Sunday, March 17, 2013

A new instrument - here come debt/equity swaps!

The deposit tax on Cypriot banks was originally introduced as an 'upfront one-off stability levy'. Subsequently, it was announced that those tax-paying depositors would receive in exchange shares of their banks in an equivalent level. In short, a debt-equity swap.

A debt-equity swap can be a very good idea provided that it is voluntary. Bonds, interbank loans and deposits are liabilities of a bank. If liabilities are exchanged for equity, ceteris paribus, the equity base of the banking system is strengthened overnight. The stability levy, so I understand, is expected to generate about 5 BEUR. After the debt-equity swap, the equity base of the Cypriot banking system would be strengthened by about 5 BEUR. I don't know how large that equity base is now but 5 BEUR more equity should make a substantial difference to the strength of the Cypriot banking system.

Things are different when a debt-equity swap is imposed by law. It may still be legal if the law is legal, but nevertheless. The key question with an imposed debt-equity swap, which may still be a prudent thing to do, is who gets hit by it.

The present proposal hits ALL depositors and those depositors are differentiated by more/less of 100 TEUR in deposits. Whoever thought of that wasn't thinking well.

When it comes to an imposed hit, any differentiation must be made on the basis of risk awareness of those who could be hit. Shareholders should have the greatest risk awareness because in a capitalist system, their money is strictly risk capital. And then there are funders of a banking system who are considered as 'professional market participants' (this is an official Basel-2 term). Typically, they are bondholders and interbank lenders. Finally, certain depositors can also be considered as 'professional market participants': an anonymous company, for one, should be considered as a 'professional market participant'. A regular depositor, that is a human being with a first and last name who invests his savings and considers himself protected by a deposit insurance law up to 100 TEUR, is NOT a 'professional market participant'.

By definition, a debt equity swap hits the shareholders because their equity will be diluted. It only hits the 'professional market participants' if they are specifically targeted. The plan for Cyprus does not specifically target them. Instead, the plan also hits regular savers who had considered themselves to be protected, up to 100 TEUR, by the deposit insurance law.

This mistaken differentiation, not the imposed debt-equity swap per se, is the enormous error underlying the Cypriot plan. There is no way of telling what sort of consequences this terrible precedent may have (even in countries which are not yet affected by the crisis)!

I am not an expert on Iceland but what I have read about it, the Icelandic government essentially said to those creditors of their banking system which were 'professional market participants' the following:

"We have never understood what our banks were doing. Since you are 'professional market participants', we assumed that you knew what they were doing and that you were happy with it. However, we always understood what our savers were doing. They were putting their savings into banks in the confidence that they would be safe. Thus, we'll protect the savers and you, the 'professional market participants', will have to fill the hole".

Austrian banks, for example, lost a couple of BEUR in Iceland. Served them right! Why did they transport Austrian savings to Iceland when they didn't understand what Icelandic banks were doing with the money?

In my opinion, the Cypriot government/parliament should approach the deliberations of the new law in the following way:

"The Troika requires the customers of our banking system to provide an upfront one-off stability levy of 5 BEUR. Since those customers will receive shares in their banks, this is a debt-equity swap. We agree that it is fair to impose such a debt-equity swap on bank customers as their contribution to the problem. We do not agree with the Troika's 'definition of customers'. We will exclude regular savers, that is official depositors with first and last names, from this debt equity swap altogether. Instead, we will increase the levy on all 'professional market participants' so that the 5 BEUR volume is reached. That is fair, equitable and, most of all, it is the will of the Cypriot people".

To me, to do that would absolutely be the sovereign right of Cyprus, and it would make sense. The real question is how the Eurogroup would react to that!


  1. The cypriot goverment was supposed to unite today. It was postponed for tomorrow, as there are rumours that the goverment is working on a "plan B". No details known.

    The Eurogroup's intentions, are pretty clear.

