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Four Feckless Features Of A Post-Cyprus Europe

Tyler Durden's picture


Authored by Gavyn Davies, originally posted at The FT,

The calmness of the financial markets in the face of the deteriorating Cyprus crisis in the past week has been remarkable. Although Cyprus is tiny enough to be completely overlooked in most circumstances, its economy and banking system have characteristics similar to other, much larger, eurozone countries. Cyprus is certainly at the extreme end, but an over-leveraged banking system, with insufficient capital and reliance on foreign funding, is familiar territory in the eurozone.

Cyprus is therefore, in some respects, a microcosm of the entire eurozone crisis, if a microcosm on steroids. The manner in which the crisis has been handled by the Eurogroup and the ECB will have demonstration effects on other economies, for good or ill.

At the time of writing, the outcome of this weekend’s negotiations remains uncertain. However, assuming that there is no catastrophic breakdown in the talks, leading to the exit of Cyprus from the euro area, the broad outline of the settlement seems to be taking shape. It is reported that the Cypriot government will accept a “bail in” of depositors in one or both of its troubled banks, allowing the release of eurozone financial support, while still keeping the government debt/GDP ratio under 150 per cent.

Furthermore, the banking sector should be sufficiently cleaned up and recapitalised to allow the ECB to release further Emergency Lending Assistance from the central bank of Cyprus next week, thus enabling the banks to re-open. Many large depositors would find themselves subject to painful haircuts, rumoured to be around 33 per cent, and then locked into equity in the “bad bank” which would be created by the bank restructuring.

Controls would be imposed on the free movement of capital, so these large depositors, many of them Russian, would be unable to withdraw their remaining funds for an indefinite period. If the Cyprus Parliament baulks at these terms, which is still not impossible, then the spectre of an early exit from the euro would once again begin to loom into view.

A deal of the sort outlined above, keeping the euro intact, would probably be enough to prevent any immediate contagion effects to other economies. After all, everyone knows that Cyprus is a special case, given the size of its banking sector relative to GDP, its exposure to foreign depositors of questionable virtue and its concentration of bank lending to the collapsed Greek economy.

No other economy has that combination of disadvantages, which has made a conventional bank rescue impossible for the Cypriot government, and unacceptable to the rest of the eurozone, especially Germany. Bank depositors in Spain and Italy will presumably be aware of these unique features, and therefore more willing to view it as a special case.

That said, four of the features of the reported deal are setting unfortunate precedents for the future.

First, the way in which the bank failures have been handled shows that the eurozone is still very far removed from a workable banking union. The original rescue plan last weekend made the cardinal mistake of requiring a haircut on small depositors of under €100,000, who could reasonably have expected protection from losses. It is a well established principle of bank work-outs that losses should be taken in the following order: shareholders first, then bondholders, then uninsured depositors, then insured small depositors. The fact that the Eurogroup was willing even to contemplate anything different sends a very bad signal, though hopefully the worst has now been avoided.


Second, the principle of divorcing the debt of governments from that of banks (and thus breaking the “diabolical loop” which threatened to bring down Spain last year), was very rapidly thrown out of the window in Cyprus. There was apparently no willingness to use ESM money directly to recapitalise the banks, even though that is being done successfully with the Bankia resolution in Spain this very week.


German Finance Minister Schauble even went as far as to say that in other countries small deposits are safe “only on the proviso that the states are solvent”. Does that not drive a coach and horses through the separation of banks and governments, which was one of the principle promises made by eurozone leaders at their crucial summit of June 29, 2012?


Third, there is the possibility that investors will view any haircut on large depositors not as a special tax, or a bail in of creditors, but as a capital levy on investors. What is the difference, one might ask? A capital levy occurs when governments require their citizens to contribute to state finances by paying a percentage of their wealth to the government. The theory is that, if this is done without warning in extraordinary circumstances, and as a once only event, it allows revenue to be raised without having the usual disincentive effects on work effort and savings.


