Cypriots Discover the Debt Jubilee

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Come again? Cypriots dis­cover the debt ju­bilee? Well yes ac­tu­ally, that is ba­sic­ally how de­pos­itors at Cypriot banks have been treated by the Troika, even if the de­cision to grab up to 9.9% of cash de­posits to fin­ance a bail out of the fin­ance sector is being presented as a tax or levy. To un­der­stand this we have to view mat­ters from the banks’ per­spective: every de­pos­itor is lending money to the bank for a fee (paltry in­terest and il­lusory se­curity) and this ap­pears on the bal­ance sheet as a li­ab­ility which in toto in the case of Cypriot banks con­sid­er­ably ex­ceeds as­sets. Treated as lenders, Cypriot deposit-​holders are being asked (ordered) to take a haircut on the debt so that the banks’ bal­ance sheets look a little better.

What we have is a kind of “bail-​in”, where in­di­viduals already in a rickety credit struc­ture are being asked to take a hit (as op­posed to a bail out where a third-​party in­jects fresh funds).

Technically, de­posit holders are not simply can­cel­ling up to 9.9% of their loans to the bank, rather they are being asked (ordered) to enter into a debt for equity swap. This means that whatever sums they wit­ness dis­ap­pearing from their bank ac­counts will be used to buy shares in a pro rata amount in the bank in ques­tion. Looking at the state of a bank like Laiki (Popular) Bank, it is fairly safe to as­sume that these shares are hardly fair con­sid­er­a­tion. Junior bond­holders are also going to take a haircut, but not the senior bond­holders, be­cause these latter might get scared and/​or throw a tantrum.[UPDATE 18/​3/​13: there are sug­ges­tions that de­posits will now be swapped for bonds guar­an­teed by the pro­ceeds from gas ex­trac­tion in Cypriot wa­ters. One won­ders why the gas fu­tures, and so the risk, are not being snapped up by others.] Given the al­most 10% cut in some cases, the at­tri­bu­tion of a fin­an­cial decim­a­tion, where a de­feated Roman le­gion would have to slaughter 1/​10th of its con­tin­gent, would be ap­pro­priate were it not for the fact that in Roman decim­a­tion the par­ti­cipants got to elect who they put to the sword.

Andrew Mellon (who seems to have been re­in­carn­ated as George Osborne) once said of the Wall St Crash of 1929 that in a crisis all as­sets re­turn to their real owners. On this he was cor­rect — fin­ance is a fant­ast­ical game of mu­sical chairs. As the music pro­ceeds the prom­ises of an ex­po­nen­tial growth in the number of chairs be­come louder and louder, until, as the rhythm halts and people rush to be seated, we find not just that there are only enough chairs for the 1%, but that this 1% sold the other chairs to pay the band to keep playing music.

As Cypriots (and Europe’s other savers, for which I mean un­se­cured bank cred­itors) have just dis­covered, mere claims to title in fin­an­cial as­sets are fic­ti­tious, the value they rep­resent has already been con­sumed some­where down the line and now fin­an­cial gravity has as­serted it­self, and only paper and ink are left. And clearly this is not just the case for risky in­vest­ments, but in­deed for any ‘thing’ which is not valu­able in-one’s-own-hands so to speak. It is worth un­der­lining again, be­cause this is really a case of the house falling down around one’s ears for savers taught that their de­posits were pro­tected. Such is the con­tinued dis­tress in cap­it­alism at the mo­ment that in­ter­na­tional debt re­struc­turing is now starting to eat into sav­ings and to re­gard savers on the same plane as in­vestors in junk bonds and penny shares.

