By Terry Connelly
It seems that the austerity police of the eurozone – the “troika” comprised of the European Central Bank (ECB), the European Commission and the International Monetary Fund (IMF) – have finally made the Cypriot government an offer it can’t refuse, and a deal has emerged to spare the island the complete collapse of its banking system and ignominious exit from the euro currency.
The idea of taxing the entirety of the Cypriot banks’ deposit base to fund a Cypriot ”bail-in” to cover about $7 billion of the current deficit to creditors while the eurozone and IMF funds about $10 billion was put aside in favor of a drastic direct “haircut” (at a much higher percentage – even up to 40% or more – than the proposed tax) of deposits in the nation’s two largest banks over $100,000 (of which there are many, particularly Russian in origin). These depositors wind up being treated like unsecured bondholders in the second largest bank (Bank Laika) who also will take a haircut not unlike their Greek counterparts a year ago. Meanwhile, Bank Laika itself will effectively be wound up, with its only good assets being transferred to the larger but also very shaky Bank of Cyprus, which barely survived and will be severely downsized (along with its depositors accounts).
A Long Time Coming
Now all this may seem like just desserts for a country that allowed itself (to paraphrase an old description of Monte Carlo) to become a “sunny place for shady deposits” – a combination laundry facility and parking garage for offshore funds fleeing the tax man in their respective counties of origin. The size of these deposits was sufficient to limit the needs of the Cypriot banks for external bondholder funding compared to other such banks around the world. In the end, there weren’t enough of them to haircut to raise the local funds that Germany and other eurozone countries demanded as a price of their continued financial help and the ECB’s emergency liquidity lifeline that until last week had kept the Cypriot Banks open for business.
The origin idea to tax the depositors fell on its face as a result of backlash by those who saw it as a repudiation of eurozone commitments to “insure” deposits at least up to $100,000, made in the earliest days of the eurozone debt crisis and implemented by national governments. The haircut is worse in financial terms for the depositors, but it “saves” the $100,000 red line (although the insurance concept in technical legal terms only applied to shield deposits from the effects of bankruptcy, not the potential for a new form of “wealth tax” – which is hardly a new idea in pan-European taxation circles). Moreover, there is precedent for haircuts in exchange for bailouts – just substitute the word “depositors” for “unsecured bondholders.” Such is the nature of eurozone demands for “private market involvement” as conditions for (German) taxpayer-funded bailouts which the Germans swore off after they “one-offed” it in the case of Greek bondholders; and now have swore back on in the case of Cypriot deposits which exceed the $100K red line – consistency seems no longer a Germanic virtue, except that they consistently label each such action a “one-off”).
But before we break into a chorus of “Don’t Cry for Me, Nicosia,” we need to look beyond the shores of the island state and consider the more global effects of yet another Sunday night deal that avoided another Armageddon Monday for global financial markets.
While bank depositors in Spain, Italy, Portugal, et al may be sleeping a bit easier as the concept of a baseline “deposit insurance” has apparently survived, US hedge fund managers may toss and turn a bit more this week. Many of them have significantly underperformed the US equity market as the first quarter of 2013 draws to a close. The last-minute Cyprus deal will make it harder for them to talk down the market to their level in the critical last week of March by predictions leaked to the markets of the immanent collapse of the euro currency down to parity with the US dollar or worse, the exit of Cyprus from the eurozone and its imminent collapse, the return of a fed-up Germany to the Deutschemark, a run on the banks of Italy and Spain leading to “contagional” runs in the US, etc. They have plenty of “market commentators” (i.e., actual but not necessarily-disclosed short-sellers) to do their bidding on cable TV by predicting the immediate onset of a 5-10% “correction” – and, by the way, why is it only downward moves are so “correct?”
For the past three years, such scare stories about Europe have triggered springtime US market sell-offs ranging to 13%. This year they have been peddling the nonsense that the market, now reaching levels not seen since the peaks of 2007, has “come too far too fast” – but do we really believe that the collective value of US public companies is not worth a dime more than it was five years ago just as the mortgage finance mess was beginning to hit the fan?
And they have been buttressing their case for the coming market meltdown by trumpeting the canard that share trading volume is tepid and downright down - which is true in share count terms, but not in dollar volume terms, because very few companies split their shares anymore when share prices reach triple digits -- think Apple, IBM, Netflix, Amazon, Priceline, Intuitive Surgical, Salesforce.com, Chipotle, to name just some of the high flyers. Indeed, there have also been a rash of reverse splits in the banking and tanker industries. As a result, the average price of public equity shares, at $63.64, is now nearly double what it was five years ago. Of course share trading volume is down, but dollar volume is another matter altogether when you need to spend twice as much to buy the same average share volume! Funny how “market commentators” have such trouble with third grade math!
Imagine the Alternatives
At least for the time being, however, the hedge fund acolytes will not be able to add a Cypriot sky is falling story to their “talk it down” agenda this week. There may be many reasons for the market to “correct,” even before the quarter is out, but let them be reasons based on data and actual corporate performance fundamentals, not just the latest Armageddon story line peddled by those traders who have bet wrong for four consecutive first quarters.
Finally, Cyprus is significant in one more important respect: let those who railed against the TARP forced bank bailouts in the US in 2008 look at the descent of Cyprus into a “pre-modern” cash and barter economy in the days prior to the final deal when all local trust in the banking system evaporated. Imagine a US economy where no merchant would take your credit card, where no contractor would take your check, where the ATM gave out no more than $100 (if anything at all).
Although myriads of candidates across the country railed against TARP in 2012 and promised they would never have voted for it, the Cypriot “weekend without credit” teaches us that the unlikely coalition of George W. Bush, Hank Paulson, Tim Geithner, Ben Bernanke, Nancy Pelosi, Harry Reid and Barack Obama probably did us all a lasting favor!
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.