I just spent about an hour (feels like 24!) gauging the reaction to the ongoing Nicosian Nightmare. I kept looking for loopholes, errors in information, hints of any rationale beyond what is naturally obvious. And for the life of me, I can't seem to find much.
Back in 1991, during India's BOP crisis, Singh quoted Hugo in saying that nothing on earth could stop an idea whose time is/has come.
Now apply the same logic here but imagine if it's a stupid one.
The idea here, is the "upfront one-off stability levy" where one can clearly see four words out of which three are misnomers.
You see, there doesn't seem to be much "upfront" about this. If you're an investor holding Cypriot debt, nothing happens to your holdings (for the time being anyway!). On the other hand, if your money is in an account, you're going to lose some of it. How much? What do you get in return? Ah, there's the little grey area.
If you've got more than 100,000 euros, you take a 9.9% hit. Why? Because double digit numbers are far scarier! I'm not sure whether this percentage is on residual amounts or the entire account but I'm also not sure it matter that much relatively. More importantly, there doesn't seem to be a floor on these holdings. So if I'm a homeless person with 100 euros in my account (or whatever the minimum is!), I'm going to lose 6.7% when the bank reopens. If that's progressive, then I'm the Queen.
I think I digressed a little there but it's hard not to, so bear with me.
The one-off part is tricky. I was under the impression that the Greek bailout was unique and "one-off". And Ireland too. And Portugal. And even Spain's shoring up of its banking sector. To this, I can only pessimistically state that things are only one-off till they happen again. Personally, I wouldn't trust someone again if they did it once.
Stability? Boring. It seems like Cyprus's main concern wasn't to protect its smaller depositors but rather ensure that it's bloated banking sector plush with a lot of Russian money didn't suffer too much and cause panic among the big fish. That corporate tax rate increase of 2.5% seems more geared at maintaining competitiveness - which is another way of also saying that they'd rather not lose the offshore safe-haven status that they've had all this while.
And while I'm at it, even levy seems like a misnomer! After all, what's wrong with "upfront one-off stability confiscation?". Is this a tax? Is it a haircut? Legally? Practically? Questions, questions and more questions...
To be sure, if you're a resident of Cyprus you're not getting nothing in return. For that percentage, depositors will receive banking shares equivalent to the amount levied. Then again, I'm not sure how much comfort that is. My money is liquid, I can withdraw it anytime. I can't do that with shares.
More importantly (other than this liquidity boo-boo), what exactly is the real value of my shares? What the government deems them to be? Nope. What I'll be able to sell them at when I can. Sorry, but I'm not taking this cash-to-equity deal if I have a choice.
Now that my rant seems to be over, I could think logically and explore other reactions. Cotterill over at Alphaville makes a similar point in a more human way - namely that the absence of a floor is puzzling. Essentially, a Russian oligarch (non-resident) has the same protection (or lack of it!) as a Cypriot widow! As logic dictates, the only rationale for this is that somewhere lies the interest in the maintenance of Cyprus as an offshore banking centre.
He also makes the point (after unsuccessfully playing a bit of devil's advocate), that we mustn't forget that there's no lack of preparation anywhere. This was done over a bank holiday weekend. In addition, the deposit for equity swap only complicated things further given that Cypriot banks have recapitalization issues and would seem to be highly inequitable, if you could call it that.
The underlying point though, is that small deposits are almost sacrosanct. Insured deposits are almost like moral bonds. They're insured for a reason. The math is inexact but could the 6.7% on <100,000 deposits have been raised by levying the uninsured more? At the cost of a double digit levy? If that was the case, would there be even more panic on the bigger deposits leading to large chunks of capital flight? It's a bit tricky if you think through it.
The most important thing though, and I can't stress this enough even though it's also the most reactively logical worry - is the very real possibility of contagion. If my money lies in Spain or Portugal etc. why shouldn't I move it out? It's not that easy for one. There are limits on withdrawals, restrictions on transfers and a lack of immediate ease in opening new accounts etc. But does that mean I won't try?
From the perspective of a Cypriot depositor (resident or non-resident), if you've levied my savings, you've broken my trust. One-off or not, the bond is forever broken. The question is, what comes next?
One Goldman analyst seems to think a bit differently - that while a deal like this could easily lead to short-term volatility, the fall-out is likely to be contained, assuming a ratification in parliament this week (not a gimme, by any means!)
