Authored by Juhani Huopainen, originally posted at his blog at TradingFloor.com,
An interesting compromise on Cyprus: a EUR 5 billion bail-in by a small haircut on deposits, with bank stocks offered in return to the depositors and a EUR 10 billion bailout from the EU, coupled with the usual austerity requirements.
By acting after the Italian elections, options were limited
The option of conducting a bail-in (confiscating deposits) was tabled months ago and leaked. The deposit flight from Cyprus was measured in billions because of that. Guess if the leak will ever be investigated? The European Union had painted itself in the corner: not wanting to deal with Cyprus immediately has proven costly. The EU had hoped for a pro-euro, pro-austerity government in Italy, but the plan backfired. The idea was that by postponing the bailout it would help in the elections.
It was impossible to wait until the German elections, as Cyprus has a bond maturity in June that it would have been unable to pay. As the maturity date was so close, there was no time to take the bond owners to court (the bonds were issued under English law, so a simple haircut was not possible). The only way to fund the bailout was either a gift from the EU or deposit confiscation. They did both.
Russia obviously made some thinly veiled threats that they would only accept a deposit haircut of below 10 percent, so in order to rake in enough money from the deposits, the EU had to go for the little people’s accounts as well – thus breaking their word on the guaranteed deposits below EUR 100,000. Even with that, the EU has to fork over EUR 10 bn as the confiscation will bring in only EUR 5 bn.
Warming up for a bank jog?
Personally I believe a simple gift of EUR 5 bn of free money would have been a better choice. The lending of EUR 10 bn raises the debt/GDP, lowers growth prospects, forces austerity and has the danger of creating a negative spiral that could turn the island into a second Greece: a continuous source of headaches and disappointment to the EU. The haircut is small and while commissioner Rehn stated that this is a one-off and Cyprus is a special case, whether the depositors in Spain and Italy believe this remains to be seen. If not, the bank jogs slow bank runs could start again. That could push Spain to eventually apply for the ECB's OMT-program. Perhaps that is what Brussels and the ECB actually want. But with the IMF and Germany coming to the negotiations demanding a 40 percent deposit cut, ‘more Europe’ is no longer a winning campaign promise.
Further apart or closer still?
There are two ways of seeing this: #1 Europe just became even more dysfunctional and fragmented, or #2 it has become more unified in doing whatever it takes to protect investors’ interests:
#1 Europe has violated the sanctity of private property, the guaranteed deposit limit of EUR 100,000, democratic decision-making, innocent people end up paying for other’s mistakes by coercion, depositors in crisis countries will move their funds to countries deemed safe, igniting the crisis. The deposit haircut will not remain an isolated case, and investors cannot trust the ECB, Brussels or Germany any more. National governments are at the mercy of the Troika, and the ECB is not the glue that holds the union together, but a weapon of financial mass destruction that forces any opponents to comply. Cyprus is not a special, isolated case.
Conclusions: Bank runs and panic. Sell EUR, sell crisis country bonds, buy safe assets preferably outside the euro area.
#2 Decision-makers have finally found a way to impose austerity on non-compliant member nations over the democratic multilateral process. The electorate is finally forced to accept its responsibility to vote for sane and proper leaders and to monitor their performance. While deposit cuts and other measures seem unfair, they are easy to implement and difficult to avoid – the only way to avoid is a bankrun, which would bring any government to its knees. By their actions, the Germans, the IMF and the ECB have shown that they mean business. Incentives for governments to freeride on the euro and pretend fiscal austerity and labor market reforms have greatly diminished. The idea of leaving the euro or partial bond defaults is suddenly less popular, as it is known that the ECB will destroy and nation stepping out of line. Government- and bank bond owners have been protected through fiscal repression, protecting investors. Cyprus is a special, unique case.
Conclusions: Euro area breakup-risk minimal, exit-talk and resistance to austerity decreased. Defaults ruled out. Buy crisis country bonds and stocks in the euro area, avoid bank deposits in crisis countries.
Personally, I’d vote for #1. The commentary is already utterly negative, but it might take some time for the markets to realize that the upside in crisis country bonds is minimal and there are no restrictions stopping the bank jogs. Next week in Europe will be very, very interesting.
On Friday morning the IMF posted a large report on Europe where they stated that the deposit guarantee scheme in the euro area must be ironclad. On Friday evening they happily agreed to go against their own advice.
Cyprus has agreed to an outside audit of its banking sector, but Nicos Anastasiades, the president, says it will “never” accept a haircut of depositors – Financial Times, March 14, 2013