To get the measure of the dis­tress, you need only focus out from Cyprus to con­sider the cur­rent and con­tinuing over-​indebtedness of the world’s fin­an­cial­ised eco­nomies. Back in 2011, BCG Analysts were already pre­dicting that na­tionals of over-​indebted states would have to be ‘taxed’ in order to chip in to a per­verse kind of debt ju­bilee in which the rich’s loans would con­tinue to be up­held and the poorest would be ex­pro­pri­ated of their fin­an­cial as­sets (sav­ings, pen­sions etc.). Ireland, for ex­ample, was so deep under the water that, in order to re­duce the country’s ag­greg­ated debt over­hang to within 180% GDP, the fin­an­cial as­sets of every cit­izen would have had to be con­fis­cated AND an­other 13% of house­hold as­sets would have had to be ex­pro­pri­ated too. The UK for its part would be hit by €1,252bn levy in which holders of fin­an­cial as­sets would have to hand over 27%.

There is a lot being said about Cyprus being an ex­cep­tional case be­cause it is a haven for Russian money laun­dering, and I too have seen funds dis­ap­pearing through Cypriot cor­porate struc­tures in proven cases of fraud. But it is bloody rich for the British press, for ex­ample, to pull this latest ver­sion of the “lazy and un­trust­worthy” libel on the Cypriots, when the source for the money being laundered was the City of London and while British banks (HSBC for ex­ample) have been proven to be up to their necks in such activ­ities. If the City un­der­went a Cypriot-​style levy to­morrow due to its un­sa­voury busi­ness prac­tises, UK de­posit holders would be coughing up €500bn. Oh, and just so our American readers don’t feel left out, a fin­an­cial asset haircut of 26% is re­quired, net­ting around €8,243bn as of two years ago.

Incidentally, as many people have been pointing out, one of the reasons the UK, US et al. have not un­der­gone such a haircut thus far is that central banks are re­lying on the prin­ciple that if you warm the water slowly enough a frog will vol­un­tarily allow it­self to boil to death. In other words mon­etary stim­ulus (low base rates and quant­it­ative easing) is at­tempting to in­flate away debt which, as this blog has sought to un­der­line, means also debts owed by banks to savers. The com­bin­a­tion of low rates, free money, and com­modity price in­fla­tion, amounts to a tax on the value of money in one’s pocket of say 5% per annum at least. The problem is, the in­fla­tion is not hap­pening quickly enough to clear the debts, and it prob­ably cannot do so be­cause the debts are so massive. This is pushing the fin­an­cial class up against the need for more drastic meas­ures; from low base rates to ex­pro­pri­ation is a straight line. The next step would be to act­ively de­base the nom­inal value of cur­rency — to start crossing zeros off notes.

One of the reasons for the slow pace of in­fla­tion is the failure of quant­itive easing (QE) and its equi­val­ents to get money into the hands of spenders, and it is this which sug­gests a wider of con­sequence of the Cypriot pro­posals (they haven’t been ap­proved yet). When I was plan­ning to write a blog for today, I was going to talk about the hissing of bubbles in­flating I have been hearing over the last months. The QE and other bailout money has gone straight into the hands of spec­u­lators, but not in ways that were pre­dict­able and it is only now that ob­servers are picking out where bubbles are in­flating again. One of these areas has been noted by Australian Minskyite Steve Keen, who has spotted a fright­ening cor­rel­a­tion and up­swing in the margin avail­ab­ility for stock in­vestors and the cur­rently gravity de­fying levels of the DOW Jones. In short, margin in this con­text is about the amount a spec­u­lator can borrow off the back of col­lat­eral to fund stock pur­chases, and the cur­rent rate in New York is USD300k col­lat­eral al­lows you to buy USD1m of stock. Money in­tended to fund loans to in­dustry is, we can only as­sume, ac­tu­ally flooding into spec­u­la­tion in equities. This margin dif­fer­en­tial is quickly ap­proaching the levels seen prior to the dotcom bust and the Credit Crunch, and will ex­ceed them within the next two years.

