This is a revised and extended version of a post in The Irish Examiner newspaper Monday 18 March 2013.
At the heart of modern finance is the concept of the Risk Free Rate. That is the rate of return on an asset whose repayment is certain. For many years we have sought this and now we know. The truly riskfree asset is a senior bank bond in a peripheral bank in a country seeking a bailout. We know that from the irish case senior bonds took equality with the deposits in Anglo (except at the very end) and were certainly much more important in the eyes of both governments than mere taxpayers. We now see in Cyprus that these assets are truly special and rank above even deposits. If we were writing an exam in CynicoFinance 101 the questions might be
- In the light of the Cyprus bailout, How does the recent Prom note deal now look?
- Is a financial crisis measure becoming a feature of St. Patricks Day?
- When exactly did wiping common shareholders, junior bondholders and the entire board of directors become a brave and radical thing to do instead of the perfectly normal course of events?
Having sustained deep financial wounds from the first greek bailout, Cyprus needed 17b of a bailout. Its banks were financed mainly by deposits but there were some bonds there….so the logical thing was to first burn these. Instead, and a dangerous precedent, the ECB and ECOFIN (chaired by Michael Noonan, fresh from lading 25b of anglo debt onto the irish taxpayer) decided to haircut depositors. All depositors over 100k were to lose 10%, those under , who had been guaranteed, are to lose 6.75%. Even government guaranteed deposits are hit. We are in uncharted territory here and there be dragons, indeed.
Why did cyprus need a bailout? For one main reason, its banks. They got too large too fast. Despite having ….And so with the linkage between the greek and cypriot economies, as the greek situation went from bad to catastrophe the cypriot banks were holed badly, having extended credit equivalent to over 150% of cypriot GDP to greece. These private sector loans are of course now damaged and the cypriot banks were further weakened by the writedown of greek official sector debt. Cyprus is criticised for having an overly large banking sector and at 7 times its GDP it is to large. Part of the reason it is too large is that cyprus, like another small island we can think of , operates as an offshore financial center. And here we see a rancid whiff of racism and xenophobia.
The meme is “Cyprus is stuffed with hot money from Russia”, and so any hit to the banking sector will show Ivan whos boss (Angela, in case anyone wondered). That this is improbable and that the data suggest that perhaps 7b of the total 70b deposit base of the cypriot banks is held by Russians from russia, some of which may be hot, is irrelevant. Anyhow 7b would hardly get you into oligarch circles nowadays.. But the meme persists . Again German paranoia is driving Europe; Despite a pretty much clean bill of health from the council of europe watchdogs on money laundering german politicians are convinced (by german sources of course) that there is widespread russian money laundering in Cyprus. This is despite there being not a single issue on which Cyprus is noncompliant, from the Council of Europe. Is there Russian hot money in cyprus? Im sure. Is there german hot money in cyprus? Im sure. Hot money goes round the world and all we can do is chase it. But should we sacrifice the small depositors of a small country to make a possibly unfounded point? I think not.
Cypriot banks were seen as safe, and so were attracting large flows from greek and other depositors. The largest growth in non-EU money came from other financial institutions, not households or corporations. But little came from bonds. And so, faced with 90% debt GDP ratios and running fast out of money the cypriots have been asking for a bailout since last June. Despite this it took another 3 am meeting, chaired lest we forget by Michael Noonan, to decide on an extraordinary course of action. A bailout of 17b would have caused a massive spike in the debt/gdp ratio, and there seems still, 5 years after Bear Sterns, to be no willingness in the chancelleries of europe to realise that a union means solidarity. Faced with the requirement to in that case restructure Cyrpiot sovereign debt to make the total sustainable Cyprus’s european partners, ourselves included, instead forced them to raid the savings of the cypriot people. Although the cypriot banks have little senior debt this was, and here we are into alice in wonderland territory, not burned. And this was accompanied by the by now familiar hectoring and bullying, with the threats of the ATMS running out and the ECB cutting off liquidity and who knows what. All reports suggest, frankly, a hegemonic germany run amok and declaring fiscal war on another small state. Shockingly the german position was aided and abetted by several smaller states who in effect ambushed the cypriots and presented them with a fait accompli. That should make everyone worried.
This is dangerous territory, setting a bad precedent. Its unjust and incoherent. It is selfdefeating; brutal realpolitik; a stupid idea…there is nobody lauding this. It is plain dumb. It is a testimony to why we should insist that all EU meetings of ministers take place strictly in business hours. A combination of urea poisoning, blackmail, fatigue and ordoliberal smugness is no way to run a multinational organisation.
This is incoherent stuff. With senior bonds of banks to be eligible to be bailed in (at least in theory) after 2014 the funding base will have to change. European banks are funded by approx €5trillion bonds, €21 trillion deposits and €3trillions capital. They need to increase the reliance on deposits, and this makes them deeply unattractive outside the core. Plus, for all the fine talk on breaking the bank-sovereign link this reinforces it. 3am decisions tend to be incoherent. If this doesnt cause a bank run in cyprus it will be astonishing. Its homerconomics.
Its unjust, in that even the smallest saver in cyprus is forced to participate. Some suggestions are of a proposed revision to make the impact less on the smaller saver but the damage is done. Some Cypriot sources suggest that up to 23% of the total cypriot contribution to their baiout will come from the small saver. But in a europe that is happy to see greek cancer patients suffer on the altar of ordoliberalism I guess the widows mite counts for little. But it should. Europe should not, must not, be (but sadly seems to be) a mere economic abstraction. People matter, even if they arent German. The cypriots seems to have been put in an awful dilemma – cut all, a little or the larger ones more. Cutting the larger ones more would have killed off the cypriot overseas banking area and seriously annoyed the Russians, who have already bailed out Cyprus.
Most of all it is a bad precedent. It is one that should worry any depositor in any eurozone country that is or might be in a bailout. For the first time in modern european history we see the deposits of ordinary savers at risk. While deposits have been lost in extraordinary bank failures, this is new territory. It puts at risk every deposit of every saver in every country now in or facing into a bailout
Jeroen Dijsselbloem, the president of the group of ministers…. declined to rule out taxes on depositors in other countries besides Cyprus in the future, but insisted that such a measure was not being considered. He said the tax would generate 5.8 billion euros.
While Ollie Rhen has said the opposite we must remember the wise words of Jean Claude Junker…
When it becomes serious, you have to lie
While we laud ourselves for having reentered the market, our bond yield is depressed by a flood of cheap money and an attractive carry trade. The fundementals are still shaky and our banks still face large losses from mortgages and there is still a chance they will seek additional funds. Senior bondholders have gone from pari passus with deposits to supersenior claims. So, if a future Irish or Spanish or Italian government seeks some assistance from europe the precedent has been set to seize deposits while saving bondholders. This is crackers even from Europe and is driven simply and solely by domestic german political considerations. Angela Merkel may have destroyed the euro by making it clear that a cypriot euro is 90% of a german one.
We await developments to see how much of a German euro an Irish, or spanish or italian one is. I know where I would be if I was in Cyprus – queuing outside my bank, acting in a totally selfish, personally optimal way. Thats the thing with bank runs – individual rational decisions cascade into deeply economically and socially irrational ones. I dont think we need to start queuing outside AIB or the credit union but if we do ever look like needing a bailout then we should not count on our deposits being safe. And that is a toxic legacy, that shows how powerless we have become in the face of a rampant Germanic economic machine. This will end badly. Trust in a fundamental Set of tenets of modern economic thinking, that guaranteed deposits of small savers are safe, and that deposits are last in the queue for losses, has been exploded for no coherent reason. Trust is the heart of banking and this rips that heart out.