Cyprus and the EU reached a new late-night bailout deal last night that will reduce the chance that Cyprus's financial system and economy will completely implode.
The 10 billion euro deal requires Cyprus to drastically shrink its banking sector, which has grown to 8Xs the size of the country's economy, by unwinding Cyprus' second largest bank, Laiki. In doing so, bondholders and depositors with more than 100,000 euros will take a hair cut.
The new deal is better than the last deal in one key respect -- deposits under 100,000 euros will be protected.
That's very important. Those deposits were ostensibly "insured." To seize them, the way the last bailout deal would have, would have been grossly unfair and would have set a truly alarming precedent.
Now, small depositors in European banks can breathe more easily. At least in this case of gross malpractice on the part of reckless bank managers, their life savings have been preserved by the EU.
"Not hitting the insured deposits is a good thing except they showed they were prepared to do it a week ago" says Lee Buchheit, partner at Cleary Gottlieb Steen & Hamilton and sovereign debt restructuring expert, in the accompanying interview with The Daily Ticker's Aaron Task. "I'm afraid that will not be forgotten by insured depositors wherever they are in the eurozone if the crisis moves forward to another country."
This deals spares Cyprus' largest bank and lender the Bank of Cyprus.
Although deposits under 100,000 euros will be spared, deposits over 100,000 euros will be seized and subjected to an as-yet undetermined haircut--with the confiscated money going to bail out the gambling losses of the aforementioned reckless idiots who run some of Cyprus's banks.
"The Europeans are not putting any money into the bank recapitalization, which means, that as far as I can tell, there is nothing in this deal that could not have been done by the Cypriots last year or the year before," says Buchheit.
This seizure, needless to say, will dampen the enthusiasm of rich depositors for keeping money in banks that get themselves into financial trouble.
And because many, many banks in Europe have gotten themselves into financial trouble, this will create a general state of unease among rich depositors throughout the Eurozone.
And it should wig out some bank lenders, as well.
After all, never before in the history of this global financial crisis has a major banking system allowed depositors to lose money, no matter how reckless and stupid and greedy their bank managers have been. And only rarely have bank lenders--those who hold bank bonds--been asked to pony up.
In this case, however, the depositors will lose money. Perhaps a lot of money. And if there had been big bank debtholders in Cyprus, they probably would have been socked with losses, too.
It's possible that everyone will just laugh off Cyprus, viewing it as an exceptional one-off. After all, the Cyprus banking system was notorious for being the offshore money-laundering arm of many Russian oligarchs, so many folks will likely view this asset seizure as a case of "just desserts."
But this optimistic view of the Cyprus horrorshow overlooks one key fact:
The main reason that Cyprus depositors will lose their cash is because it has become politically difficult (impossible?) for leaders in Germany and other rich European countries to bail out their brethren in the "periphery" without taking many pounds of flesh.
And it is that precedent, in addition to the fate of big depositors in Cyprus, that should spook Europe's big bank depositors and lenders.
If Germany is done bailing out countries and banks without having those countries and banks cover some of the cost, it's not clear why Germany will relent next time Spain, Italy, Greece, and other countries in near-desperately bad financial shape come rushing to the EU with their hands out.
Unlike Cyprus, the banking systems in these countries do have bondholders that can get haircut before the depositors get haircut, but the effect will be the same.
"The one lesson that you can take from the Cypriot experience is: the race goes to the swift," says Buchheit. "And if you get out of Dodge early, you are completely protected. If you stay, and in effect trust the politicians, they not only come after [your money] they lock it up."
And that means, for the first time since the collapse of Lehman Brothers, those who lend their money to banks or keep their money in banks are at risk.
Because the neighborhood loan shark (Germany) is now extracting much more onerous terms.
That's a sobering precedent.
And it will likely cause many people to wonder and worry about where their money is.
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