Saturday, March 16, 2013
The title of this post comes from an excellent book TMM would recommend to anyone interested in the rather large historical geopolitical importance of the tiny island of Cyprus. And in TMM's minds, this morning's announcement from the Troika merits a new chapter for this book. For once again, the people of Cyprus have been truly stitched up by foreign powers. TMM issue a passionate plea to the government & peoples of Cyprus to "JUST SAY NO" to this utterly idiotic, stupid idea of haircutting depositors between 6.75% & 9.9% of their money.
TMM believe that this is the worst policy action that European policymakers have come up with to date in this crisis. It simply must be stopped before the upfront wealth hit exacerbates Cyprus' already severe recession as households slash spending in order to repair the hit to their balance sheets (colloquially known as "theft") from this action.
Whenever this policy has been attempted (in Asia in 1997/8, and in Germany in 1919-25) is has failed, either by eventually not being implemented (in the former case), or in total economic catastrophe (in the latter). TMM do not believe the example of the early/mid-1990s in Italy counts here, as it was both negligible (at just 0.6%) and also accompanied by a large devaluation which cushioned the blow and restored competiveness. This is clearly not the case for Cyprus: it is taking the upfront wealth hit that a devaluation would incur, but not gaining any competitiveness as exports become cheaper. This is a clear economic failing in this plan, and will merely result in more of the same as the recession deepens, forcing government debt higher. Reportedly, the Cypriot team were forced into this as the IMF & Germany threatened a haircut of 40%, as would occur in a Euro exit. TMM don't believe this threat: the Troika know just as well as the rest of us that a Euro exit of ANY country brings the Euro down through contagion.
This also fails to consider that many Cypriots have external assets as well, which would provide some cushion in a Euro exit (though TMM are not advocating such a drastic action). TMM believe that Cyprus is about to experience capital flight of a degree not seen by a country since the Emerging Markets crises of the 1990s. The confiscated portion of deposits is being frozen, but now there is no reason why households would wish to hold very much capital in the country - if they can steal from you once, they can steal from you again. And one thing TMM has learned over the years is that you *cannot stop domestic currency outflows*. The Troika have just shouted "FIRE!" in a crowded room: money held in Eurozone banks is not safe, even if it is below the insured limit (more on this below).
Now, onto the implications of this policy action, which TMM believe are far reaching. The Europeans are obviously using the old "this is a one off" line, and a precedent is not being set, but the market, media and population are getting more used to this now. The general approach is to make the borrowers pay in order that French & German banks don't have to take losses. In this respect, TMM cannot understand why bank bondholders have not been restructured. This position is not sustainable, and TMM believe the Cypriot parliament will force this (again, more below). This is a clear repudiation of the legal precedent for creditor hierarchy: *insured deposits sit at the top of the creditor structure* (with only employee salaries & a couple of other minor things higher). The Troika have unilaterally torn up the rule book on this. While attempting to label this as a "tax", it is a clear manipulation of the law, and TMM expect lawsuits both against the banks & government, as well as in the European Court of Human Rights.
More importantly, *de facto, there is no longer a deposit protection scheme in the Eurozone*. This, in TMM's view, will lead the capital flight out of Cyprus to spill-over as contagion to the rest of the iPIGS, with nervous households seeing the news from Cyprus that their money is *NOT* safe in a Eurozone bank. The Troikia & government are trying to put a spin on the move that the money will be exchanged for bank equity, but this just seems to us like smoke & mirrors to try and make this look less like theft- Cypriot bank equity is worthless given its deposit base is about to leave the country.
One idea TMM have had is whether the depositors (as senior creditors of Cyprus' banks) can form a creditor committee to seize the banks (which are demonstrably insolvent) and put them into administration. Such a move would provide protection under bankruptcy law for the banks' assets (including from the tax authorities), and may well result in a greater return to depositors than under the haircut scenario.
TMM strongly urge Cyprus to say "NO!" to the Troika. This is a truly awful deal that will merely serve to seriously exacerbate the recession, spark massive capital flight from Cyprus & probably spark contagion elsewhere in the Eurozone. Of course there are losses that have to be taken, and a tab to be paid. But this is NOT the way to do it.
TMM believe Cyprus instead should default on its external debt, place its banks in administration (and threaten to restructure their repurchase agreements with the ECB unless the Troika ease off), negotiate a loan extension/reduction with the Russian. Or at least go back to the Troika and threaten to the above. The solution the Troika have imposed entails a good portion of the pain that a Euro exit would involve, but without the positive impact a devaluation would provide in terms of competitiveness gains. Given the circumstances, radical actions are required. Cyprus should not allow the Troika to impose a reparation-like punishment on its citizens for the crime of its banks (with the reported encouragement of the Central Bank of Cyprus [i.e. - the ECB]) in buying Greek Government Bonds. Given depositors in Cyprus have not exactly been able to move their deposits to foreign banks over the past 8 years (lack of banking competition), it is hardly fair to argue that depositors, as lenders to Cyprus' banks, should have known better. So much for consumer protection and in particular the insured deposit limit. The fact that this is occuring without bank bondholders being hit is a complete affront to the rule of creditor preference in law and a CLEAR example of the Germans & French applying one law for themselves and another one for everyone else.
The clear conclusions to TMM are that the Troika have gone too far, and Eurozone deposit insurance is now worthless. The Troika have let the cat out of the bag, and TMM do not think it likely that this will eventually be implemented as it is likely to result in protests, serious rioting, and possible assassinations (given the alleged involvement of the Russian mafia). The market reaction to this is likely to be rather bad.
[TMM apologise for ranting.]