Tuesday 26 March 2013

Say bye-bye to European bank bail-outs...

No matter what the Eurozone authorities may officially say, the troika's (EU, ECB, IMF) Sunday evening decision on Cyprus is a game changer. It is reasonably save to say that the EU's debt crisis will be solved via private and public debt restructuring followed by bail-ins / debt-to-equity swaps in the European banking sector.

No more, or only very limited, taxpayers' money will be used to recapitalise Eurozone banks. From now on, bank shareholders and debt holders will bear the burden. Welcome back to a proper functioning market economy.

The most relevant bit of the Eurogroup's Sunday statement on Cyprus gives us all the hints we need:


"Following the presentation by the Cyprus authorities of their policy plans, which were broadly
welcomed by the Eurogroup, the following was agreed:

1. Laiki will be resolved immediately - with full contribution of equity shareholders, bond holders and uninsured depositors - based on a decision by the Central Bank of Cyprus, using the newly adopted Bank Resolution Framework.

2. Laiki will be split into a good bank and a bad bank. The bad bank will be run down over time.

3. The good bank will be folded into Bank of Cyprus (BoC), using the Bank Resolution Framework, after having heard the Boards of Directors of BoC and Laiki. It will take 9 bn Euros of ELA with it. Only uninsured deposits in BoC will remain frozen until recapitalisation has been effected, and may subsequently be subject to appropriate conditions.

4. The Governing Council of the ECB will provide liquidity to the BoC in line with applicable rules.

5. BoC will be recapitalised through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders.

6. The conversion will be such that a capital ratio of 9 % is secured by the end of the programme.

7. All insured depositors in all banks will be fully protected in accordance with the relevant EU legislation.

8. The programme money (up to 10bn Euros) will not be used to recapitalise Laiki and Bank of Cyprus."


The Eurogroup's full statement on Cyrpus can be found here:
http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/136487.pdf


For a detailed analysis and explanation of the agreement you don't need me. You just have to go to:
http://ftalphaville.ft.com/2013/03/25/1437052/scratch-one-stupid-idea/?

Saturday 23 March 2013

Cyprus - why not keep it simple?

This is where we stand:
1. The Cypriot government/taxpayer has no resources to bail-out its banking sector
2. The EU authorities/taxpayer don't want to bail-out Cyprus' banking sector
3. Even if 1 and/or 2 were not true, why should the taxpayer - Cypriot or EU - bail-out Cyprus' banks anyway? Because they are systemic for the country? Because without bank recapitalization the country will collapse economically and have to leave the Eurozone? Ok, fair enough.
Then again, isn't there enough capital in the banks' balance sheet to allow for a swift bank recapitalization without the use of taxpayers' money? The answer is: yes, there is. Unsecured debt (bondholders and depositors with more than Eur 100k) is this capital. Unsecured debt holders took freely the decision to invest in bonds issued by the banks and deposit their money at the banks. Unsecured debt holders should therefore accept the responsibility of their actions and bear the burden of banks' recapitalization. They made the decision to become banks' unsecured debt holders. Not the taxpayer. In a democracy, freedom and responsibility go hand in hand. And a market economy cannot work if those making decisions are not held accountable for them.
So, let's keep it simple:
A) Depositors are fully protected to up to Eur 100k in line with the explicit bank deposit guarantee given by the government / taxpayer in the past
B) Shareholders are wiped out
C) Unsecured debt holders become the banks' new shareholders via debt-to-equity swaps: an approximately 15% levy is raised on bank deposits above Eur 100k and this amount - after any necessary haircuts following asset write-downs - is then swapped for newly issued bank shares
As a result:
i. Banks are recapitalized without the use of taxpayers money
ii. Small depositors are fully protected
iii. The large depositors become the new banks' shareholders. They appoint a new management team and over time recoup from the short-term losses they suffer as the economy recovers and banks' share prices rise. 
On top of it, by converting into shareholders they also become stakeholders in the country's economy as only a good economic performance will lead to rising share prices. 
Capital flight? Possibly in the immediate aftermath of the debt-to-equity swaps. But once it is clear that the recapitalized banking system is sound and stable - and as shareholders the (former) large depositors will know this better than anyone else - some of the deposits will possibly return to Cyprus.
And if not, who cares? Cyprus' banking sector, once recapitalized, will have access to market and ECB finance again. Problem solved. Cyprus' citizens will be able to sleep well and carry on with their lives. Again.

Finally, it is certainly true that a democracy is the freedom to chose among alternatives.  However, the alternatives among which to choose must be feasible ones. Choosing the impossible, no matter how desirable, is not an option. 


This begs the question: what is the alternative to a recapitalization of the Cypriot banking system along the lines just mentioned? It is a disorderly insolvency of Cyprus' banking system, the country losing access to international financing, being forced to drop out of the Eurozone and the re-introduction of the Cypriot pound as national currency. The Cypriot pound would then unavoidably devalue 35% to 50% relative to the Euro.


Choosing a 35% to 50% loss for each and every Cypriot bank depositor can surely not be considered the superior alternative, can it?