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?