In history seemingly innocuous events portend more serious outcomes – albeit we recognize them in hind(e)sight. This is the dramatic irony of history. Just as a single shot in Sarajevo, took out a largely unknown European aristocrat, Archduke Franz Ferdinand, who would have known then that the world would plunge into World War I. The Cypriot savers must have thought the authorities were being highly ironic, of the Socratic kind, when they were told they were receiving a bail-out, except it was a “bail-in”. I don’t know the Greek/Turkish for – you are having a laugh, but I bet that’s what they are saying. So what is a bail-in?
A bail-in takes
place before a bankruptcy, and involves losses being imposed on bondholders,
something that has rarely taken place throughout the GFC and euro crisis. In
fact taxpayers (the government) have consistently bailed-out the private sector
in full. The Cypriot bank rescue is no exception, except this time there is a
bail-in and ironically again not of bondholders but of the depositors first.
This is a direct contravention to the usual legal claims on the capital
structure.
So there you have
it – on Friday 14th March Cyprus became the 5th country
to receive an EU bail-out (in), except this one was a bail-in but one with a
significant and severe twist of fate. The Cypriot government in Nicosia is
scheduled to vote on a EU bail-out plan which calls to extract a “tax” on bank
depositors (savers) some €5.8 billion: 6.75 per cent for anyone with less than
€100,000 in a Cypriot bank account, 9.9 per cent for anyone with more than
that.
This is an
unprecedented assault on individual property rights and every individual in the
developed world should take notice, and far from stabilising the eurozone, the
bail-out likely heightens contagion risk across the EU.
Why bother holding
a bank account when your government can expropriate your savings? Far from
containing a bank run in Cyprus it will exacerbate it, absent capital controls,
and likely begin significant depositor flights across the European periphery.
These events I
believe signify one of the most alarming developments in the Eurozone crisis
and by dint the global economy since the financial crisis began.
Cypriot Disputes
and Levies
For a sovereign
entity so small, Cyprus is a country that has had more than its fair share of
international controversy and disputes. Cyprus has a long and convoluted
history with the British, Turks and Greeks, whose tensions have wreaked havoc
across Europe over two World Wars. This weekend marked yet another period of
disquiet in the history of this troubled island.
Cyprus is reeling
from an oversized and ailing banking system. Technically bankrupt,
domestic banks stand at €126.4 billion in size, or over 7 times the size of the
economy. Without a bail-in, depositors would be wiped out and Cyprus
would undergo economic collapse, bringing along with it all the attendant
social misery and deprivation of a depression.
Ironically Cyprus
is no stranger to levies. The British extracted taxes in the 19th century
to cover the compensation they owed to the Ottoman Sultanate, who had conceded
the island to the British.
In 1878, under the
Cyprus Convention, the Cyprus became a protectorate of the British in a secret
agreement between the United Kingdom and Ottoman Empire. The Greek Cypriots
believed the British would eventually help Cyprus unite with mother Greece,
just as with the other Ionian Islands. The indigenous Cypriots believed it
their natural right to reunite the island with Greece; after all the very first
census showed the population was comprised of 74% Greeks and 24% Turks.
Fast forward half
a century and most of us over the age of 40 refer to the Cyprus dispute as that
of the conflict between the Republic of Cyprus, and Turkey, over
Turkish-occupied North Cyprus. My knowledge of the origins of the Cyprus
dispute is a little sketchy but as I understand it, the dispute originally was
born out of the Cypriots’ desire for self-determination away from the British
Crown, which had unlawfully declared itself the constitutional ruler after
Greece failed to fulfil its WWI obligations to invade Bulgaria; in return the
Republic of Turkey recognized British rule of the island.
Eventually this
colonial dispute became an ethnic one between Greek and Turkish islanders and
their respective mother countries. In 1974 Turkey invaded Northern Cyprus and
declared unilateral independence, as well as itself a sovereign entity – the
Turkish Republic of Northern Cyprus – but has never received UN and
international recognition. There has been a UN no-go zone buffering North and
South ever since.
Another irony of
the day was that in return for the British protectorate the Ottoman Empire
received military support against Russia in Asia. As I will cover later Russia
has been integral to the demise and now the future well-being of Cyprus.
Another legacy dispute that has compounded the Cypriot collapse was their
adherence to Enosis. This refers to ‘the union’,
literally speaking, of the Greek-Cypriot population to incorporate the island
of Cyprus into Greece. Observance of this tradition led the
Cypriot banks to misguidedly purchase vast amounts of Greek sovereign debt
before and during the euro crisis. Cyprus became a casualty of the Greek’s very
own bailout restructuring. Oh the irony again.
Creditor Structure
Bank depositors by
now will have realised that bank deposit guarantees are not worth the paper
they are written on and the legal precedent to label this confiscation of
assets as a ‘stability levy’ or tax has no doubt been framed as such so as to
circumvent EU deposit guarantee law, which this levy clearly violates. This is
stealing – period.