Barry Eichengreen’s fascinating analysis of the history of capital levies argues that they will inevitably be considered when governments get themselves into severe debt crises, though he adds that they are hard to apply in democracies, and are rarely successful. It would be most unfortunate if investors in the euro area began to fear that capital levies of this sort might come onto the agenda if the crisis gets worse. A flight of capital could result. (See also “Cyprus Levy: Historical Precedents” by Carola Binder.)


Fourth, there is the fact that direct controls over the exit of capital from a eurozone member will have occurred for the first time in Cyprus. This replicates what happened in the Icelandic bank crisis, when capital controls were originally said to be temporary, but have proven impossible to remove ever since. But to have this happen within the borders of a “single currency” is a different matter. Indeed, it seems to breach one of the basic principles of a single currency in the first place. (See Jeremy Warner.)

If the reported deal is done to keep Cyprus inside the euro by Monday, we can expect to hear, very loudly, that this is a unique case, and that the unfortunate features of this settlement cannot be extrapolated to any other future circumstances. Let us hope not. If nothing else, it would certainly demonstrate that the eurozone still has much work to do before the crisis is fully under control.

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Sun, 03/24/2013 - 16:06 | 3369294 TeamDepends
TeamDepends's picture

Can't happen here.

Sun, 03/24/2013 - 16:07 | 3369297 THX 1178
THX 1178's picture

Can't not happen here.

Sun, 03/24/2013 - 16:32 | 3369372 TeamDepends
TeamDepends's picture

Okay, can happen here by mid summer.

Sun, 03/24/2013 - 16:52 | 3369438 Sudden Debt
Sudden Debt's picture

after the summer okay?
I'm in America on holliday for 5 weeks this summer.

Sun, 03/24/2013 - 17:16 | 3369580 TeamDepends
TeamDepends's picture

Obviously, you are a 1%er so you're on your own.

Sun, 03/24/2013 - 18:01 | 3369729 flapdoodle
flapdoodle's picture

Speaking of the feckless features of the 1%...

Feck you Bernanke!

Sun, 03/24/2013 - 17:19 | 3369592 hornster
hornster's picture

The euro was intended to unify Europe: Fail.  It is creating the greatest tension in western Europe since the 1930's.

Sun, 03/24/2013 - 18:45 | 3369864 DonutBoy
DonutBoy's picture

Yes, and Milton Friedman told us exactly that before they committed to it.

Sun, 03/24/2013 - 23:56 | 3371085 old naughty
old naughty's picture

...and the founding papas of the ECB said "Friedman don't know sh't".

Sun, 03/24/2013 - 16:22 | 3369338 Motorhead
Motorhead's picture

I'm somewhat surprised to see on that chart that the US is so low (or, does "private" mean something different?).

Sun, 03/24/2013 - 16:54 | 3369446 Sudden Debt
Sudden Debt's picture

moneyprinting and exporting nflation seems to be part of the US GDP.

Sun, 03/24/2013 - 16:29 | 3369356 uranian
uranian's picture

After all, everyone knows that Cyprus is a special case...


hahaha. It's different this time, OK?

Sun, 03/24/2013 - 16:44 | 3369398 asteroids
asteroids's picture

Any deal that touches depositors is a disaster. Theft is theft. Why ANYONE would leave their money in an EU/ECB bank after Monday is a mystery. Why a Soveriegn would allow its citizens to be raped by bankers is too a mystery.

Sun, 03/24/2013 - 17:02 | 3369454 Lore
Lore's picture

Re: "Why a Sovereign would allow its citizens to be raped by bankers is too a mystery."

That's the point. They don't like sovereignty and want it to go away. Look it up: some of them even call themselves 'breakers of nations.' The best method is create a union for the purpose of harvesting debt too big for individual nations to handle, foster a debt crisis, and then dump payment terms on people who had nothing to do with it, thus wiping out the wealth and potential of the subject populace and disempowering them when the time comes to roll out a new totalitarian super-fiefdom.


Sun, 03/24/2013 - 16:35 | 3369380 xamax
xamax's picture



Sun, 03/24/2013 - 16:14 | 3369295 Tinky
Tinky's picture

"Four Feckless Features"? For Fuck's sake, it was Frankly Foolish not to have Filed this on Friday! Ya Feel me?

