Things in Cyprus: kinda bad. There are better places than here to read about it; I particularly recommend Joseph Cotterill here and here, pseudo-Paweł Morski here and here, Mohammed El-Erian here, the FT’s coverage here and here, the Journal’s round-up of analyst reaction here, etc.

The basic story is that Cyprus’s government and banks are both massively overindebted and need a bailout, and the EU and IMF will provide a €10bn bailout, but they demanded that Cyprus chip in some €7bn, which it has decided to do by means of a tax on deposits in Cypriot banks of 6.75% for up to €100,000 and 9.9% above €100,000. (Is that rate on bigger deposits marginal or absolute? No one knows!) Those numbers are being renegotiated and may end up not being approved by Cyprus’s parliament.

The various reasons to object to this boil down to its violations of absolute priority; the way things are supposed to work is more or less:

  • When a bank goes bad its equity holders lose,
  • If zeroing the equity holders doesn’t cover the losses, then the bondholders lose,
  • If zeroing the bondholders doesn’t cover the losses, then the depositors lose,
  • But even there deposits under €100,000 shouldn’t lose, since they’re government guaranteed under the EU deposit insurance scheme.

In Cyprus sort of the opposite happened: equity holders are being diluted but not confiscated,1 bondholders weren’t touched (there are essentially no bonds),2 and depositors under €100,000 were haircut in order to limit the damage to depositors over €100,000. The reasoning for this is unclear; a leading theory is that softening the blow on over-€100,000 deposits was viewed as necessary to retain Cyprus’s status as a haven for offshore deposits by tax-dodging Russian oligarchs. This is an odd theory; losing 9.9% of their money is no doubt a more pleasant proposition than losing 15% though it’s not what you’d call absolutely pleasant and they don’t seem particularly pleased with it. A competing theory is that Cyprus’s president, who decided on the tax brackets, “only has rich friends.”3

The counterarguments are numerous too and boil down to “it’s the government, it can do what it wants, it can tax, this is a tax, whatever.” Taxes can do whatever they want. There’s a broad sense that this tax is unfair, but fairness is more of a nice-to-have than a must-have in taxation.

I think more and more these days about this great Interfluidity post about complexity in finance:

Financial systems help us overcome a collective action problem. In a world of investment projects whose costs and risks are perfectly transparent, most individuals would be frightened. Real enterprise is very risky. … This is a core problem that finance in general and banks in particular have evolved to solve. A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs.

Like so many good con-men, bankers make themselves believed by persuading each and every investor individually that, although someone might lose if stuff happens, it will be someone else. You’re in on the con. If something goes wrong, each and every investor is assured, there will be a bagholder, but it won’t be you. Bankers assure us of this in a bunch of different ways. First and foremost, they offer an ironclad, moneyback guarantee. You can have your money back any time you want, on demand. At the first hint of a problem, you’ll be able to get out. They tell that to everyone, without blushing at all. Second, they point to all the other people standing in front of you to take the hit if anything goes wrong. It will be the bank shareholders, or it will be the government, or bondholders, the “bank holding company”, the “stabilization fund”, whatever. There are so many deep pockets guaranteeing our bank! There will always be someone out there to take the loss. We’re not sure exactly who, but it will not be you! They tell this to everyone as well. Without blushing.

Once I objected: well, no, complexity in finance is about intensive specifying of rules, not ambiguity. Laying out crystal-clear waterfalls is important. Finance people hate ambiguity; complexity is a way to avoid it.

That seems a little dumb now, no? There are crystal-clear rules about who loses in what order when a bank is insolvent, and who gets their deposits guaranteed, and those rules are … well not violated, technically, this is after all a specific strange form of wealth tax, not a loss imposed on deposits, that would be illegal. But if they’re your deposits it comes to the same thing. The rules exist, but they don’t protect you. Because someone else – here mostly Cyprus government creditors though also big depositors – is being protected at your expense.

You can read in various places speculation and worry about how the Cyprus bail-in might spark bank runs in the rest of peripheral Europe / core Europe / the world / whatever; I don’t especially counsel panic but then all my money is safe at JPMorgan Chase so who am I to say? Markets are off, anyway.