Another locus, as Gillian Tett in the FT has in­dic­ated, is the rush of in­vest­ment funds into high yield cor­porate bonds. Here the driver is not so much QE money as the low, zero, or even neg­ative yields of the “safe” in­vest­ments that these funds, which provide in­sur­ances and pen­sions, tend to pursue. This is the mon­etary policies of low base rates and in­fla­tion at work, in which savers are being co­erced to spend by the de­valu­ation of sav­ings, and small in­vestors and their funds are scrab­bling around in the search for yield. The per­spic­a­cious Tett high­lights the ma­turity mis­match of in­vestors in such funds who can with­draw their money quickly, and funds own in­vest­ment in one, three and ten-​year ma­turity of cor­porate bonds being is­sued in re­cord num­bers (a) be­cause of the avail­ab­ility of cheap fin­an­cing and (b) the de­sire to avoid funding by bank syn­dic­ates after the hor­rors of the Credit Crunch (see these pages passim).

And yet an­other bubble is in real es­tate in London and in Germany. The latter is par­tic­u­larly in­ter­esting be­cause it ap­pears to be one of the few mani­fest­a­tions of an oth­er­wise sub­ter­ranean cap­ital flight from the European south into German as­sets. Pre-​Euro this flight would have been quickly ap­parent by the rise in the value of the Deutschmark as Greeks, Italians etc. sold the local cur­rency and bought marks. We see this in the battles by the Swiss Central Bank to sup­press the value of its Franc (cf also Japan). Post Euro, how­ever, these intra-​Eurozone trans­fers have not caused vari­ations in the Euro. But they have had to be ac­counted for.

The European Central Bank’s TARGET2 system deals, among other things, with such trans­fers, with the ef­fect that a move­ment of cash from a Greek to a German bank is com­pensated by a loan by the German Bundesbank to the Greek central bank, so that everything bal­ances. The Greek central bank ends up a debtor to the Bundesbank, and the Bundesbank bal­ance sheet fills with credit as­sets to Eurozone member na­tional central banks. Up to the Credit Crunch this worked fine, everything bal­anced nicely, but since then there has been massive cap­ital flight from the Eurozone ‘peri­phery’ to Germany, Netherlands, and Luxemburg to the tune of some €750bn. Under the burden sharing ar­range­ments for these li­ab­il­ities set out in the treaties, the Bundesbank would be hit for about 27% losses in re­spect of any Eurozone member state which uni­lat­er­ally bailed out of the Euro and in par­tic­ular the TARGET2 system. And the con­sequence of the in­flow of cap­ital? Germany’s nor­mally stag­nant real es­tate market is in­flating by about 4.7% in 2012 and rising sharply.

The point of these ex­amples? Well as I say, I am not the only one who senses spec­u­lative bubbles are rap­idly in­flating. Could the Cypriot bail-​in and pos­sible con­sequen­tial bank runs be the trigger for an­other bang in at least one of these areas? What Cypriots will be more con­cerned with how­ever, is how they have overnight man­aged to be­come the latest vic­tims of “ex­cep­tional” meas­ures in the name of cre­ating a new, more “moral and dis­cip­lined” Cyprus, and what they are going to do about it.

I leave you with the fol­lowing quo­ta­tion about the Cypriot levy from Lars Seier Christensen, CEO of Saxo Bank:

This is full-​blown so­cialism and I still cannot be­lieve it really happened.

I am re­minded of the depu­ta­tion of Petrograd workers who de­clared to Lenin that they were on strike, to which the Chairman re­sponded, “You work for the workers now. How can you strike against yourselves?” Perhaps Mr Christensen should con­sider who is being hammered for not ac­cepting that they are now all fin­an­cial capitalists?

Ida Ince is an inde­pend­ent re­searcher in crit­ical legal fin­ance and has pre­vi­ously worked for many years in inter­na­tional finance.

  1 comment for “Cypriots Discover the Debt Jubilee

  1. Elena Loizidou
    17 March 2013 at 8:01 pm

    Thank you Ida for this!

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