Every saver in
Italy, Spain, Portugal, but not limited to these countries, as it potentially
applies to any saver in northern Europe and the UK, are at risk of a confiscation
of their hard-earned money. We will likely see depositor flight from the
periphery to the supposedly more robust surplus countries – principally
Germany. This is despite the very large outstanding Target2 balances owed
Germany by the periphery, but don’t expect the man in the street to be aware of
this fact. This is unfortunate as some progress was being made in the
reduction of Target2 imbalances as deposits in the periphery showed renewed
signs of growth.
The Troika has run
roughshod over the rule of law. By calling for a universal bail-in
of depositors (the securest part of bank capital ladder) before extracting
money from shareholders, junior and subordinated bondholders, the EU
bureaucrats and IMF have unilaterally ripped up the legal framework for
property rights. This is a truly worrying and frightening progression –
actually regression – in economic freedom.
At Hinde Capital,
we have no issue with uninsured depositors contributing to the
bail-out of a banking system, even as unpalatable and clearly undesirable as
this would seem.
Unfortunately bank
depositors (savers) have long been under the misguided impression that they are
potentially immune from a bank collapse, with the State providing a safety net
in the form of deposit guarantees up to a declared sum. I would argue
that individuals, partly due to government propaganda in the good times, have
long since forgotten – or indeed have never understood – that once you deposit
your money into a bank, you give up your right to ownership, ie, It’s a LOAN!
An asset which is lent out multiple times as is the agreed practice under
fractional reserve banking, clearly has a risk of no return, albeit a seemingly
a low risk when confidence and trust is high in the economic system.
In truth the correct
order of claims on the creditor structure in this ‘bankruptcy’ proceeding has
been largely ignored as the Cypriot banks have such a small sliver of equity
and debt, and have an unusually large depositor base. It is the
involvement of the depositor base that turns this whole debacle into a plot of
immense political intrigue and, indeed, even conspiracy.
Cyprus-sia ‘Tax’
Haven
It has been long
known that Cyprus has held a vast sum of deposits from Russian lenders, and
because of that Russia has been its biggest direct foreign investor. Low
corporate tax rates, sub 10%, were the attraction, with Russians transferring
their money into companies based in Cyprus. Some of this was then reinvested
back in Russia. According to Der Spiegel:
An internal study by the German foreign intelligence agency, the Bundesnachrichtendienst (BND), says banks in Cyprus hold $26 billion (€20.33 billion) in deposits by Russian investors. According to the BND, most of this money has been illegally moved abroad to evade Russian tax authorities. By Cypriot standards it’s a tremendous sum given that the island’s entire annual GDP amounts to €17 billion.
The Cypriot government on Monday denied the money-laundering accusation. A government spokesman said SPIEGEL was trying to besmirch the reputation Cyprus has as an international investment location. The country had effective money-laundering rules and adhered to EU law, the spokesman said.
Indeed, Russians
aren’t the only ones who sought the refuge of this once tax safe-haven, and
consequently other European countries were not keen to be seen to be using
their own tax payers’ money to afford a bail-out for ‘tax dodgers’ and money
laundered in Cypriot banks by Russian KGB, mafia and their own citizens. So you
could call the tax on uninsured depositors actually a levy on money laundering
– call it a 10% haircut for washing your dirty linen. I bet any good money launderer
worth his salt would take that cut.
Conspiracy Talk
The question is
why have the small savers been penalized This is the point in the plan which
makes the EU bureaucrats look so dysfunctional or at best dishonest – I meant
to phrase it that way round. By penalizing small depositors, mostly local
Cypriots, they, as I have stated, undermined the universally agreed
EU depositor guarantee that currently stands at €100,000. The talk is that the
Cypriot government who took a line of credit of some €2.5 billion from Russia
in 2011, and having utilized it fully, wanted to appease the
‘motherland’. So they have agreed not to levy the full tax on deposits
above €100,000. By doing this they hope for further assistance from Russia. I
suspect they will offer support as Russian banks have loaned in excess of $40
billion to Cypriot companies of Russian origin (according to financial
reports).
The Private Sector
Initiative (PSI) on depositors is a victory for the ‘northern league’ of
Europe, for now at least. With a German election year in full swing
Merkel needed to satiate German taxpayers by no longer exposing their euros to
the profligacy of the periphery. Yes, a victory in round one for Merkel and the
CDU, but ‘ding ding’, here comes round two: I bet the Cypriots pull a few
punches by pushing back on the levy on small depositors. ‘Ding, ding’ – round 3
– I say Merkel gets knocked off her feet as depositors flee the periphery and
then (eventually) Mario has to step in and decide whether to cite ‘irreversibility’
status as a clause to stem a banking sector collapse in Europe, and provide
unlimited monetary support, but without the conditionality clause of austerity.