But you could put a positive spin on the precedent. Start with the negative: pseudo-Paweł Morski notes:

The hedge funds win again. A favourite trade for speculators has been Cypriot government debt. And it’s done very nicely. Mayfair sends its thanks. Update: This implies that you’re better off with your money in peripheral government debt than in a bank. That’s a message I personally would be very hesitant to send.

And:

Probably of more lasting importance is the latest bout of rule-changing by the authorities. Debt unwindings are generally well-defined in law. First equity, then sub debt, then deposits and senior bonds together, and all treated equally. Most of these principles have been tweaked over the last few years, but the tweaks are getting steadily more aggressive. … While there’s clearly no point in market participants playing the shocked blushing virgin in the face of a situation where the consequences of following the legally-logical steps are socially unacceptable, the uncertainty generated creates costs too.

That seems right, but does it create benefits too? A series of rescues that respected a single rule of absolute priority, wiping out junior claims while leaving small depositors untouched, would send certain clear messages to people holding those junior claims. A series of rescues that concentrated the pain in only one of government debt (Greece), bank sub debt (Netherlands), or bank deposits (Cyprus), would send a clear message: get out of that asset class.

A series of rescues that inflicts pain in new and surprising ways each time sends ambiguous messages to the effect of “everything might be screwed but you can’t really know that you’ll be the guy who’s screwed.” Selling your peripheral government bonds to put your money in the bank, or taking your money out of the bank to buy bonds, could always turn out to be the wrong choice.4 Add in a dose of reassuring everyone all the time that their claims won’t be touched, right up until they are,5 and you’ve got … something? Maybe not a stable system, but one held in balance by all its conflicting instabilities?

A stupid idea whose time had come and The stupid idea, and the system [FTAV]
Cyprus: A Brutal Lesson in RealPolitik and Cyprus: What Were They Thinking? and some other notes [Paweł Morski]
Cyprus Prepares New Deposit-Tax Proposal [WSJ]
Cyprus Bailout Puts New Pressure on Europe’s Banks [DealBook]

1. Diluted because the depositors are getting shares. I see Bank of Cyprus shares trading at like €0.207 on Friday, for a market cap of ~€372mm, which wouldn’t do much toward raising Cyprus’s €7bn contribution, but still. I also see – as of a 9/30/2012 balance sheet, so whatever – book shareholders’ equity of €2.3bn, so that’s super.

2. Management compensation wasn’t touched … here you can read an article, dated Friday, about how the former CEO (until last July) of the Bank of Cyprus got a €2mm compensation payout this month under threat of litigation. I find this … somewhat hard to believe?

3. Absolute priority as among banks and sovereigns is a trickier matter. Judging by people’s gut reactions it seems like everyone thinks small depositors rank above government bondholders, morally, when the bank-and-sovereign complex is getting bailed in, but I’m not sure there’s much rationale for that.

4. Moving your money to Germany: always the right choice? I dunno, some form of retroactive tax is imaginable there too.

5. In that regard note:

  • Cyprus’s finance minister reassuring depositors by saying about the idea of a deposit haircut, two weeks ago, that “Really and categorically – and this doesn’t only apply in the case of Cyprus but for the world over and the euro zone – there really couldn’t be a more stupid idea,” and
  • “Cyprus is an isolated event” – everybody, today.
60 comments (hidden to protect delicate sensibilities)
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Comments (60)

  1. Posted by Drunk Mick Banker | March 18, 2013 at 9:31 AM

    What the huh? Where's opening bell and why does Matt expect us to be able to make it through this the Monday after St. Paddys?

  2. Posted by Guesti | March 18, 2013 at 9:34 AM

    Matt's inner thoughts?

  3. Posted by Guest | March 18, 2013 at 9:42 AM

    Why did you wait until today to post this, trying to convince us you didn't already have it done before midnight?

