Cyprus’ Draconian Bailout Terms (closed to updates)

The bigger implications of Cyprus: Cyprus may represent only a small slice of the EU’s total GDP, but the negotiated details will loom large over Greece, Spain, Italy, etc. The consequences of the Troika’s actions are starting to grow more deadly for the continued existence of the euro, and for global financial markets.)

From scanning the headlines (or the lack thereof) in the American mainstream media, it would be hard to appreciate the seriousness of the Cyprus bailout negotiations. Less discussed than the woes of Greece, Cyprus has been in crisis mode as well since 2011, when Greece’s debt restructuring ruined the financial health of Cypriot lenders (amongst others) including the Bank of Cyprus and Cyprus Popular Bank. But on 03.16.2013, an initial European Union bailout had emerged after months of negotiations.

There was little to cheer about in the details. Bank depositors were required to pay a one-time tax of 6.75% on deposits of less than $130,000, and 9.9% on deposits over that amount, as part of the bailout terms.

How convenient to avoid a double-digit tax rate (it looks bad in print), but as developments unfolded on the ground after the announcement, it appeared bank runs would erupt. As if no one could have predicted the potential for a run on banks. And to think of the incomes drawn by those cats from the EU, ECB and the IMF. I wish I could get paid that kind of coin for being stupid. It’s so much easier than thinking through potential consequences.

This story from the New York Times centered on small depositors, and the potential for bank runs could not be ignored: The week of 03/17 turned out to be a long bank holiday, to prevent a bank run. Before the implementation of capital controls (see below), speculation ran rampant Russian deposits in Cyprus may start returning to Moscow, but never mind (yet here is a counterpoint so is the former story simply bluster?) as the upper middle and small business owners are going to get hammered, not the Russians.

However, the Cypriot parliament INITIALLY did the right thing and rejected the deposit tax. And Yanis Varoufakis stands in agreement with the latter contention.

The initial bailout also included a lame consolation prize, with depositors receiving shares in the Cypriot banks in return for the tax on deposits. But consider:

“Cypriot banks are loaded up on bad loans made to Greek companies and individuals, which have turned sour at an alarming rate as Greece has dealt with the fourth year of a devastating economic and financial crisis.”

The details emerging from negotiations now appears that insured deposits – at the Bank of Cyprus and Cyprus Popular Bank (a.k.a., Laiki Bank) – under €100,000 will remain in a “good” bank, and all uninsured deposits over €100,000 will be brushed into a “bad” bank, which will become the Cyprus Popular Bank (CPB). All uninsured depositors and senior bondholders with CPB are essentially trapped. The alleged losses will total ~€6 billion, a huge sum for tiny Cyprus to digest. Capital controls as still in the mix, i.e., severe restrictions will be placed on the withdrawal and movement of deposits, but this time such controls were provided to the Cypriot government thanks to emergency legislation passed by the Cypriot parliament, not the Troika.

CPB’s woes started last year, a result of the Troika’s negotiated terms with Greece for its bailout. This from the Cyprus Mail:

“The plan is likely to mean very heavy losses for uninsured deposits in Laiki, which has suffered since writing down the value of its holdings of Greek government bonds last year.”

In the short term, this will be deadly for small business owners, those most likely to be holding amounts over €100,000. The uninsured accounts will likely be wiped out in the CPB, and we can see what the Cyprus Parliament/Troika is angling at: Keep the smaller depositors intact, which would give lower- and middle-income Cypriots less of a reason to take to the streets and create public unrest.

The implementation of capital controls carry grave consequences. While Cyprus is still on the euro, capital controls essentially cut off the free flow of the euro within the EU region. Therefore, the “Cyprus euro” becomes a national currency, not an EU-zone currency, yet unlike a national currency printed by a central bank, Cyprus holds no control over it.

There are already limited capital controls in place in Greece, Italy and Spain, and now would be a good time for the national leaders in those countries to start losing sleep. If citizens there develop a twitch they could trigger premature bank runs, perhaps at a slower pace and over time, unless something causes a quickening of the pace of withdrawals. This slow-motion bank run may catch the Troika by surprise. They seem to be clueless as it is.

Yet the wealthy public bondholders of Cypriot debt escaped losses. And consider this from voxeu.org:

“The next bond maturing on 3 June 2013 in the amount of €1.4 billion – a large chunk of which is reputed to have been bought by international hedge funds over the last six months at prices ranging from 70-75 cents in the euro – will be paid out at 100 cents in the euro in about ten weeks. Each depositor in a Cypriot bank, large and small, will be making a… contribution toward that payment to bondholders.”

and to put a ribbon on it…

“… yes indeed, peripheral Eurozone sovereign bonds do benefit from an implicit northern European guarantee.”

The voxeu.org article outlines an intriguing alternative for the Cyprus bailout, based on certificates of deposit, coupled with bondholders shouldering elongated maturities. This approach holds the benefit of honoring the bonds – no matter how grating we may find the circumstances surrounding the purchase of those bonds by vulture hedge funds – without defaults or haircuts, which in the future would push the international bond markets to punish Cyprus. At the same time, this at least slaps the face of the vulture funds for trying to take advantage of a very unfortunate situation, by tying up their investments longer than hedge funds are normally inclined to do.

But as far as can be determined, none of the proposals suggested at voxeu.org are on the table.

It appears Cyprus will have a “banking system” in name only. And the larger implications for Europe are sketched out by Bruce Krasting.

Final update: In the immediate post-settlement air, the details on Cyprus look ugly.

And if you want to see what daily life has now become on Cyprus, just scan the headlines at http://www.cyprus-mail.com/

P.S. From a comment over at naked capitalism: “Cyprus is a low-tax jurisdiction, not a tax haven.”

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