The biggest worry of how other depositors in the EU periphery will react can be tempered by the ECB waiting on the sidelines, ready to combat signs of deposit flight using the ELA and other ad hoc measures. Another important point that he makes is that private creditors being asked to share more of the restructuring burden seems to be a "natural continuation of a trend developing on the euro banks bailouts front".
To be clear, it's self-evident why the push for deposit haircuts took place. From the IMF's vantage point, having the government on hook for the entire bailout amount would have caused a debt-GDP ratio of about 145%, a level and trajectory dynamic deemed unsustainable and essentially removing the Fund from loan contributions. For clarity, the math here is easy - the government needed about 17 billion euros (about the size of the Cyprus economy) but they could only get 10 so the difference was accounted for through the UOOSL (you-sill! - how cool does that sound?)
Meanwhile, while it's true that politicians rarely say what's on their mind, Finance minister Michalis Sarris's statement has an undercurrent of poignancy, guilt and something else I can't quite put my finger on. He said, "I am not happy with this outcome in the sense that I wish I was not the minister that had to do this, but I feel that responsible course...general welfare...stability of system...blah blah..."
He also said that the government had (naturally!) moved to ensure deposit holders could not make large withdrawals electronically before the opening on Tuesday. The perfect ambush it would seem! Furthermore, Asmussen (an ECB board member) mentioned monitoring of deposit flows on an intraday (try intra-minute if things get worse!) basis for signs of a bank run but then he justified the measure by basically saying that the burden has been broadened. On whose shoulders?
Funnily enough, he also justifies that going after all large deposit holders (Russians, Britishers) would ensure that outsiders help fund the rescue; conveniently enough, he forgets about there being no floor.
El-Erian plays a bit of advocate too, and states four reasons why influential EU countries (Germany *cough) would have forced Cyprus into this situation. The size of the banking sector, lax regulation/reputation, adverse alternatives, and the issue of moral hazard. But in their own right, these issues are relatively weak and he spends more time instead, castigating not the decision but its construct. He feels that the approach reeks of regressiveness and undermines the powerful concept of a deposit insurance scheme.
The most forthright opinion unsurprisingly, is Munchau's who re-emphasizes the looming and dooming scenario of a run. He makes it clear that this is not a default nor an imposition of loss. Legally, this could be a wealth tax and economically, a haircut. I'm not sure there's anyone who would argue against a depository tax on amounts above 100,000 euros (the insurable ceiling). The point, as made here again, is that it represents a default on an insurance guarantee for bank deposits.
It's easy to understand how it played out up till a certain point. Bailout determined at 17 billion -> Germany rejects loan that they know Cyprus will default on -> turn to depositors -> big deposits wouldn't have sufficed. They key here is the last point. Is it that they wouldn't have sufficed or what it came with adverse consequences?
Rightly so, the after-effects will be colossal because politics will soon enter the fray. One needs to only look across at Italy to see this. Munchau states that it is only rational to expect Cypriot savers to withdraw their money for protection from further possible haircuts. An experience like this only further reinforces the view that the "solvency of a deposit insurance scheme is only as good as that of the state". Italy? Spain? Portugal? Therein lies your answer.
The problem is that a bank run is a horrible spiraling snowball that gathers mass and momentum at astonishing speeds. Munchau ends aptly saying that the euro zone's complacency over the past year might come back to haunt it and most importantly, depositors know and believe that even though Draghi said "whatever it takes", "whatever" it takes could also mean their deposits.
To end, I can't help but attempt to analyze the rationale once again. Was the risk of contagion not clear enough or did it work no matter which path was taken? Why stir the hottest pot in the kitchen when there's more than one alternative? And most shockingly, where were the morals while determining who gets what portion of the whack? Why aren't bondholders being hit?
And because I'm finally sick of questions, the whole point of "sound banking" is the encouragement of deposits. As a Schumpeter column claims, deposits are "sticky" (insured) and "flighty" (can be moved). Impact on the first will trigger the second because the confidence assumption of deposits never running will fail. That's when stuff might hit the ceiling.
As a post-script, might we imagine what happens Tuesday morning when banks reopen? Might we see lines at ATMs (Salmon claims this is already happening)?
The President says that the alternative would have been catastrophic for the banks but he failed to mention the bank-runnin' sword of damocles hanging over their heads now. What he also fails to mention is that his government pledged and promised to guarantee their citizens' money up to a 100,000 euros - even in extreme circumstances.
