Saturday, March 30, 2013

"Risk takers MUST remain risk carriers in a restructuring!"

I have pointed out before the potential nightmare which the implementation of the plans for the Cypriot banking sector is likely to trigger. This plan is full of preferential treatment elements and few things motivate smart lawyers as much as preferential treatment when there should be no preferential treatment.

All of this just makes it even more un-understandable for me why the Eurogroup did not even consider the proposal made by Lee Buchheit. His proposal was the standard approach to ANY financial restructuring, be that the debt of the Cypriot banking sector, the debt of the Greek state, the debt of a corporation, or whatever.

Buchheit's proposal rested on 2 major principles: (a) risk takers must remain risk carriers; and (b) if losses are to be taken, creditors/depositors should be given the choice to take them right away or to defer them into the future against the chance that, perhaps, the losses can be avoided in the longer term. As Felix Simon stated in his commentary: 'That’s it! That’s the whole plan, and it’s kinda genius. If you have bank deposits of more than €100,000, they will be converted into bank CDs, with a maturity of either five years or 10 years — your choice'.

As I have argued over and over again: the same principles should have been applied to the sovereign debt of Greece (Buchheit had recommended that for Greece. He ended up engineering Greece's lamentable haircut only because that was set as a condition precedent by the Troika).

The one counter-argument against such an approach is the famous but abstract argument of debt sustainability. That sounds like a very good argument but, in practice, it is close to nonsense.

Debt sustainability only matters when principal and interest of debt need to be paid in cash. Put differently, if principal or interest on debt never had to be paid, debt sustainability would be infinite. That 'debt' would then be called 'equity'.

To return to Cyprus: if creditors/depositors over 100 TEUR were given new CDs with 5 or 10 year tenors in exchange for their loans/deposits, those CDs would have had a value in the secondary market from the start. Those who didn't trust Cyprus for 5 or 10 years could have sold their CDs and taken a loss. The others could have held on to them and, if things went well, even collect interest at the end. No one would have been forced to take losses right away. And one could still have dreamed up additonal incentives like offering a bit of bank equity to the lenders/depositors or, as Felix Simon suggested, receipts of future gas revenues as collateral.

If EU authorities had followed the principle of 'risk takers must remain risk carriers in a financial restructuring', the Eurozone would financially be a much safer and more stable place today than it is!


  1. I saw an argument against the Buchheit proposal (it may have been on Krugmann's blog, I'm not sure).

    The proposal (by my limited understanding, at least) is to replace deposits above €100,000 with Certificates of Deposit f(CDs) or 5 or 10 years. Thus "pinning" the capital but allowing the deposit holders to exit the market for these CDs at a loss if they prefer.

    The trouble is, it hits against the "round-trip" aspect, of running business in russia or the former soviet union via a cypriot shell.

    And the very last thing a shell-company wants to do, it have its capital pinned.

    I agree, it would have been a better plan, and one the Troika should have been pushing for. But I don't think the cypriot government would have wanted it.

    1. What is often overlooked is that the bulk of bank deposits generally does stay with the bank for long periods. Maybe not 5-10 years, but certainly for longer periods. So when you term out the maturity of deposits, you are doing forcefully what depositors would have done voluntarily, if only there had not been a panic.

      Even with round-trip money, I would suspect that these round-trips are of a longer term, too. I mean, they are investments in Russia and investments are of a longer term nature.

      With depositors it is quite similar as with banks when they lend. Banks never want a loan repaid if the rate is good and the borrower is triple-A. If the borrower turns bad, banks want the loan repaid like yesterday. Depositors want their money back from the bank as soon as they have doubts about the bank's stability. When they take the money out, even the most stable bank gets into trouble.

      All the Buchheit proposal would have accomplished is to somewhat forcefully create a situation which would have happened naturally if only the crisis had not broken out.