When even JPM says to panic, it may be time to panic. And then we ask why is all of this happening right now, why is even JPMorgan advocating a risk-off posture, and then we recall that every single year in late March, early April Europe comes back front and center with a bang, just as we forecast in "It's Deja Vu, All Over Again: This Time Is... Completely The Same" and then everything becomes very clear.
From JPM's Alex White:
Significant near-term risks after flawed Cypriot deal
- Significant chance that Cypriot Parliament votes ‘no’ (30%) or has to further delay the vote (40%)
- Either outcome would be highly problematic, highlighting regional stresses
- President to address MPs on Monday at 9.00am GMT. Earliest likely time for vote late afternoon GMT.
- This could be pushed back significantly
- A delayed vote could require an extended bank holiday in Cyprus to avoid broader bank run
- Regional contagion impacts should be containable, but risks unclear with new precedents set
It is difficult to over-state the extent of popular anger in Cyprus over the bailout deal which was pulled together on Friday evening. The deal includes €10bn of support from the Troika, as well as a depositor haircut, to be implemented through the introduction of a ‘stability levy’ of 9.9% on deposits over €100,000 and 6.75% on smaller deposits. Cypriot depositors with savings nominally below the European deposit guarantee threshold (€100,000) appear to have been squeezed between the policy interests of their major external partners; including Germany and Russia.
In insisting on a depositor haircut, the Eurogroup appears to have reflected the realities of German domestic politics (where the Cypriot package has been turned into an electoral battle-ground, in part as a consequence of SPD pressure). In agreeing to a levy on small depositors, as opposed to simply those with deposits above the guarantee threshold, the Cypriot Government also appears to have bowed to additional political pressure from those constituencies with large Cypriot deposits (including Russia). The total quantum of insured deposits in Cyprus is around €30bn, while uninsured deposits (i.e. deposits above €100,000) total €38.4bn. It would therefore have been possible to raise the total required (around €5.8bn) with a levy of 15.4% on the uninsured deposits; a path which the deal avoids in favour of more socialised pain. The result is highly problematic in the near-term, in our view.
Cyprus could vote ‘no’
As with other packages, the Cypriot bailout proposal needs to be approved by the ESM members, through a parliamentary ratification process, which could present some difficulties in Germany and elsewhere (with votes likely in April). The near-term challenge - securing domestic Cypriot approval – appears far more potent however. The parties which nominally provide support to President Anastasiades have a majority of one in parliament, and the opposition Communists (AKEL) have already given a clear indication that they will vote against. The extent of depositor pain, and the strength of public reaction, has pushed other parties in AKEL’s direction. We think the Government can be reasonably confident of only around 26-28 votes at the most (with risks to the downside), while the opposition may be confident of around 26. In total, 29 votes are needed for a majority in the 56 member parliament. Our best estimates of a potential vote have it too close to call at this stage (Evroko, a pro-European centrist group which has given differing indications, may be the swing party).
The ECB, and others within the Troika, have put intense pressure on the Cypriot Government to vote on the measures before the market opens on Monday; only to have President Anastasiades make clear that he does not yet have the numbers. We think there is a material risk of the vote failing if brought before parliament. Given the small size of the Chamber, parliamentary managers are likely to have a good idea of a potential result and might choose to delay a vote still further if they don’t have the numbers by Monday evening. Given the importance of having an agreement in place before Cyprus’ banks open their doors, this leaves open the possibility of an extended bank holiday (possibly through the week).
A ‘no’ vote, or a failure to bring the package before parliament in the immediate term could have significant regional implications. Germany has made clear that it won’t bring any measure which does not include depositor haircuts before the Bundestag. The extent to which the region has played hard-ball with Cyprus was indicated in Anastasiades' claim that he was threatened with an immediate withdrawal of ELA support if he did not commit to the deal as it stands. In the event of a need to renegotiate, the path of least resistance in our view would probably see an amendment of the existing deal, such that the pain is redistributed to impact uninsured depositors (we think there is a chance of the Cypriot Government seeking to amend the terms in this direction before bringing measures to parliament if it faces the prospect of failure). In effect however, the damage would already have been done if Cyprus sees significant deposit flight, absent a deal. In the context of the Troika’s current disagreement with Greece on further disbursements, and the likelihood of political dead-lock in Italy, a return to a more stressful episode of the European crisis cannot be discounted, in our view. Should these hurdles be passed, longer-term we think there is a possibility of legal challenge to the package, under both Article 23 of the Cypriot Constitution, and under the European Convention of Human Rights (ECHR) given the requirements of both in respect of property rights.
Has Europe bazookaed itself in the foot?
Even if we avoid a negative outcome this week, events in Cyprus invite broader questions about the region’s commitment, repeated ad nauseum since June to ‘break the feedback loop between sovereigns and banks’. The IMF warned as recently as Friday that the Euro area lacked an effective deposit guarantee framework (before agreeing to a haircut that adroitly proves its point). The Cypriot package reinforces the fact that existing deposit guarantee schemes are only as strong as the sovereign which backs them; something which is unlikely to go unnoticed in the rest of the region (although we think specific contagion risks are limited near-term). Other EU member states will likely be affected, there are significant numbers of UK depositors in Cypriot banks, some of whom the UK has now promised to protect (with echoes of the Icesave situation), and some potential contagion channels may not be obvious. It is notable that German policy-makers have been insisting on Cyprus’ significant ‘systemic relevance’ over recent days while pushing a package that may test it.