As of now, that promise is not even worth the paper it was written on. And that to me, says it all.
Back in 1991, during India's BOP crisis, Singh quoted Hugo in saying that nothing on earth could stop an idea whose time is/has come.
Now apply the same logic here but imagine if it's a stupid one.
The idea here, is the "upfront one-off stability levy" where one can clearly see four words out of which three are misnomers.
You see, there doesn't seem to be much "upfront" about this. If you're an investor holding Cypriot debt, nothing happens to your holdings (for the time being anyway!). On the other hand, if your money is in an account, you're going to lose some of it. How much? What do you get in return? Ah, there's the little grey area.
If you've got more than 100,000 euros, you take a 9.9% hit. Why? Because double digit numbers are far scarier! I'm not sure whether this percentage is on residual amounts or the entire account but I'm also not sure it matter that much relatively. More importantly, there doesn't seem to be a floor on these holdings. So if I'm a homeless person with 100 euros in my account (or whatever the minimum is!), I'm going to lose 6.7% when the bank reopens. If that's progressive, then I'm the Queen.
I think I digressed a little there but it's hard not to, so bear with me.
The one-off part is tricky. I was under the impression that the Greek bailout was unique and "one-off". And Ireland too. And Portugal. And even Spain's shoring up of its banking sector. To this, I can only pessimistically state that things are only one-off till they happen again. Personally, I wouldn't trust someone again if they did it once.
Stability? Boring. It seems like Cyprus's main concern wasn't to protect its smaller depositors but rather ensure that it's bloated banking sector plush with a lot of Russian money didn't suffer too much and cause panic among the big fish. That corporate tax rate increase of 2.5% seems more geared at maintaining competitiveness - which is another way of also saying that they'd rather not lose the offshore safe-haven status that they've had all this while.
And while I'm at it, even levy seems like a misnomer! After all, what's wrong with "upfront one-off stability confiscation?". Is this a tax? Is it a haircut? Legally? Practically? Questions, questions and more questions...
To be sure, if you're a resident of Cyprus you're not getting nothing in return. For that percentage, depositors will receive banking shares equivalent to the amount levied. Then again, I'm not sure how much comfort that is. My money is liquid, I can withdraw it anytime. I can't do that with shares.
More importantly (other than this liquidity boo-boo), what exactly is the real value of my shares? What the government deems them to be? Nope. What I'll be able to sell them at when I can. Sorry, but I'm not taking this cash-to-equity deal if I have a choice.
Now that my rant seems to be over, I could think logically and explore other reactions. Cotterill over at Alphaville makes a similar point in a more human way - namely that the absence of a floor is puzzling. Essentially, a Russian oligarch (non-resident) has the same protection (or lack of it!) as a Cypriot widow! As logic dictates, the only rationale for this is that somewhere lies the interest in the maintenance of Cyprus as an offshore banking centre.
He also makes the point (after unsuccessfully playing a bit of devil's advocate), that we mustn't forget that there's no lack of preparation anywhere. This was done over a bank holiday weekend. In addition, the deposit for equity swap only complicated things further given that Cypriot banks have recapitalization issues and would seem to be highly inequitable, if you could call it that.
The underlying point though, is that small deposits are almost sacrosanct. Insured deposits are almost like moral bonds. They're insured for a reason. The math is inexact but could the 6.7% on <100,000 deposits have been raised by levying the uninsured more? At the cost of a double digit levy? If that was the case, would there be even more panic on the bigger deposits leading to large chunks of capital flight? It's a bit tricky if you think through it.
The most important thing though, and I can't stress this enough even though it's also the most reactively logical worry - is the very real possibility of contagion. If my money lies in Spain or Portugal etc. why shouldn't I move it out? It's not that easy for one. There are limits on withdrawals, restrictions on transfers and a lack of immediate ease in opening new accounts etc. But does that mean I won't try?
From the perspective of a Cypriot depositor (resident or non-resident), if you've levied my savings, you've broken my trust. One-off or not, the bond is forever broken. The question is, what comes next?
One Goldman analyst seems to think a bit differently - that while a deal like this could easily lead to short-term volatility, the fall-out is likely to be contained, assuming a ratification in parliament this week (not a gimme, by any means!)
