Cyprus: Mission accomplished?

Last night my newsfeed was full of pictures of a middle aged German woman in her black bathing suit while on vacation in Italy. Despite of the less than pleasant attention she received from the local Italian press, the German chancellor certainly deserved a short holiday following the Cyprus fiasco. From Angela Merkel’s point of view, the past couple of weeks have been if not a complete triumph, a respectable success. The German chancellor showed her constituents that she drove a brutal bargain.

The details of the Cyprus rescue have become increasingly clear and most publications talk about the €17 billion bailout calculated assuming that it would provide €7 billion for the banks and €10 billion for the government. It’s worth noting that the final plan provided not a single Euro for the banks who ended up having to raid their depositor base to come up with the whole €7 billion.
Of the €10 remaining billion, €7.5 billion is being used to refinance maturing debt. It doesn’t take an Einstein to work out that this debt is mostly pledged as collateral at the ECB. Consequently if the tiny island of Cyprus defaults it would take out a large portion of the equity capital of the ECB. While it is not a matter of public record it is estimated that Cyprus has guaranteed more than €10 billion of collateral at the ECB. So, the €7.5 billion is being lent to Cyprus in order to be paid right back to Europe. Given that, it is perfectly fair for me to say that on a practical level, the EU bailed Cyprus out for FREE!

The Troika is very emphatic about what the future of bailouts looks like. Nevertheless the head of the Eurogroup and Dutch finance minister Jeroen Dijsselbloem was pilloried for announcing that so-called “bail-ins” — forcing shareholders and large depositors rather than taxpayers to take the hit when banks fail - should become the norm in the eurozone.
The timing could not have been worse and his remarks immediately spooked the financial market. Aside from the incitement to panic, there is actually plenty to like about this in principle as it’s consistent, transparent and it doesn’t ask taxpayers to write blank cheques - we all know that blank cheques are a dangerous, dangerous species.  Mostly importantly, the new template is progressive – things that hurt only people with more than €100,000 tend to be.
Except it won’t work. The obvious issue is that depositors over €100,000 control enough money to overturn the European economy if they stampede. When I first started my career in derivatives trading, the first lesson I learnt was that the price for 1 billion is very different from the price for 1 million multiplied by 1000. You can not play and experiment with money on this scale unless you have planned a fully controlled detonation of a massively complex and fragile system.
Mr Dijsselbloem’s remarks would have been taken more kindly had the Cyprus operation gone well. It didn’t. The so-called rescue has inflicted massive, irretrievable destruction on the economy of Cyprus. The capital controls currently in place are draconian. There will be a forced rollover of debt. Cheques may not be cashed. Business working capital is frozen. Basic cross-border trade is severely curtailed. Credit card use abroad will be limited to €5,000 a month. And in spite of the above, the money will still leak out of Cyprus even if the island gets encircled with razor wire.

If Macdonald’s tested a new meal that killed 10% of the sample group, it is reasonable to assume that they’d hesitate with the global rollout of Cyprus HappyMeal. Instead, the Troika is clapping the dust off its hands, announcing that they think the Cyprus mission is accomplished, and looking to have another go somewhere else.