Tuesday, March 26, 2013

The Cyprus deal

Joseph Cotterill digs into the weeds of the actual EU/Cyprus deal in Scratch one stupid idea FT Alphaville 03/25/2013.

Cyprus' two largest banks are the Marfin-Laiki Bank and the Bank of Cyprus (BoC). Laiki is done. It's being closed down and put through a normal "bank resolution" process, which Cotterill sketches here. Its bad loans will go into a "bad bank" to be resolved, meaning that some will be written off, some given a "haircut" to reduce the principal, others renegotiated, some paid off under the original terms. The healthy pieces of the bank will go to BoC.

The deal between Cyprus and the Troika (EU, ECB, IMF) also provides €10 billion to Cyprus for its public budget. It will be in the form of debt, which will put Cyprus into the same kind of trap in which Greece has found itself since 2009.

Angela "Attila 3" Merkel and German Finance Minister Wolfgang Schäuble lay waste to Cyprus in this 20.03.2013 cartoon by Yanis Iaonnou

Yanis Varoufakis gives his own summary in The Good, the Bad and the Extremely Ugly (aspects of the Cyprus deal) 03/25/2013. Among the "good" aspects he includes:

The new deal treats different banks differently, as it ought to. The earlier Eurogroup decision imposed blanket haircuts on all accounts irrespectively of the bank’s bottom line. At least now uninsured deposits will be haircut in proportion to the size of the bank’s black hole, thus restoring a degree of private responsibility on the part of depositors viz. their choice of banker.
There are a lot of details of the deal still to be finalized. Varoufakis calls attention to these two:

  • The transfer of €9 billion of ELA money from winding down of Marfin-Laiki to the Bank of Cyprus – it flies in the face of basic banking resolution principles, reflecting the ECB’s Taliban-like defence of what it considers to be its 'realm'.
  • Capital controls have been touted, even though it is not clear how they will be implemented, creating a second-tier euro: Cypriot euros that are no longer exportable (nb. Imagine Vermont dollars that cannot be taken out of Vermont: a logical travesty within a currency union)
This idea of the "Cypriot euro" is a confusing one, as if the economics of a currency union like the eurozone weren't confusing enough. It's essentially a functional way of describing capital export and import restrictions within a currency union. Which, as he says, is "a logical travesty."

Then there's his "extremely ugly" catgory:

... in one short week Europe has managed to put in jeopardy the sacrosanct concept of state guaranteed deposit insurance (even if, in the end, they took this threat back), to bring back into question the integrity of the Euro-area and to sacrifice the European Union’s single market principle according to which capital controls are inadmissible.
Interestingly enough, even the German public is expressing doubts about the safety of their own deposits! Spiegel Online reports in Forsa-Umfrage: Wähler zweifeln an Merkels Spargarantie 26.03.2013 on a Forsa Institute poll that found 67% of Germans have either some or a lot of concern about the safety of their bank deposits.

We've heard some many promises based on bad economics - or just plain ideology divorced from actual economics - about how the Confidence Fairy was going to eventually jump in and boost economies that practiced austerity economics during this depression, that any time I see the word "confidence" pop up in discussions of economic policy now my first reaction is that some "con-man" is pulling yet another "confidence game." But banks and national financial systems do rely on confidence from depositors that their money will be reasonably safe on deposit. That's the whole point of government deposit insurance, so that people will know that up to the defined limit, they will get their money back even if the bank goes belly up. Otherwise, we'd be having bank runs like the one depicted in It's A Wonderful Life every time there was bad news about a bank.

So the short-lived proposal to tax away part of even insured deposits raised new questions about the competence and seriousness of the leaders of the eurozone. After backing away from that idea due to the unanimous rejection of the Cypriot Parliament, a bone-headed official did some more damage on Monday, as Felix Solomon explains in The Dijsselbloem Principle Reuters 03/25/2013:

If a gaffe is what happens when a politician accidentally tells the truth, what’s the word for when a politician deliberately tells the truth? Dutch finance minister Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts.

Those comments are now being walked back, because it’s generally not a good idea for high-ranking policymakers to say the kind of things which could precipitate bank runs across much of the Eurozone. But that doesn’t mean Dijsselbloem’s initial comments weren’t true; indeed, it’s notable that no one’s denying them outright. ...

Dijsselbloem’s interview today was undoubtedly a prime piece of political incompetence: there’s no reason at all for anybody in the Eurogroup to be drawing broader lessons from Cyprus at this point. The market can speculate about the Cypriot precedent all it likes; it behooves no politician to to be clear about what they think it means, least of all the Eurogroup president. Maybe, in a few months’ time, when the Cyprus chaos has died down, the EU could start putting out extremely long and dry papers about what has been learned from Cyprus, along with a detailed look at the costs and benefits of letting banks fail rather than bailing them out. But if you’re making policy on the fly in Cyprus, the last thing you want to do is turn that cobbled-together precedent into something semi-binding on the rest of the continent — whatever the policy might be.