    - Hit the deposits: Intention: Shut down Cyprus as banking destination.

    - Raise the corporate tax by 2,5: Kill the companies that prefer Cyprus as business center because of low tax (several greek shipping magnates use also Cyprus as their base of operation and cypriot flag for their ships).

    This will result into a big hit in the economy of Cyprus (which i am sure "nobody predicted" and will be later rectified by a 2d, 3rd troika program). In the meantime, Cyprus will start pumping gas (under the kind supervision of the troika), so all is good.

    The rest is details.

  2. You can expect a bank run on at least the cypriot banks in Greece on Tuesday. Probably a bank run on greek banks too and in the best scenario, the greek gov's plan of having the deposits return, will go down the drain.

  3. For someone so loose as mr. Asmussen and Schoible(germans must be excellent poker players) on the event of Cyprus leaving the eurozone, something sounds fishy today...

    The scheduled Parliament session for today in Cyprus, was postponed for tomorrow.

    The ECB now, sent to the Central bank of Cyprus, letter, asking to vote the plan immediately. Also, a representative of the ECB, flew to Cyprus, to convey the same message in person and also asked for the cypriot banks to open normally on Tuesday (there is a rumour that the goverment plans to declare Tuesday a bank "holiday" day).

    According to cypriot tv, the request to make the parliament vote today, was read by the president's office and was rejected.

  4. Thanks to Lagarde's idea of 40% on the deposits, here's a revolutionary idea.

    Do it! Cyprus will need then no troika help! Remaining bank deposits will flee either way. Give stocks over state profits from gas to the deposit holders as collateral. You have the bonus of not raising corporate tax and kicking the troika out of the island! Of course it will be political disaster for Anastasiades' political career, but i think he is finished either way. Of course, i doubt he has the stones to do that.

    Another would be to give soil and water to Russia. With Syria out of the game, i am sure Russia would appreciate a naval base on Cyprus and exclusive exploitation rights for Gazprom.

    The damage the cypriot economy will suffer from this deal anyway, probably exceeds all the money of the program, surely the 6 bln of the haircut.

  5. It gets better.

    The central bank of Cyprus just froze all accounts.

    What does this remind me of? Ah, yes, the Argentinian Corralito.


    1. Yes, a deposit freeze is last resort in such situations. I have been through one in Argentine in the 1980s. After the intitial shock, it quickly ceases to be big news because depositors wouldn't normally withdraw their money anyway and as long as there are certain amounts free for withdrawals (personal use) and as long as the interest paid is good, things continue the same as before.

      Thus, a deposit freeze is not nearly as dangerous a precedent as hitting depositors who trusted that they would be protected by the deposit insurance law. That really is playing around with the State of Law quite a bit!

      This game-of-chicken allegedly displayed by the Eurogroup is beyond comprehension for me. Perhaps their intent is to drive Cyprus out of the EZ just to really hurt those Russian oligarchs (who would then indeed hurt!). Can't think of many other good explanations.

    2. Mr. Kastner, you think that the Germans are playing "dice" with the euro-banking system, just to give a "moral" lesson to russian oligarchs? This is a bit like playing russian roulette to scare away a fly that sits on your forehead.

      There is only 1 thing that is worth such risk in the area. In one way or the other, it's the only thing that makes sense.

      RBS' assessment on cypriot gas deposits, is that they exceed 600 bln euros.σωτήρια-αποθέματα-φυσικού-αερίου/a-16590370

      Add, that Cyprus has accords with Israel, to route together the israeli gas towards the EU market too (probably with an undersea pipeline). Together these deposits, will surpass in quantity, the Azerbaijan deposits.

      If, to those, you add possible greek deposits, then the area from Greece to Israel, is a new "persian gulf" of gas. Already, the norvegian ship that was doing survey on the Ionian, because of the encouraging indications, has gone way off schedule and is doing extra surveys. Israel-Cyprus-Greece, will be the new EU route for EU's gas supply. Influencing that no russian companies will be involved, is just as important.

