurosystem (the Central Bank of Cyprus remains part of the Eurosystem family, albeit a red-haired stepchild). The ex-Bank Laiki had around EUR9bn of ELA claims at the ECB – enough to severely dilute the depositor haircuts had it been bailed in as per its legal status. In its anxiety to prove Professor Sinn wrong and that ECB claims are not a problem for Germany, the Troika has made it clear that they are a problem for the periphery.

Furthermore, after the Greek PSI, sovereign debt is out of the firing line. Cypriot banks were “different” in having a very small layer of non-depositor debt. But the EU is already divvying up various special classes of “bailinable” and “non-bailinable” depositor. This includes apparently putting interbank deposits on the firing line, presimably because they feel that Mr Draghi is a little comfortable post-OMT and would like the challenge of defrosting a frozen interbank money market.

Citi were out this week with a handy spotters’ guide (thanks Simon Hinrichsen for link) to figuring out which depositors should worry.

For depositors to be at risk, three conditions have to be satisfied. First, there have to be systemically important banks, that is banks whose insolvency would cause economic and financial damage significantly larger than the losses of the directly
involved bank creditors. This likely requires a large banking sector (..). Second, depositors have to be a large share of total bank funding,… Third, the banks have very poor asset quality and are insolvent, with the insolvency gap exceeding the value of the banks’ unsecured liabilities other than depositors.

So this comes down to an issue of asset quality. If the assets are good, then this will probably blow over. If they’re not, and uninsured depositors start to worry, this could get very messy very fast. Good job that we’re endlessly reassured that European banks are in fabulous shape.

24 Responses to “Cyprus: Of Course It’s A Template”

  1. Willem de Leeuw April 11, 2013 at 10:31 am #

    “All of this falls on the depositors in the 2 big banks.”

    Why shouldn’t uninsured depositors in failed banks lose part or all of their deposits? Isn’t it the way it’s supposed to work? E.g., see an FDIC resolution notice. Even if the argument is that the healthy banks would fail when the others do, if you think it’s a good idea to burn depositors in otherwise healthy banks ‘for the greater good’ than you’re asking for chaos. You have to let the chips fall in the order that is considered fair.

    • carol April 11, 2013 at 3:28 pm #

      Previous bailouts were unfair: forcing taxpayers in other countries to pay for bankrupt (both ethically and financially) companies.

      This Cyprus bailout is unfair too.

      How could citizens, who are working, paying tax, and able to save some of the remains, have known that those 2 banks were bankrupt?
      The banks passed the EU stress test; had their year report approved by accountants; had received ELA from the ECB etc.
      The ECB may ONLY give ELA to a solvent, viable bank!

      And to top it of: by taking NO (=zero) haircut on deposits of branches in Greece; by allowing open doors for the well connected via London and Moscow branches, the ordinary citizens have not been haircut, but scalpeled.

      All of a sudden Olli Rehn et al. refer to ‘large’ depositors as investors. However, they do NOT provide savers with the information necessary to take well-informed decisions as if they were investors!
      Were is the off-balance sheet info, were is info re derivatives positions, were is info on all activities abroad etc. etc.?!

      • John Hill April 12, 2013 at 5:14 am #

        “The ECB may ONLY give ELA to a solvent, viable bank!”

        No. Not really. Really not.

        The ELA is meant for banks that are no longer viable and hence no longer are granted access to the regular ECB liquidity operations. They will already have lost access to ‘normal’ (interbank) funding long ago by then. Basically, such banks have lost all ordinary means for funding, and that is for no other reason than that they are bust.

        At that point, enter the ELA: the ECB’s version of bank purgatory. It is administered by the national Central Banks precisely because the ideas is that a bank that enters the ELA is past salvation and has no other option but to work out a plan for recapitalisation or orderly wind-down with its national government and regulator (ie, the national Central Bank). The ECB’s message is then: sorry, game over, go back to your national government to be saved (if they deem it important enough) or to be wound down.

        The ELA in the meantime is purely meant as a facility that can buy the bank some time to organise this (the bail-out, recap, wind-down, takeover or whatever the last resort solution is). It allows the bank to continue its day-to-day operations while its sovereign and regulator figure out what to with it. This is done to prevent outright disruption of the system (shuttered branches, unsettled accounts etc).

        But the moment a bank goes into ELA it is a BIG red flag. It is the final and last stop before bankruptcy on a one-way track. Definitely not a sign of approval from the ECB; on the contrary: it is the ultimate red card.

        And the ELA is meant to be a facility that keeps doomed banks afloat for days, perhaps weeks.

        The Cypriot banks in question had been in the ELA since June last year, and the Cypriot government/regulator kept dragging its feet in all manners of ways to delay/avoid the inevitable. And the likes of Mr Rehn let them get away with it.

        The whole Cypriot Crisis that we had two weeks ago was only brought about because the EU (embodied by Mr Dijsselbloem)/ECB had had enough of this 9-months charade, and threatened to pull the plug completely.

        The villains in the story are not the EU and ECB officials, but the Cypriot bank executives, regulators and politicians who for years let a banking sector go lightly regulated, letting it grow completely out of proportion, and then, to make it even worse, when trouble came knocking and the music stopped, they were unable/unwilling to do their jobs and failed to tackle the situation for almost a year. As soon Greece was restructured more than a year ago, any bank executive, regulator, politician or investor in Cyprus knew that those banks were in very serious trouble and needed assistance to survive. And so did the EU/ECB, throwing them into ELA in June, and trying to assess the precise need for the inevitable bail-out. It is just maddening to now hear those very same people (the Cypriot bank regulators, politicians and execs) play the innocent victim and blame ‘the Germans’ for their own complete and utter failings.

