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A stupid idea whose time had come

Friday 29 March 2013

Joseph Cotterill | Mar 16 18:37

Part of the A Cypriot Precedent series

A “one-off” often isn’t. Calling something after “stability” isn’t very stable. Saying that something is not a precedent usually makes it one. Presenting the Cyprus bailout’s “upfront one-off stability levy” for depositors in Cypriot banks:

It is a levy of 9.9 per cent on deposits above €100k, but also of 6.7 per cent on those holding amounts below €100k down to zero. The move by the Eurogroup will also hit resident and nonresident depositors alike. We see no sign of a floor to protect the savings of the average Limassol widow or Larnaca house-buyer. Carsten Schneider, a German politician of the SPD, hooted this month about burning “Russian black money”. Rather less about the little people. What a socialist.

Still, note that it is what it is: a tax, not a haircut or a sign of banks blowing up. That’s the whole point.

OK, you’d best start off by reading Pawelmorski, really. Meanwhile our headline comes from Karl Whelan. As for myself, I’m actually quite shocked that they’ve gone ahead and levied the depositors below the €100k level. And I thought I was jaded about a) the malleability of domestic law for eurozone states to carry out things like this b) the sheer scale of the problem, and the lack of easy options, for financing Cyprus’ bank rescue.

The spin that this is about spanking money-launderers is rubbish. The 9.9 per cent levy will be the cost of doing business for the average CIS corporate shell, as Pawelmorski notes. More to the point, someone clearly balked at increasing the rate above 10 per cent for big-ticket depositors — because why else distribute pain to small holders to make up for it. Someone has an eye on Cyprus somehow maintaining a future as an offshore banking centre.

Still, should we really be shocked? Some points for the defence. (Please note I’m being partly devil’s advocate)

It’s a tax. People generally expect to be taxed on their wealth. It could fall on consumption or income, for example. This time (unusually) it’s on deposits and a one-off (they say) but there’s a principle underneath. Deposits are not stores of value. While the government might make you safe (to a degree) from your counter-party risk lending to a bank, it will not make you safe from applicable fiscal laws.

At the same time, households always bear the brunt of eurozone bailouts and the conditions that come with them. Cyprus will be raising corporate tax rates as part of its bailout deal. There will be other deep cuts. The statement from last night totted up a consolidation of 4.5 per cent of GDP. It’s not as if Cyprus is going out to people and saying sorry, we can’t honour what you’re owed under the depositor guarantee scheme. The levy is parallel to the government’s obligations there. Securing the official loans on Friday night if anything made the looming risks of holding a deposit in a Cypriot bank fade away. These were the counter-party risk, and also redenomination risk, assuming the alternative to a bailout was Cyprus leaving the euro. More on this in a bit. But then this is undermined a bit by the fact that the authorities clearly came prepared for a shock. Doing this over a bank holiday weekend. Having “contingency plans”. Incidentally note the line that “the Eurogroup welcomes that an agreement could be reached on the Greek branches of the Cypriot banks”– if there was any shock that would ensure Greece took responsibility for the Greek units, this could be it. In Britain, the requisite moves had been ordered some time ago.

So now for the offence. Or at the least, some background that I think is important.

1) This is a bail-in. Depositors will get shares in the banks after being levied. Does that mean cash isn’t being taken outside the banks directly (as Lorcan noted on Twitter)? Slightly complicated for a tax. The deposit-for-equity swap’s especially surreal given that Cypriot bank recap needs are pretty inequitable (so to speak). Laiki needs everything it could get for instance. Others less so. And yet this levy applies across all banks. Bail-ins are fine: the Eurogroup statement also confirmed banks’ junior bondholders will be burned. Bailing-in like this? A little weird.

Maybe this is a reason to contrast the levy with one of the analogies that’s been floating around in support of it — the Italian government’s one-off tax of bank and postal service deposits in 1992. Italy did that as part of a big fiscal house-clearing. The safety of Italian banks wasn’t an issue. (It was also pre-EMU; Italy was leaving ERM at the time.)

2) Cypriot banks don’t have senior unsecured debt. As in seriously, barely any paper to rub together. An illustration of this comes from the balance sheet of Laiki bank (chart via Exotix): Cliquez ici avec le bouton droit pour télécharger les images. Pour protéger la confidentialité, Outlook a empêché le téléchargement automatique de cette image à partir d’Internet. You can see how much more the bank funded its business with plain old deposits. Actually, you should expect the numbers up there to have gone down since they were captured in September, ironically in part because of eurozone officials’ constant off-the-record musings in recent months about burning deposits as a fix for the Cyprus bailout. Serious geniuses, these eurozone officials.