      Now THAT would worth to play russian roulette!

  6. FYI, the russian deposits in Cyprus are 18,3 bln.Παλμός-της-Αγοράς/item/83160-κύπρος-στα-183-δισ-δολάρια-οι-ρωσικές-καταθέσεις-–-έως-18-δισ-η-ζημιά-από-το-haircut

    Supposing the improbable event of Cyprus exiting the euro and that all will be lost, do you really think that Merkel & Co are taking a HUGE risk as well as tremendous negative pubblicity in european public opinion(just go to any spanish newspaper you want and read user comments) in order to "bleed" 18 bln out of the Russians in the best case and 1,8 bln in the more probable case that Cyprus will accept and do 10% haircut?

    Give Mrs Merkel some credit! You don't gamble your house to gain peanuts.

  7. I have been following this strange story for the last couple of days and having both a bank account and a Cyprus company I can tell you the following. a) The company tax rate is irrelevant. The tax code in Cyprus works in such a way that you can have any profit you choose. I will keep the Cyprus company for the time being. b) Destroying Cyprus as a banking destination does not make much sense. The Cyprus banks were going to be nationalized anyway. So it would have been easy to install EU administrators to stop any hanky-panky with Russians and simply sell the banks to the preferred owner. Something like that is happening in Greece. c) Gas, getting it out and transferring it to the market will require extensive EU participation. In other words the EC more or less owns the gas. There is no need to grab it.d) There are several risks involved but I think the worse is P. Grillo in Italy. I can almost see him threatening everybody with a banking panic "The Germans are about to take your money. Buy gold/vote for me/......"If something like that happens the reelection of Frau Merkel is history and God only knows what the repercussions will be. Keep in mind that, as it is often repeated in this blog, Deutsche bank is essentially a hedge fund. It is this political gift to P. Grillo that makes me worry about what really happened.
    My guess: this is the Cypriot version of the referendum that resulted in the firing of G. Papandreou from Greek PM. From personal experience I can tell that the Cypriots can be real weasels. To the point where even mainland Greeks can blow their top. I suspect that, even after the elections, the Cypriots insisted on some weasel, nefarious trick to protect the big, foreign depositors, from which the Cypriots get lots of political leverage. It is likely that they insisted so much that the rest of the Eurozone just lost it and demanded that everybody was considered a professional market participant or something to that effect. If this is case then everybody is trapped.

    1. I do remember reading one article saying that the IMF (Lagarde) wanted to only hit 'professional market participants' but those with 30% and that Cyprus opposed that idea for reasons you mention. Who knows? I guess the dice is rolling and sometime early this week we'll see where it falls and what the fall causes.

    2. a) The company tax rate is irrelevant, but the troika forced to raise it. They must have seen some relevance.

      b) Destroying Cyprus as banking destination is a fact, either intended or not. Who will leave his deposits in Cyprus after that and knowing that the troika program also asks that the total deposits/GDP by 2018 fall to 3.5? There is already written in various articles that this may mean a 2nd hit on "high deposits" in a second moment.

      3) Gas, taking it out and routing it to Europe is something any company can do, including russian ones. Also, getting "lots" for exploitation is something not written in stone that can't be given to russians either. But you can bet the EU will want "no russian" in that area. After the Nabucco debacle, the eastern Med, will become the best EU "non russian" gas area. That is, if no russian company gets a hold in any of the "lots".