Sun, 03/24/2013 - 16:31 | 3369369 francis_sawyer
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Alotta Alliteration for Twitchy Tongued Tinkies Tweaking Thoughtful Threads...

Sun, 03/24/2013 - 16:33 | 3369376 MissCellany
MissCellany's picture

Fully, fervently, and forsooth, friend!

Sun, 03/24/2013 - 16:09 | 3369302 The Onion Of Tw...
The Onion Of Twickenham's picture

And if we wake up tomorrow and find that the new, democratically elected government of Cyprus has been removed on order of Rehn and Merkel and replaced by a Goldman apparatchik, what then? Is that bullish?

Sun, 03/24/2013 - 16:46 | 3369400 Van Halen
Van Halen's picture

Everything's bullish! It's the new normal!

Sun, 03/24/2013 - 16:47 | 3369407 disabledvet
disabledvet's picture

no man...that's called MUSIC. http://www.youtube.com/watch?v=ypJZ-K1gHhk

Sun, 03/24/2013 - 16:09 | 3369305 Ban KKiller
Ban KKiller's picture

Capital controls. Love it....means the banks keep what they want, you get enough to live on. You are free....to donate to the well being of the banks. How funny is this? At least these slaves have tv, no? 

Sun, 03/24/2013 - 16:09 | 3369306 Bad Attitude
Bad Attitude's picture

"...this is a unique case..."

Until the next unique case, and the next...

Forward [over the cliff]...

Sun, 03/24/2013 - 16:11 | 3369312 ebworthen
ebworthen's picture

I'd bet the phone lines from Russia to Cyprus decision makers are very hot right about now.

Sun, 03/24/2013 - 16:20 | 3369334 kaiserhoff
kaiserhoff's picture

Naw, the Ruskies just used Fed Ex to send them a few horse heads.

Sun, 03/24/2013 - 16:51 | 3369433 Harbanger
Harbanger's picture

They will have to make some concession for the Russians who've set up banks in Cyprus, the IMF can't compete with Russia. If they insist on confiscation, they will create a tremendous velocity into gold.  Woo hoo! we're rich!! :)

Sun, 03/24/2013 - 16:15 | 3369318 q99x2
q99x2's picture

Get up a posse and go after the ones that stole the money.

Or they can wait for Goldman's technocrat to come in and steal the rest of it. 

Sun, 03/24/2013 - 16:14 | 3369319 toys for tits
toys for tits's picture

"It would be most unfortunate if investors in the euro area began to fear that capital levies of this sort might come onto the agenda if the crisis gets worse. A flight of capital could result."

Gee, you think?

Sun, 03/24/2013 - 16:15 | 3369320 Seasmoke
Seasmoke's picture

how long until it crosses the Atlantic Ocean ??

Sun, 03/24/2013 - 16:37 | 3369386 max2205
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Janet.  Please hit the internet kill button

Sun, 03/24/2013 - 17:03 | 3369509 Harbanger
Harbanger's picture

Not too long, there's been undetected russian and chinese submarines popping up everywhere.

Sun, 03/24/2013 - 16:18 | 3369329 steve from virginia
steve from virginia's picture




The entire euro-as-energy-hedge is undone in an instant. By stiffing bank depositors, the EU has defaulted. There are no two ways around it.


The Chinese bosses are reaching for those Maalox bottles right now. China holds a trillion in euro-denominated debt instruments, so does Japan. Germany appears not to have thought this through. Regardless of what happens in/with the eurozone, Germany is on the hook for the overseas euro-trillions. Germany is the only EU country with money: it is responsible for all those Target 2 liabilities as well — this is another trillion euros. If not Germany, who picks up the tab?


Germany is declaring that overseas holders of euro currency are going to pick it up — starting with the Russians! Off the hook is the euro-establishment itself and its pet tycoons. High-level finance acumen is not necessary to understand how outrageous and destabilizing such an arbitrary action is: head-loppage was never part of the euro sales pitch! The euro was to be a ‘better, sounder’ dollar, always ‘good as gold’. Now, its fairy money, worthless outside the hands of ‘special friends’ who only discover they are so after the fact.