Still, the toothpaste is out of the tube now, and the traders selling off bank shares were acting entirely rationally. The chances of European banks being allowed to fail are higher now than they were pre-Cyprus. As a result, we should expect uninsured deposits to continue to flow from the periphery of Europe towards the center. Which in turn means extra pressure on Italian and Spanish banks, just when it’s least needed. [my emphasis in bold]
Cyprus has decided to keep the banks closed until Thursday now due to concern over bank runs. (Angst vor Run auf Einlagen: Zypern schließt Banken bis Donnerstag 25.03.2013)

Varoufakis thinks the endgame is about to come into view:

However, the ugliest dimension that the new deal has introduced is the effective end of any hopes of a genuine Eurozone-wide banking union. Mr Dijsselbloem, the new Eurogroup head who seems terribly keen to be more amenable to German thinking than his predecessor, Mr Yuncker ever was, said so in no uncertain terms when rejoicing that the Cyprus deal paves the ground for new bailout arrangements such that the European Union “…will never need to even consider direct recapitalisation” of failing banks. This constitutes the death knell of both the direct recapitalisation agreement reached last in the EU’s June 2012 summit and, naturally, of any meaningful banking union. The message is thus clear: Each to his or her own! All plans to use the ESM in order to de-couple the banking from the public debt crisis are off the table.

The combination of (a) the denial of the need to effect public debt consolidation, (b) the derailing of a meaningful banking union and (c) the heavy-handedness with which Cyprus was treated over the past week, spell a new, uglier, state of affairs in Europe. Up to now, supporters of austerity and of the German approach to the Eurozone Crisis in the deficit countries (including France) have argued that we need to go along with Berlin and Frankfurt so as to inspire sufficient confidence in those who control the purse strings (in our willingness to ‘do our homework’) before they can yield to the inevitable eurobonds, to the logic of a banking union, to whatever it takes to bring about greater political and economic union.

Alas, the Cyprus deal reveals how wrong this view was: Even though peoples throughout the periphery (in Ireland, in Portugal, even in Greece and Italy) have, however grumpily, bowed their heads to severe austerity and the removal of labour protection laws, the powers that be in Berlin and Frankfurt are shifting away from unifying moves, adopting increasingly authoritarian, divisive policies that are pushing the Eurozone in precisely the opposite direction to that dictated by political and economic sustainability. [my emphasis]

On a related note, there has been a lot of often snarky comment about the role of shady Russian money in Cyprus. Peter Coy surprisingly writes in Europe's Cyprus Crisis Has a Familiar Look Bloomberg Businessweek, "There’s no evidence to support German parliamentarians’ allegations that Cyprus is a haven for tax evaders. In January even Russian tax authorities gave Cyprus a clean bill of health."

I'm not sure how reassuring the Russian tax authorities' public position is on that topic, though. Misha Glenny gives this background on the Russian financial presence there in "Russian cash in Cyprus is no mere financial problem" (also titled: Russian cash carries wider risk in Cyprus) Financial Times 03/25/2013:

The origin of Russia's vast investment in Cyprus lies in the 1990s, a period known for "gangster capitalism". Fearing a restoration of an authoritarian regime, the oligarchs who were seizing state assets in the fire sale of the century sought to place their money in tax havens and money laundering centres around the world.

Up to $300bn, often in cash or gold taken from the state vaults and packed into suitcases, made its way out of Russia in the first decade after the demise of the Soviet Union. Switzerland, the City of London and Wall Street all received their fair share of this windfall.

But the most visible Russian presence was to be found in and around the Middle East. Dubai and Israel were both cherished, the former for commercial reasons, the latter on cultural grounds. In relative terms, however, Cyprus was by far the most popular. It had everything the Moscow elite loved - Mediterranean sun, tax-haven status and a deeply incurious police force. The attraction of Cyprus's Eastern Orthodox culture was also important. Most Russians were welcomed with open arms by Cypriots as co-confessionals and generous investors.

Equally important but less well known was a considerable clandestine KGB presence on the island during the cold war. From here, Moscow would monitor events in the Middle East. When the oligarchs and crime syndicates started gutting the Russian economy, the remnants of that intelligence network was vital in turning Cyprus into the world's largest laundry for dubious money.
And he reminds us that the sensational aspects of Cyprus' image shouldn't distract us from some of the real geopolitical implications of Russia's role there:

But while the popular image of Russians in Cyprus is about bling and gangsters, the money from Moscow also plays a strategic role. The discovery of gas reserves in Cypriot waters, combined with civil war in Syria, has implications for Russia's regional policy . Moscow is concerned about the impact of the gas on the markets for its own output. That is why it has floated the idea of exchanging debt for partial control over Cyprus's gas. Likewise, Russia is contemplating losing its strategic foothold in Tartus, Syria's naval base, if the regime of Bashar al-Assad falls.

And, in the long run, these considerations are more important in Moscow's calculations when responding to the current crisis than the lifestyle of its rich and famous on a Mediterranean island.
To sum up the state of play on the Cyprus deal and the continuing euro crisis, let's all give a big "Heck of a job, Angie!" to German Chancellor Angela "Frau Fritz" Merkel.

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