      4) Beppe Grillo, you will allow me to say, that is a very misunderstood figure in Greece, in the way the greek media depict it. Just like for years the greek media erroneously presented Italy in the "brink of chaos" and "starvation". Grillo has internal problems in italian politics and inside his "non party" right now, trying to make a cohesive party out of a "Non party". The cyprus' issue is a non existent in italian media, contrary to spanish ones. Grillo's popularity, is due to the corruption of the traditional italian political system, in addition to a general discontent of the very "lightweight" austerity (in comparison to the greek one), that Monti imposed, which isn't giving tangible results and the Italians are tired of a stagnation of their economic situation over the past decade, blaming the euro, while, at the same time, they don't want to leave the euro, because they don't want the devaluation. Part of Italy's problem, is that a) even the mild austerity imposed is causing problem to the liquidity of many italian firms and a bit of hike in unemployment, b) the much chanted "Monti reforms", were at the end "half-made" once in the parliament and senate, because of political compromise between PDL and PD, which were the parties supporting Monti. At some point the compromises became impossible and led to elections. The "huge success" seen by the german press for example, never became reality in these reforms. It was more of a mediatic propaganda to praise Italy so that the spread of italian bonds would drop. THe same that happened with Samaras, where Merkel started praising Samaras in August, when in Greece Samaras had done nothing else than saying "we will honour the agreement". So, the Italian voter was promiced initially "a small drop of GDP and then stabilization". It didn't happen. THen he was promiced for 2012 a 0,8% drop in GDP, it was 1,5%. Now the Banca d' Italia says that it will drop this year too (initially it wasn't supposed to), and comes Grillo and says "enough" and gets a quarter of the votes.

      Grillo does not have enough leverage to put Italy out of the euro, but he is gaining enough strength to make obstruction to the political system and the ideal solution for the Italians, would be "eurobonds and weaker euro". Now, the difference between Grillo and the other politicians, is that Grillo, in the currently impossible event he would become PM, is crazy enough to blackmail the Germans with exiting the euro if they don't make Italy's life easier.

      Take this from someone with 20 years of life in Italy on his back. The rest of what the average greek newspaper presents as italian or "grillian" reality, is a mix of whishful thinking and "condolences to the widow".

    3. You think that Cyprus had enough leverage in the Eurogroup as to say who will get the cut? Come on! It's Cyprus for God's sake, not Britain!

      And politicians in Cyprus, either they like it or not, get elected by the Cypriots, not the Russian deposits holders. Anastasiades just signed the death sentence of his political career and possibly his party too. Nicosia University did a flash poll and 75% of the pubblic opinion wants the Parliament to trash the bill.

    4. Was that article german or greek? Because i think i have read the opposite. At any case, i think it is laughable to expect that Cyprus, had so much bargaining power, that of all the possible solutions, chose to impose to IMF+EU+ECB the haircut on deposits and have even Angela Merkel coming out today defending such choice.

      I may be crazy, but i find this between irrational and ridiculous. If Cyprus had some power, they would have convinced the troika about what the link says. To include in the salvation program, the cash CYprus would be taking from 2018 from gas. But as the link says and was written in FAZ (the german paper), the troika rejected to include such part in the solution as "fantastic figures". So much for the cypriot "power" of pushing down the throat of the eurogroup their position...

    5. Hot off the press: the participation of the small fry (deposits below 100000 Euro) in the haircut was a CYPRIOT government suggestion to protect its status with Russians. (Mega channel just now)I think the Europeans are trapped, badly trapped. If tomorrow morning there is a hint of bank run in Spain or Italy or both then I see the Eurozone caving in (behind the scenes). This is why the ECB has just sent representatives in Cyprus pressing mercilessly. Is it possible that Asmussen and Schoible are so stupid? If they bluffed and the Cypriots call the bluff indirectly by delaying then we in for a big laugh against the Germans.Are Cypriots better poker players than Germans?

    6. @Athensdog,

      I think we must distinguish between "news", "rumours" and "journalistic speculation" as different things.