I say‘eventually’ as Mario had repeatedly slapped the EU finance
ministers, and Schauble particularly, for advocating a haircut on bank
deposits. So he could really make Germany sweat by holding back on a re-load of
its big bazookas’ – long-term LTROs and OMTs.
In the interim the
national central bank (NCB), in this case Cyprus is no doubt utilising the ELA
(Emergency Liquidity Assistance) to supply the Cypriot banks with sufficient
funds to remain liquid in the event of insolvency and failure. This is at
the risk of the NCB concerned and outside the ECB’s refinancing operational
framework. It is completely opaque and in truth it will appear as a
Target 2 ledger or on the ECB asset side as ‘Other assets’.
For now the
Cypriot banks are now on holiday, forcibly closed for business until at least
Thursday at time of writing, so depositors cannot withdraw their money.
Likewise, ATMs have been deactivated and electronic wire transfers suspended.
They will be opened once the Cypriot parliament has ratified (or not) the
deposit levy and other terms of the bail-in. It could well be that the terms
change yet to protect small savers as they should have been all along. Either
way, the psychological damage has been exacted across European populations.
Contagion Risk
Those who think
there is little risk of a levy being imposed on other periphery members are missing
the point. The seeds of doubt have been planted. As a saver facing zero yields
on deposits and a potential haircut, why keep your savings in a bank? Sure it
is convenient for electronic transactions, but individuals can adapt easily. As
one of my more amusing colleagues put it, “mattresses now hold a 10 per cent
premium”.
Talk of
‘exceptional’ circumstances and a ‘one-off’ are true but only because Germany
and the Troika would never succeed in enforcing such illegal measures on Italy
and Spain without risking social unrest and a collapse of the euro. The
Cypriots have more leverage than they realise. The Russians don’t need a
failure as it could mean Russian bank risk. Moreover, Target 2 imbalances
likely ensure that the ECB would not cut off the ELA and risk a euro currency
break-up.
Conclusion
What this should
reaffirm to you all is how the handling of the crisis has only succeeded in
heightening the risks associated with this current monetary order. The
excessive amounts of debt have continued to grow and are clearly not
sustainable. Policymakers have resorted to draconian methods of expropriating
private sector assets (households, pension funds and corporate, either by
excessive explicit ‘taxation’ and/or stealth taxation administered by a policy
of negative real rates to help reduce the fixed real burden of debts.
It also reinforces
our long-held views that when push comes to shove policymakers (the State) will
escalate oppressive tactics against their electorate in a bid to maintain their
status quo and that of their fiat currency system.
Of most importance
is the adherence to retrospective changes of law and different rules for
different people and countries. Insolvencies are generally well-defined in law.
First equity, then subordinated debt, then deposits and senior bonds together,
take the hit in that order. The creditor structure has been up-ended and
more than merely tweaked over the last few years. I suspect with levels
of ignorance high amongst populations they haven’t quite woken up to the
reality that the state is not in fact here for your protection as it once was
and that we all need to take on self-reliance and a heightened sense of
responsibility for ourselves. Some notable rule changes of late are subtle but
growing in number:
1.
The ECB, holders of Athens-law and foreign law Greek
debt all received different treatment
2.
The Dutch didn’t restructure SNS Reaal paper,
they confiscated it
3.
The Irish banned lawsuits against the ultimate
wind-down of Anglo Irish
4.
Portuguese
private pensions were confiscated
The list is long
but you get the idea. Rule-changes are getting ‘regressively’ more
creative and sinister. As a friend pointed out to me this as if the
“football referee has gone from being a quasi-neutral arbiter, to pulling off
his black shirt to reveal a Manchester United one underneath and awarding
himself a series of penalties.”
The bail-out
should have been a legal bail-in whereby equity is wiped out, and all bank debt
is written down. Then unsecured (uninsured) depositors ie above €100,000 should
have taken a double digit hit. By doing this EU finance ministers and lawmakers
would have been respecting the creditor hierarchy while adhering and honouring
the rule of law. The retrospective change of law is what should alarm us all.
The insidious and subtle nature of this encroachment on our civil rights sets
an ominous precedent and those who glibly mock libertarians for their ‘rants’
are no doubt those same people who thought PIIGS really do fly.
The bail-in
announcement for the Cypriot banks late Friday night was one of those events
when we all look back and think that was the beginning of the end of the real
global financial crisis. This should leave any individual in Europe under no
illusion that the political elite will enact whatever it deems fit to protect
their positions in the name of the euro and their own positions of power.
It is very clear
that markets and investors underestimate the reality that debt restructurings
are very necessary but won’t necessarily be enacted which leaves only more
private sector wealth transfers (confiscation) and likely circumvention of the
underlying problem of sovereign insolvency by central bank deficit financing.
So much for EMU
solidarity…comrades.
No comments:
Post a Comment