  4. Posted by investorcluzo | March 18, 2013 at 9:42 AM

    For the 2014 test we will be adding the following question: please calculate the risk premium on cash deposits.
    -Cyprus CFA Institute

  5. Posted by Guest | March 18, 2013 at 9:44 AM

    Lesson for Cyprus: Next time borrow your money from Spanish and French banks.

  6. Posted by Guest | March 18, 2013 at 9:55 AM

    "Add in a dose of reassuring everyone all the time that their claims won’t be touched, right up until they are,5 and you’ve got … something? Maybe not a stable system, but one held in balance by all its conflicting instabilities?"

    Or a system that people try and get out of at any cost. What requirements do you need to meet to open a bank account in Canada or Hong Kong?

  7. Posted by anonhfm | March 18, 2013 at 9:56 AM

    The absolute right answer for the creditor in the next at-risk country (let's say Slovenia) is unclear, if the choice is between Slovenian bonds, Slovenian bank bonds, or Slovenian bank deposits. But all that means is that the clear right answer is to dump any assets subject to Slovenian law and take your money to, oh, Germany or Switzerland. That won't work out so well for EMU stability.

  8. Posted by VonSloneker | March 18, 2013 at 10:02 AM

    Opa!!! …and they said my business model would never work.

    - Dimitri, CEO, Cyprus Matress & Coffee Can Emporium

  9. Posted by Guest | March 18, 2013 at 10:07 AM

    Lesson for Cyprus: Don't give up your sovereign currency rights ever, ever ever

  10. Posted by where next west man | March 18, 2013 at 10:09 AM

    Problem is the swiss are charging to hold funds too in some sense. they won't allow blind buying of the franc to the extent they can control it, and they are charging at a bank level to hold large deposits in switzerland.

  11. Posted by MLM sales | March 18, 2013 at 10:15 AM

    Life is a pyramid scheme

  12. Posted by PermaGuestII | March 18, 2013 at 10:25 AM

    Withdraw your money in cash (or buy gold), pack it into a briefcase, take the train to Zurich and rent a safe-deposit-box there.

    -Guy who bets there is more than one person standing on the platform at Milano Centrale this afternoon who is doing just that.

  13. Posted by Fewdollarsmore | March 18, 2013 at 10:29 AM

    The real serious problem is that the "market participants are playing the shocked blushing virgin". Here are some tips for traders on how to stop blushing http://www.youtube.com/watch?v=bUjBr20kl20
    1) Relax out if it
    2) Announce it, "Here we go again! I'm going to go red now" (my fav)
    3) Accept it "I am a blusher"
    4) Don't worry about other people's opinions
    5) Retrain your body with self-hypnosis
    6) Remember – no one is perfect

  14. Posted by Fewdollarsmore | March 18, 2013 at 10:46 AM

    …or hire a pimp. He may bring you more business but you lose the right to get f*ked up on your own terms!

  15. Posted by lucas | March 18, 2013 at 10:50 AM

    You can add all peripherals to Slovenia. The result will be a wider the gap between the high and low performers in the Euro zone, further calling into question the feasibility of the Euro, which, ironically, is exactly what the Cyprus bailout was supposed to prevent.

  16. Posted by Think about it | March 18, 2013 at 10:50 AM

    underrated

  17. Posted by lucas | March 18, 2013 at 10:53 AM

    "they won't allow blind buying of the franc " – I don't know what that's supposed to mean. If you want to buy CHF, no one's stopping you. In fact, the SNB will even print more of them until you've had your fill.

  18. Posted by Turkish | March 18, 2013 at 10:56 AM

    Hey France, when was the last time you won a war?

  19. Posted by Great Name Quant | March 18, 2013 at 10:57 AM

    Phew, thanks for the clarification, I was worried this was going to put a crimp in my plans for the Helen Keller European currency opportunities fund.

  20. Posted by Guest | March 18, 2013 at 11:01 AM

    Any specifics? What do they look like, what are they wearing, what color is the briefcase, and how much cash are we talking about.