      The MEga channel commentator, Kapsis, said literally:

      "certainly the small savers don't have anything to do with moneylaundring from Russia. What fault do the cypriot small savers have? That's why the proposal of Mr Shultz to exclude the small savers under 25000 is very logical. And it is surprising, what the british press is writing, according to which, this choice of dividing the cost between small and big savers, was a choice of the cypriot goverment, in order to keep being destination of russian capital. It is something surprising me. For sure there is a big injustice that must be rectified".

      a) The british press, if anything, has written the biggest amoung of bollocks about Greece and Cyprus, since they have vested interests on the island and on the euro. Don't you think that if anything, someone from the german side, instead of being depicted as "evil", would say "we wanted to exclude small savers, but we let it to the cypriot side to decide"? No, i bet, Merkel prefers taking all the hatred and nobody of the "evil northerners" that ganged up Cyprus wanted to leak this in their local newspapers. As usual, the "truth" comes from the British (no source mentioned btw).

      b) Do you really believe that by paying "only" 10%, Cyprus will "keep being destination of russian capital"?

      c) Do you really believe that Anastasiades, if could take in that night an exclusion of a small amount, wouldn't have taken it, just to appease to poorer cypriots? Instead he prefered to go to pass the bill, in a parliament where he has 28 out of 56 votes with a plan that basically BURNS every single cypriot voter, who voted him just 2 weeks ago on the promice that bank acounts won't be touched?

      One must seek a logic in what he hears.

    7. @ Athensdog,

      For Italy, you can be sure, that tomorrow there won't be the queue on the banks. The news about Cyprus has been burried under a ton of quarrels between the politicians trying to vote president of parliament and senate and Grill trying to find out the "traitors" in his party that vote Grasso in the Senate and asking them to come forth and resign. In the best case, some Italian may have understood that "EU saved Cyprus".


  8. Conspiracy theories aside, in all greek and cypriot newspapers, the story (confirmed also by greek fin.min Stournaras), was:

    - Beginning, Lagarde, supported by Schoible propose 40%. Mr. Stournaras called it "expropriation of bank deposits". The cypriot minister abbandoned the room and contacted his president. Returned to say it was unacceptable.

    - Then it fell to 12,5%.

    - Finally, it was agreed on the known numbers as "take it or leave it", with Asmussen picking up the phone to make the cypriot minister the final offer "he couldn't refuse".το-δραματικό-παρασκήνιο-που-οδήγησε-σε-«κούρεμα»-των-κυπριακών-καταθέσεων

    It's the classic maximalistic tactic any lawyer that knows must arrive to a settlement does. Ask 1000 to get 100. By having the opposite side starting at 40%, the margins for the cypriots were dminished rapidly and taking the 6,5-10% in comparison is "good".

  9. So much for the nefarious cypriot plan. Anastasiades just made pubblic statement. Among other things mentioned that they continue their efforts to reduce the weight on the small savers. The SKAItv correspondent said, that the cypriot gov will propose 3% for small savers, 10% up to 500.000 and 12,5% over 500.000. Also the savers will get stock of the banks and those who will keep their deposits for 2 years, will get half the value of their contribution in bonds connected to future income from gas.

  10. Confirmation of the skaitv corresponded, that the cypriot gov is preparing a counterplan to alleviate smaller savers. They will propose:

    3% up to 100.000
    10% up to 500.000
    12,5% over 500.000

    I guess to please the russian oligarchs to keep their money in Cyprus :))))))

  11. Something else to consider. If a part of the savers get excluded, this will most likely open the way for legal action on behalf of others. So while Martin Schultz proposal may sound "humane", how will the cypriot state explain in a court, why the saver with 26.000 gets taxed and the one with 25.000 doesn't?