    • Matthew Judd April 11, 2013 at 8:43 pm #

      Uninsured depositors should be in line to lose, but no more so than senior bondholders, including sovereigns. The uninsured depositors would have been better off if the banks had been allowed to fail before the ECB bailed out the non-sovereign bondholders. All depositors in Europe should learn the lesson; once the triad starts supporting your bank, you are moving closer to being bailed in as in Cyprus, and should react accordingly,.

  2. RichL April 11, 2013 at 6:31 pm #

    Perhaps I’m less sophisticated living in the US. When Washington Mutual was in poor shape, they paid high rates on their deposit accounts. I placed deposits there to take advantage of the offer, but only with sums below the insured limits. WaMu went out of business, and my money was returned due to the insurance. That’s what happened in Cyprus, as best as I can tell. Yes that is a template. Yes, contracts were not abrogated. And, YES, those who didn’t pay any attention to the obvious risks while chasing high yields lost money.

    Why is this outcome wrong?

    What is questionable was the initial threat to take insured deposits. Also, why didn’t the government of Cyprus move sooner to deal with their issues?

  3. PPP Lusofonia (@ppplusofonia) April 11, 2013 at 7:28 pm #

    Previous bailouts were unfair: forcing LOCAL taxpayers to pay off cross-border investors, professional speculators as far from the defense-less “widows and orphans” as you can get.
    Local depositors are not part of the problem and they must, by definition, be part of the solution. If you continue to penalize local savers, the Euro will disappear into a bottomless pit.
    The Cyprus capital controls are 5-years too late, they should have prevented the incoming “tsu-money”. See the blog

  4. Gloeschi April 11, 2013 at 9:30 pm #

    Great write-up.
    Mystery as to why EU suddenly trying hard to scare off depositors and wholesale funding at the same time. Is the plan to drive entire European banking sector into nationalization?

  5. Milton Arbogast April 12, 2013 at 9:40 am #

    You know it’s a good post when the comments are (almost?) as good as the post.

    I agree that the villains of the piece are the criminals in the Cypriot banking sector/government. And the next stop is Slovenia.

    And the US “solution” to its banking crisis stinks to high heaven.

    Is the reason that the peasants are not storming the castle in the US that the US banks were not permitted the same excesses in leverage that the European banks were “permitted”?

  6. Milton Arbogast April 12, 2013 at 9:54 am #

    Jeroen is at it again. And the bedrock underneath it all appears to be the €100,000 ceiling on insurance.

    Well, guess again, Jeroen. Sure, in the US there’s this $250,000 thingy that seems to keep everyone happy, particularly because there are tons of “banks”.

    But what you’re doing Jeroen is telling people, “Banks are not banks.” That’s the message. Banks are not a place to put your money. They’re something else. Criminal enterprises? Naughty children? Un-Dutch? But they are not banks. Here in Europe we don’t have banks.

    Europe cannot last long in that environment. I try very hard not to be a doomsayer, but I’m saying doom. Europe will break up.

  7. Milton Arbogast April 12, 2013 at 9:57 am #

    I know the counter-argument is our host’s graph showing 99% of depositors are covered by the €100,000 limit. Okay, let’s turn it around and say that banks cannot accept deposits above €100,000. That’s our definition of banking. Sure.

    • John Hill April 12, 2013 at 3:12 pm #

      Naturally, and when my soup has a hair in it, it is sewage.

      Why oh why is it such a shocker that uninsured deposits are, well, uninsured? Or even that a guarantee is only as good as the guarantor? This has always been the case. Yes, if you put your >100k deposit with a bank, you need to pay some attention to its capital position. In fact, even sub-100, you do too, especially if there is doubts about the supposed guarantor. It is your money. Take some responsibility for it. Choose a bank wisely, and not because it has a pretty logo and gives you a balloon when you open an account. It isn’t that hard. Even without any expertise, any idiot can figure out that the banks with the higher interest rates are the riskier ones. It is like that free lunch thing: there isn’t any.

      The alternative is what? All banks, all deposits are always and forever completely guaranteed? Oh sure, the banks would love that – fantastic funding opportunity right. No wonder the finance community has scrapped ‘Jeroen’ off their Chritmas card list. But that would ring the real death bell for efficient capital allocation in and through the banking system, which is its key economic function and the backbone of capitalism. We are trying to restore some degree of healthy capital allocation and long-term soundness in a banking system that is, in many parts of the Eurozone, both undercapitalised and badly managed. That is going to be a painful struggle, with more painful battles to come. It is an important one though – it is a necessary condition for European prosperity in the coming decades.

      I feel at times we have gone through the looking-glass. We now have Labour politicians like ‘Jeroen’ defending basic capitalist principles like those about bank capital and primary actor responsibility while supposedly free-market adherents are screaming for total government backing and market intervention.

      • Milton Arbogast April 12, 2013 at 6:28 pm #

        What you say would be true if banks had not been working like madmen to conceal their true financial condition. Our account representative closed the door to his office and told us that six months prior he had been told that CA had no exposure to the US housing market. He was lied to. And that was before they bought a Greek bank.

        What the public should not be asked to do is penetrate dishonesty, and if your position is that the true condition of banks is always transparent at any time, you are living in a bizarre parallel universe.

        Is it not the case that Cypriot banks passed stress tests in the recent past?

        Who could have guessed that Hollande’s Finance Minister was a common criminal breaking the very laws he was appointed to enforce?

        What’s your solution to pervasive dishonesty?


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