Time to Play Hardball

Here is the current state of play: (1) Cyprus agreed to break up Laiki (2nd largest bank) into good bank/bad bank structure, imposing huge losses on the uninsured depositors (they have announced 40% but the real number will be 90% plus - in the meantime 100% of these deposits will be frozen for years).   This is right and fair, albeit very harsh locally.

(2) Cyprus agreed to put huge haircut on uninsured depositors of Bank of Cyprus (largest local bank) -- in the 20-25% range.   Hysterical smears in the Western press aside, depositors >100K euros in Bank of Cyprus are primarily local individuals and, more importantly, local businesses (only a single digit % of all Bank of Cyprus deposits are Russian - about 1B euros).

Bank of Cyprus is the main money center bank in Cyprus (Laiki is #2) and at the heart of most commercial utility banking transactions so this will have a large effect on working capital / liquidity of local real-economy businesses.

#1 and #2 above are a major concession for Cyprus, along the lines of our Scenario B here, in that it protects foreign depositors in solvent banks.   It is noble though I think a bit quixotic.   After the burning Cyprus has received, we really should be considering our Scenarios C and Scenarios D to make the debt load bearable.

However, it does not appear that the Troika has any interest in any solution that does not leave Cyprus in the Stone Age, banking-wise.

The current *NEW* ask from the Troika is that Bank of Cyprus assumes the 9B of ELA that Laiki has.   I can not think of any possible reason why it should do that:

(a) Why is it the Bank of Cyprus's problem that the ECB is going to take losses at Laiki?

(b) This would immediately make Bank of Cyprus insolvent, leading to an even larger (60-90%) haircut of Bank of Cyprus uninsured deposits (which are, I repeat, overwhelming local businesses).

Cyprus is already headed to a 25-30% drop in GDP based on our predictions just from:

(1) Reduction of financial services business (45% of GDP, pre-crisis)

(2) Reduction in consumption from confiscation of deposits

(3) General austerity

If Bank of Cyprus is also sent into full resolution, a large majority of the non-financial businesses in Cyprus will never re-open and economy will revert to, I dunno, bartering goat cheese...

If this is what they are pushing Cyprus toward, then Cyprus has nothing left to lose.   It is time to pull the hand grenade in the negotiations, as follows:

1.  Announce a 100% haircut of depositors in the Greek branches of Bank of Cyprus and Laiki.   They are branches of the Cyprus parents, so I believe regulated by the Central Bank of Cyprus, not that of Greece.

This will save 8B euros, which coincidentally be very close to the 7B they have cost the Cyprus people (5B of ELA + 2B of absorbed losses).   It has the virtue of allocating blame where it is due.   Moralizing aside, Cyprus is not bankrupt because Russians may or may not be evading their taxes to the Russian Treasury nor because of local profligacy.  It is bankrupt due to the Troika led PSI and subsequent depression in Greece.

It is time to throw those losses back where they belong, in the hands of Greece and its handlers.

2. Announce pending default on the sovereign debt payment in June (yes, a lot is held by local banks, but not all of it) and on the ELA

3. Large haircuts of non-EU depositors in Cyprus (no offense to anyone, but I think the offshore sector is gone anyway.  If need be, you can always do a side deal later with Russia for some compensation if it is strategically important).

4. Whatever local haircuts and pension plan nationalizations are needed to make up the difference

Is that the end of Troika assistance plan?  Yes.

Does that mean we go to the Pound?  Not sure, have not run the numbers, but there are quite a few tens of billions available in 1-3 to confiscate, so it is just conceivable that, with capital controls, you could squeeze by if the cuts are deep enough.

But whether it is hard default within the Euro or return to the Cyprus Pound, it is hard to imagine this is worse than 90% haircuts of Laiki and BoC large depositors, aka almost every functioning business in Cyprus.   If the Troika is compelled to set Cyprus back several decades, we can at least do it with honor and on our own terms.

And this at least puts some pressure back on Troika to:

(1) Explain despite 2 weeks of assurances that it is a Cyprus-only problem, why there are suddenly depositor haircuts in Greece that either need to be bailed out by Germany (Greece certainly does not have the money) or set a precedent that depositor haircuts can happen anywhere in the  EU

(2) Discover if the irreversability of the euro is real or not.


Posted on March 24, 2013 and filed under Cyprus.