3) The role of emergency liquidity assistance. This is pretty much a continuation of point 2). You can see in Laiki’s balance sheet some €10bn of “central/other banks”. As of January, the Cypriot central bank was extending around €9bn of secret liquidity in return for collateral no longer accepted at normal ECB liquidity ops. Much of it (it’s naturally difficult to determine how much) was probably going to Laiki. This is a dangerously high amount relative to both the size of the Cypriot economy and, quite likely, the size of the ECB board’s comfort zone with allowing national central banks to extend ELA for long periods.

You have to know this stuff about the ELA, firstly because it shows the kind of risk that was on the table for depositors in any case, and also (I guess) why a ‘tax’ has been used rather than something scarier like a direct haircut. Anyway, will this ELA be going up or down now? That might be a good question.

4) The great escape of the sovereign bondholders. This is what I find stunning. If you were in the June 2013 foreign-law paper issued by Cyprus, then frankly well done you. I recall being laughed at and criticised for the suggestion that the eurozone might (while there was still time) like to consider offering foreign holders of Cypriot government debt to reduce their claims. Something more equitable than going to taxpayers once again, basically.

As Lee Buchheit, Mitu Gulati and Ignacio Tirado put it in their paper at the time: Why? If official sector negotiators have learned to steel their hearts against the pleas of the old age pensioners, the unemployed, the homeless, the sick, the blind and the lame in bailout recipient countries, why should they show such solicitude for the country’s creditors? Why, to put the question in a lurid way, should the official sector insist that cancer patients in the recipient country forego their medicine in the interests of salutary “fiscal adjustment” but simultaneously recoil at visiting some discomfort on a hedge fund manager in Greenwich, Connecticut who holds the country’s debt obligations?

Well, the critics were right. Nothing like it came out of last night’s 10-hour negotiations.

As it is, there were lots of good reasons why a sovereign debt restructuring did not happen. I don’t want to downplay them. Notably, the fact that the bonds that were best to restructure were governed under English law, and were likely held by the kind of investor who’s willing to litigate. I listed the problems here. Around it all was the inability to get write-downs out of Cypriot domestic-law sovereign debt, because that was held by the banks which already bore big black holes in their balance sheets. Again we come up to something that could be raised in the defence of the deposit levy — local exposure was so great everywhere, that any distribution of losses would have been painful. For the widow depositor, substitute the pension fund holding local-law bonds.

(Could local holders have been corralled into extending the maturity of their debt? We’ll never know now, I suspect.)

Quite simply time had also run out to restructure the foreign-law paper. While there was only so much of the bill that foreign-law bondholders could share anyway — after the maturity of bonds in June, it would have become uneconomic. That means it really became uneconomic at the start of March, because that’s how long it likely would have taken to do the standard process for getting bondholders to swap into depleted claims on the sovereign. It includes contacting creditors, drawing up lawyers, making regulatory filings, and so on. This typically takes around three months.

Of course, theoretically, Cyprus could have been given a nod and a wink to carry on all the way into June and then suddenly announce a ‘hard’ payments default. You then really get into trade-offs there — would Cyprus want to be regarded as that kind of sovereign? Would it be good for it as a banking centre? You also have to think how deposits would have reacted in that kind of hard sovereign default.

But then you get to stuff like the lack of equity in this depositor tax. And the fact that Cyprus announced its need for a bailout last June, a long time in which to at least consider the merits of PSI, and where the losses could be absorbed. And I wonder.

I hope Mr Schneider’s happy, anyway.

A Cypriot Precedent series

In the early hours of Saturday 16 March 2013, a deal was reached to ’tax’ both uninsured *and insured* depositors as part of the Cyprus bailout. We cover the consequences.

A stupid idea whose time had come
Beyond financial repression
Teaching a lesson, lesson learned
The stupid idea, and the system
The Cyprus depositor pain-distribution ratio
Delaying the not inevitable [updated]
The Russian angle
More on the Russian angle
Buiter: ’Get in there, Cyprus!’
Snap Alphachat: Cyprus edition
"The Eurogroup continues to be of the view that small depositors should be treated differently..."
Mind the sovereign, too
First they came for the deposits...
What will Russia do?
What did the ECB tell Cyprus?
Political blowback from Cyprus
So, are they stupid?
You say nein, we say oxi [updated]
A Cypriot game of chicken

FT Alphaville

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