Sun, 03/24/2013 - 16:27 | 3369352 flacon
flacon's picture

Interesting. I wonder what would happen to the price of gold if the Russians dumped the EUR and went with the USD...

Sun, 03/24/2013 - 16:50 | 3369418 disabledvet
disabledvet's picture

or Switzerland...

Sun, 03/24/2013 - 18:33 | 3369827 mjcOH1
mjcOH1's picture

"Interesting. I wonder what would happen to the price of gold if the Russians dumped the EUR and went with the USD..."

Paying in Euros? Good luck.

Paying in dollars? Could be on sale.....

Sun, 03/24/2013 - 16:56 | 3369460 Sudden Debt
Sudden Debt's picture

why would you trade crap for crap? both stink...

Sun, 03/24/2013 - 17:09 | 3369547 Harbanger
Harbanger's picture

They don't want FRN's, Russia is buying gold even faster than the China.  I think it won't be long before they force the price of paper GLD in line with physical.

Sun, 03/24/2013 - 17:44 | 3369675 OpenThePodBayDoorHAL
OpenThePodBayDoorHAL's picture

I think gold and silver have been completely financialized so don't represent what they used to represent: financial freedom. Naked short selling, funny tricks with GLD share issuance, futures markets shenanigans. The derivatves are controlling the price of the underlying, not the other way around. Like what happened with mortgages in 2008. Prepayments moved by like 1%; which killed the crappy tranches; which then killed the good tranches; which then reached into the real economy and killed the underlying (real people making real monthly payments).

Sun, 03/24/2013 - 22:24 | 3370790 Harbanger
Harbanger's picture

There is no "real" economy anywhere right now.  The currency devaluation wars will only lead to multiple sovereign bankruptcies and a need for balance.  The only limited substance that allows for this balance, are a nations Gold reserves.

Sun, 03/24/2013 - 17:18 | 3369587 Terminus C
Terminus C's picture

I wonder what would happen if the Russians dumped the Eur and the USD and bought gold...

Sun, 03/24/2013 - 18:12 | 3369768 Tango in the Blight
Tango in the Blight's picture

You haven't been paying attention, have you? THEY'RE ALREADY DOING THAT!

Sun, 03/24/2013 - 18:11 | 3369765 hardcleareye
hardcleareye's picture

I do enjoy reading your work Steve..... ;)

Sun, 03/24/2013 - 16:22 | 3369341 q99x2
q99x2's picture

Massive market futures ramp on Cyprus not being fixed when it wasn't supposed to be broken.

Sun, 03/24/2013 - 16:30 | 3369361 Banksters
Banksters's picture

The way to stabalize markets is to go balls deep on bad news- Dr. Bernank

Sun, 03/24/2013 - 16:41 | 3369367 Lordflin
Lordflin's picture

'its exposure to foreign depositors of questionable virture'... this is of course unlike such paragons of virute as HSBC, BofA, Wells Fargo... etc... etc... One thing was made perfectly clear in Cyprus, assuming that it was not clear before... the banks are the true political entities... governments little more than a cosmetic front...


Sun, 03/24/2013 - 16:53 | 3369439 disabledvet
disabledvet's picture

the target is the media not the banks..."to wipe the stain clean." New York City's reputation appears to have moved to Connecticut. "the risk" appears to have remained however...

Sun, 03/24/2013 - 16:33 | 3369374 valkir
valkir's picture

We all expect to see,how Europe will bi "fixed"again.I have some predictions to say,better you can see it


Sun, 03/24/2013 - 17:35 | 3369649 Big Slick
Big Slick's picture


Fantastic metaphor to the current situation - and good explanation about the storing of potential energy at the end - this is akin to the leveraged derivative vehicles that have been built up by the banks

Sun, 03/24/2013 - 16:34 | 3369377 hairball48
hairball48's picture

But But But...we have the FDIC, and we're the world's reserve currency. We can print dollars and make all the FDIC covered depositors "whole" if we have bank runs here. Right?


Sun, 03/24/2013 - 18:06 | 3369749 hardcleareye
hardcleareye's picture

For now.......  10, 9, 8, 7, 6, etc.....

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