The biggest worry of how other depositors in the EU periphery will react can be tempered by the ECB waiting on the sidelines, ready to combat signs of deposit flight using the ELA and other ad hoc measures. Another important point that he makes is that private creditors being asked to share more of the restructuring burden seems to be a "natural continuation of a trend developing on the euro banks bailouts front".
To be clear, it's self-evident why the push for deposit haircuts took place. From the IMF's vantage point, having the government on hook for the entire bailout amount would have caused a debt-GDP ratio of about 145%, a level and trajectory dynamic deemed unsustainable and essentially removing the Fund from loan contributions. For clarity, the math here is easy - the government needed about 17 billion euros (about the size of the Cyprus economy) but they could only get 10 so the difference was accounted for through the UOOSL (you-sill! - how cool does that sound?)
Meanwhile, while it's true that politicians rarely say what's on their mind, Finance minister Michalis Sarris's statement has an undercurrent of poignancy, guilt and something else I can't quite put my finger on. He said, "I am not happy with this outcome in the sense that I wish I was not the minister that had to do this, but I feel that responsible course...general welfare...stability of system...blah blah..."
He also said that the government had (naturally!) moved to ensure deposit holders could not make large withdrawals electronically before the opening on Tuesday. The perfect ambush it would seem! Furthermore, Asmussen (an ECB board member) mentioned monitoring of deposit flows on an intraday (try intra-minute if things get worse!) basis for signs of a bank run but then he justified the measure by basically saying that the burden has been broadened. On whose shoulders?
Funnily enough, he also justifies that going after all large deposit holders (Russians, Britishers) would ensure that outsiders help fund the rescue; conveniently enough, he forgets about there being no floor.
El-Erian plays a bit of advocate too, and states four reasons why influential EU countries (Germany *cough) would have forced Cyprus into this situation. The size of the banking sector, lax regulation/reputation, adverse alternatives, and the issue of moral hazard. But in their own right, these issues are relatively weak and he spends more time instead, castigating not the decision but its construct. He feels that the approach reeks of regressiveness and undermines the powerful concept of a deposit insurance scheme.
The most forthright opinion unsurprisingly, is Munchau's who re-emphasizes the looming and dooming scenario of a run. He makes it clear that this is not a default nor an imposition of loss. Legally, this could be a wealth tax and economically, a haircut. I'm not sure there's anyone who would argue against a depository tax on amounts above 100,000 euros (the insurable ceiling). The point, as made here again, is that it represents a default on an insurance guarantee for bank deposits.
It's easy to understand how it played out up till a certain point. Bailout determined at 17 billion -> Germany rejects loan that they know Cyprus will default on -> turn to depositors -> big deposits wouldn't have sufficed. They key here is the last point. Is it that they wouldn't have sufficed or what it came with adverse consequences?
Rightly so, the after-effects will be colossal because politics will soon enter the fray. One needs to only look across at Italy to see this. Munchau states that it is only rational to expect Cypriot savers to withdraw their money for protection from further possible haircuts. An experience like this only further reinforces the view that the "solvency of a deposit insurance scheme is only as good as that of the state". Italy? Spain? Portugal? Therein lies your answer.
The problem is that a bank run is a horrible spiraling snowball that gathers mass and momentum at astonishing speeds. Munchau ends aptly saying that the euro zone's complacency over the past year might come back to haunt it and most importantly, depositors know and believe that even though Draghi said "whatever it takes", "whatever" it takes could also mean their deposits.
To end, I can't help but attempt to analyze the rationale once again. Was the risk of contagion not clear enough or did it work no matter which path was taken? Why stir the hottest pot in the kitchen when there's more than one alternative? And most shockingly, where were the morals while determining who gets what portion of the whack? Why aren't bondholders being hit?
And because I'm finally sick of questions, the whole point of "sound banking" is the encouragement of deposits. As a Schumpeter column claims, deposits are "sticky" (insured) and "flighty" (can be moved). Impact on the first will trigger the second because the confidence assumption of deposits never running will fail. That's when stuff might hit the ceiling.
As a post-script, might we imagine what happens Tuesday morning when banks reopen? Might we see lines at ATMs (Salmon claims this is already happening)?
The President says that the alternative would have been catastrophic for the banks but he failed to mention the bank-runnin' sword of damocles hanging over their heads now. What he also fails to mention is that his government pledged and promised to guarantee their citizens' money up to a 100,000 euros - even in extreme circumstances.
As of now, that promise is not even worth the paper it was written on. And that to me, says it all.
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