  12. According to this, claiming Wall Street Journal, the cypriot gov is in continuous negotiations with the ECB in order to change the tax to 3%, 10%, 13%ανατροπή-των-δεδομένων-αναθεωρούνται-οι-φορολογικές-κλίμακες-για-τις-τραπεζικές-καταθέσεις-–-δημιουργούνται-3-κλίμακες-φορολογίας-προωθείται-φόρος-5-για-ποσά-έως-100000-και-13-για-ποσά-άνω-των-500000-ευρώ

  13. OK so I am not the only one writing diatribes. It is comforting.
    a) I don't claim that it is a Cypriot plot that worked. I suspect that it is a Cypriot plot that went horribly wrong and everybody lost control. The reason I believe this is because I agree with Herr Kastner analysis about professional market participants. I was one of those once. They and shareholders should take the hit. As things stand now a holder of preference shares or bondholder or an interbank lender charging extortionate rates seems to keep his capital, whereas a 85 year old Cypriot saver with 1000 Euro as his only fortune is participating in the rescue. This has the whiff of scandal. Who may I ask are these bondholders?
    b) There is an EU directive that says that deposits up to 100000 EU are to be unconditionally guaranteed by member states. This provide ample legal justification for excluding many savers.
    c) I agree that English papers specialize in Cyprus related bollocs. However that does not mean that they are always wrong. I missed the point about the english papers, as typing on the PC, listening to the TV and pacifying the kids can affect concentration. But I do not consider MR Kapsis particularly reliable anyway. I just pointed out that others share the same suspicion.
    d) I don't believe that P. Grillo can take Italy out of the Euro. I never said that anyway. But keep handing him gifts and he will be able to eventually.
    e) Company tax in Cyprus is irrelevant, believe me I have personal experience. The increase was theatrical. This only intensifies my belief that most politics we see is staged. As opposed to what we don't see. This is not conspiracy theory. This is an acknowledgement that, as Karamanlis sr. is reputed to have said, in politics there are things you say but you never do and things you do but never talk about.
    f) Power in politics is often nefarious. If an EU politico has some Cyprus activity he is very vulnerable, as Mr. Vulgarakis can attest. I will not be surprised if some heavy politicians in Austria for example are on the payroll of Cypriots. Clearly you cannot blackmail everybody in the Eurozone, but imagine that several German politicians having accounts under assumed names in Cyprus to avoid being exposed by the data thefts in Swiss or LIchtenstein banks. Then blackmail is possible, followed by a very messy political battle.
    g) Finally let us assume that these exchanges about 40% etc actually took place. What stoped the Cyprus Finance minister (career over anyway irrespective of a 4 or 40% cut)from calling the bluff? Simply resign and let the banks go down with the risk of political instability in Cyprus and almost certainly Greece. Syria is in civil war, Egypt & Lebanon are at a precipice, Israel threatens to nuke everything that moves, Libya well...And you are telling us that they were prepared to risk a political explosion in Cyprus? Such a negotiation can take place only if the counterparty is assured to play along with the basic plot, ie the result is predetermined to a great degree. I suspect that the Cypriots tried to pull the wool over everybody's eyes to evade the political deal and they failed. And for this, the punishment was severe.

  14. Well, the mystery is getting less dense.

    According this article, Schoible said to ARD radio that he proposed to tax over 100.000, but the cypriot goverment, the European COmmission and ECB wanted to tax all and will have to explain why to the cypriot people.

    They needed a minimum amount to be raised from the tax on deposits, the how was open.

    According to this, cypriot "official" said to Financial Times that it was impossible to avoid taxing those lower than 100.000, since 35% of the cases are under this and it would mean that those over 100.000 would be taxed so high that it would not be regarded as tax.

    Makes more sense... And the "british source" said a partial truth. But the bottom line, is, "did the cypriot gov prefer hitting the savings as solution?" I will never believe that.

    1. Yes, I, too, saw Schäuble make that statement on TV. But that's a bit besides the point. Even if the depositor's cut (the non-professional market participants, that is) had come at the express will of the Cypriot government, the Eurogroup would have had to veto it on the grounds that it would bear unacceptble consequences for the entire Eurozone.

  15. What happened to the banking deposits in Cyprus will be understood by Italians TODAY, since it finally made the news in a place where one can see it. :)