    - UBS Head of Research

  21. Posted by Guest | March 18, 2013 at 11:03 AM

    1) It would never occur to me, a non-blusher, that uncontrolled blushing might be a plague on some people
    2) Therefore I would never think that a (relatively) well produced Youtube video on how to control a blushing problem would exist.
    3) You seem to have known about the video before this post. I mean really, who would read that sentence and go search for blushing on Youtube?

    So my only conclusion can be that you have a blushing problem.

  22. Posted by guest | March 18, 2013 at 11:05 AM

    You acually really need to go to a cantonalbank. They strongly frown on that sort of thing at the money center physical locations, and will say no to foreigners with briefcases type stuff right away. Mostly because their Swiss clients, won't do biz if that is the perceived environmnet. It helps to have been "referred" by a german speaker who is known to the staff.

    I've actually done this with a side deal I had with a European colleauge. You go to these banks, and they are very clear that these funds will be safe here as they have been for centuries, but you will not be receiving interest of any kind, and there will be an annual fee structure. Moreover you will not be interacting with the account in any conventional sense. No correspondence, nada. They more or less say in not so many words that you must present yourself there with your valid passport and an actual kind of passbook /account number or detailed knowlege of the transaction to ever withdraw the funds.

  23. Posted by Fewdollarsmore | March 18, 2013 at 11:08 AM

    Here we go again! I'm going to go red now.

  24. Posted by lucas | March 18, 2013 at 11:09 AM

    You need an account number/passbook to access a deposit box?

  25. Posted by Frog | March 18, 2013 at 11:17 AM

    You fight zee wars, we bang zee french girls…

  26. Posted by Foghorn Leghorn | March 18, 2013 at 11:17 AM

    Let's take 9.9% of Dimitri Mafiacovitch's cash deposits and convert it to equity in a Cypriot "financial institution." Nothing good will come of this personally for Cypriot bankers and government officials.

  27. Posted by Z10 | March 18, 2013 at 11:26 AM

    July 12, 1998

    And you?

  28. Posted by Guest | March 18, 2013 at 11:26 AM

    Банкиры онанисты

  29. Posted by guest | March 18, 2013 at 11:39 AM

    Except you have the swiss central bank on the other side saying above this it will not rise. buying around there is pretty ballsy is my point

  30. Posted by VonSloneker | March 18, 2013 at 11:40 AM

    …is my St. Patty's day tribute cocktail making me look gay??

    - Matt's inner thoughts as he glimpses himself in the mirror, holding a Midori-Marg at McSorley's

  31. Posted by Nervous Trident Guy | March 18, 2013 at 11:41 AM

    Uhm, isn't Cyprus pretty close to Malta?

  32. Posted by Laxbro | March 18, 2013 at 11:43 AM

    My weekend was miserable. I'd love to share a non-fiction story about my rowdy weekend full of random tory burch flat wearing fillies — but I can't. I got drunk, yes, but I woke up next to the same girl each morning. We went to brunch with friends. I'd love to say you all are witnessing the maturation of Laxbro — but I can't. At brunch I wanted to order a 3rd Bloody Mary but nobody else did, so I began eye wandering around the cafe, wishing I was seated with this table of NYU girls that were on trying their best to get shit faced at noon. So carefree, their hair in disarray, still wearing yesterday's outfit, with today's shame all over it. My table is some jerkoff talking about the India rape so he can segue his trip to Nepal like I give a fuck. Here I am on the Monday after Patty's Day staring at monitors without a hangover. Gross.

  33. Posted by Flo | March 18, 2013 at 11:47 AM

    TLDR

  34. Posted by Ludwig W. | March 18, 2013 at 11:47 AM

    This was our paradox: no course of action could be determined by a rule, because every course of action can be made out to accord with the rule. The answer was: if everything can be made out to accord with the rule, then it can also be made out to conflict with it. And so there would be neither accord nor conflict.

  35. Posted by lucas | March 18, 2013 at 11:53 AM

    The guy just wants a stable place to park his assets, not to make money trading currencies. CHF may not skyrocket, but it won't go down too much either. So it's a pretty safe asset all things considered.

  36. Posted by Fan of Laxbros Dad | March 18, 2013 at 11:57 AM

    Maybe email your dad and then post the reply here?

