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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