  37. Posted by Boink | March 18, 2013 at 12:04 PM

    Hold up, has anybody else noticed that, along with footnotes, some of Matt's links have tooltips (or whatever the correct term is)?? Hover over the link to: " safe at JPMorgan Chase"

  38. Posted by guest | March 18, 2013 at 12:04 PM

    What building do you doorman in?

  39. Posted by Describing The Scene | March 18, 2013 at 12:05 PM

    holding a Midor-Marg while discussing Modigliani–Miller at McSorley's?

  40. Posted by VonSloneker | March 18, 2013 at 12:12 PM

    Two words for you: toothpaste & diamonds

    - Bradley Birkenfeld, Retired – Flouride Quant, UBS

  41. Posted by Donny | March 18, 2013 at 12:24 PM

    We see this as a positive move, it's great to be first mover on extra fees –

    B of A

  42. Posted by Guest | March 18, 2013 at 12:34 PM

    Did you ever stop and think, Matt, that these rates were set to punish Boris, Natasha and Mr. Big? What's 10% to a money launderer? Might as well put the dirty money to good use and keep some before it disappears off to the Vatican Bank.

  43. Posted by guest | March 18, 2013 at 12:36 PM

    Is that like some kind of gay slang?

  44. Posted by T Durden | March 18, 2013 at 12:37 PM

    Zero Hedge commenter says what?

  45. Posted by guest | March 18, 2013 at 12:40 PM

    One does not simply call taking my insured cash and freezing my account a "holiday".

    -Cyprus citizen who drove a bulldozer into a bank and is about to reenact Denzel's last stand from Training Day

  46. Posted by Guest | March 18, 2013 at 12:45 PM

    Trust us, we woulda had to have been like really drunk, really fucking drunk, to invite you over.

    –NYU girls who like to party at various cafes around Washington Square

  47. Posted by guest | March 18, 2013 at 12:52 PM

    I don't understand why this is so shocking. In the U.S. we've been doing this for years. It's called "quantitative easing." At least the Cypriots have gone about it openly.

  48. Posted by Interwebs GPS | March 18, 2013 at 1:04 PM

    Got lost on your way to ZeroHedge?

  49. Posted by PermaGuestII | March 18, 2013 at 1:18 PM

    "My table is some jerkoff talking about the India rape so he can segue his trip to Nepal…"

    Welcome to the next 10-15 years of life in Manhattan.

    -guy thinking of moving to New Hampshire

  50. Posted by Guest | March 18, 2013 at 1:23 PM

    Commenting via iPhone 5

  51. Posted by Guest | March 18, 2013 at 1:35 PM

    Laxbro's posts are like a perpetual fratboy version of Girls.

  52. Posted by guest | March 18, 2013 at 1:35 PM

    you'll want to google translate this one

  53. Posted by DB Compliance | March 18, 2013 at 1:56 PM

    Slams against bankers must be converted in to U.S. English before posting. Minus 10

  54. Posted by Geek Quant | March 18, 2013 at 2:19 PM

    Paulson is way up the food chain on you……..

  55. Posted by Guest | March 18, 2013 at 3:31 PM

    Not sure I'd want to be messing with angry Russians looking to get all their money back, even if I was located in another, sovereign nation.

  56. Posted by Alexander Litvinenko | March 18, 2013 at 3:47 PM

    Tell me about it.

  57. Posted by Commentariat | March 18, 2013 at 6:22 PM

    -CFA L2 candidate / fashion quant

  58. Posted by Disappointed | March 18, 2013 at 9:16 PM

    I was almost certain it would turn out to be "UBS Sucks"…

  59. Posted by dandraka | March 19, 2013 at 9:41 AM

    Ah, *that* article. I loved it, especially this line :

    " You can have opacity and an industrial economy, or you can have transparency and herd goats. "

    Might as well have said "all your base are belong to us" !

  60. Posted by dandraka | March 19, 2013 at 9:52 AM

    In the sense that Europe is close to the Americas, yes. In fact, it's a bit closer.