The state of play in Cyprus is that negotiations in Parliament are underway, with the hope of a yes vote on a “Plan B” today (see update at the end, this is looking a lot rockier than conventional wisdom surmised). The Cypriot officialdom has allowed for slippage in this timetable, with the bank holiday in effect till Thursday. The latest events were largely a nothingburger, aside from the big news of the failure to approve the president’s plan yesterday: European ministers confirmed that they’ll approve an agreement so long as Cyrpus obtains €5.8 billion from depositors. Monday night, President Nicos Anastasiades gave his version of the Hank Paulson armageddon speech on national TV, laying out the fact that no deal means an immediate collapse of “one bank” (presumably Liaki), and a possible exit from the Eurozone.
The widespread assumption is that the Cypriots will fall into line, since the alternative really does look even uglier. But the runway is pretty short. The government could conceivably extend the bank holiday through Friday, which means through the weekend. But anything beyond that likely starts to eat at the real economy.
Moreover, even getting a deal still will have a big, negative economic impact in Cyprus. Deposits are certain to flee, so the bank crisis that was hoped to be averted is still a real possibility. After all, it is not clear that Cyprus will be out of the woods with this rescue; many experts expect further restructuings are in the works. Why sit around and let your ox be gored a second time? The Prodigal Greek (hat tip Guardian) notes:
No matter what today’s outcome, Cyprus’ banking system will not be the same ever again. If Germany’s intention was to reduce the size of it – closer to the eurozone average – they managed to achieve that with a masterful stroke in just one weekend.
Deposits flight combined with the sale of the Greek operations will probably leave the Cypriot banking system half the size it was on Friday night, even left with one systemic bank after restructuring.
Cannot see a smooth transition period without some form of capital controls.
By the time the dust settles, the Cypriot economy will sink and PIMCO’s adverse scenario will materialise. Many people did their best to make this a reality.
Felix Salmon takes issue with Andrew Ross Sorkin’s “those dirty Cypriots had it coming to them” for living in a tax haven. Ahem. People in glass houses should not throw stones. How exactly are tax evaders like GE and Apple any different than Russian oligarchs (some of whom evade taxes via perfectly legitimate big companies?) As Nicholas Shaxson pointed out in his book Treasure Islands, the biggest tax haven in the world is now run by the US, between Delaware and Wyoming corporations (you can hide ownership just as well via Wyoming limited liability corps as Isle of Man shells) and our friends in Caymans. By Sorkin’s logic, it would be OK to cram down everyone in Delaware because they benefitted from the local tax avoidance business.
Separately, Sorkin is way too sanguine about contagion risk. Did he miss that there was already destablizing deposit flight from the periphery, and only the successful OMT headfake of last September calmed nerves enough to put it to a stop? You don’t need lines at ATMs to bring a bank down; a slow big deposit drain will do that too if the bank has dodgy, illiquid assets. That is exactly what brought down WaMu, and plenty of Spanish banks have balance sheets at least as ugly.
But Salmon is also unduly enthusiastic about a hail Mary idea of having the Cyriot government vote through a plan to convert deposits over €100,000 to 5 or 10 year CDs, with the longer term ones secured by gas revenues. You could completely spare the under €100,000. Now I will say the plan is exceedingly clever and Salmon cheekily urges the Parliament to pass it and force the Eurocrats to dare to shoot Cyprus in the head with a perfectly reasonable, indeed better, plan on offer.
The problem is that this idea is altogether too late. I’ve been in a fair number of two party negotiations, and unless both sides trust each other a lot, radical new ideas at the 11th hour are generally seen as a sign of bad faith dealing. People have gotten locked into positions and find it psychologically difficult to budge. It’s even harder to get bigger groups on board. Given that Anastasiades is so afraid of rattling the Eurocrats that he felt the need to get their blessing merely for rearranging the deck chairs on his Titanic (shifting the amounts various depositors get whacked to meet the required €5.8 billion target), I doubt he would back this sort of idea, and without his support, I don’t see how this could get through Parliament (Salmon isn’t wrong in thinking the Germans would look like idiots to refuse this deal, but if the surplus countries feel they are being played by the Cypriots, don’t underestimate national prejudices overriding sensible reactions).
But there is another potential wild card, which is Russia. If nothing else, Putin is ripshit about not being included in the negotiations, as well as having all Russian activity depicted as money laundering. Some (much) undeniably is, but there are also Russian retirees living in Cyprus, and perfectly legitimate Russian companies who use Cyprus because it is an English law jurisdiction (as in a lot of international companies prefer entering into contracts with Russians in that jurisdiction; I know Americans who do deals regularly with Russians who operate this way). As the New York Times pointed out:
The din of criticism from Moscow signaled the importance of Cypriot offshore financing for the Russian economy. The island has long served as an escape valve for Russian businessmen. Some are surely dodging local taxes. Others, paradoxically, are seeking better courts in the British law system practiced in Cyprus.
Offshore domiciles are so ingrained in the post-Soviet way of doing business in Russia that Cypriot shell companies are linked not only with money launderers and organized crime, but well-established companies like the metals giant Norilsk Nickel.
In theory, Russia has a lot of leverage. It has a €2.5 billion loan to the government, and it has been asked to lower payments and extend the maturity. After making its displeasure with the deposit grab known, and convening an emergency ministerial meeting to contemplate what to do, it has pointedly said it has not made a decision about whether to restructure the loan, and is reconsidering its position. This is a comparatively small piece of the overall equation, but with all sides locked into positions and time running out, a Russian reversal would be a serious, potentially fatal complication. And Russia is going to be even more unhappy with a deal that hits Russian depositors even harder, which is the only sort of deal the Parliament might approve.
But as the Financial Times tells us the Russians do not want to blow Cyprus up, which is what they could do if they try flexing their muscles:
The main fear is blockages in money transfers from or through Cyprus as a result of the authorities stepping in to deal with a pending deposit run on the island, according to David Nangle, head of equity research for Renaissance Capital, a Moscow-based investment bank. While Russians own billions in Cyprus deposits, the island is far more important to the Russian economy as a conduit for financial flows – Russian money goes to Cyprus, where it gets advantageous tax treatment, and then back into Russia.
In all honesty, I’m not sure I buy that Cyprus is indispensable. It would take some doing to operate out of other tax havens, but Cyprus is not unique. But the cost of a meltdown would be much larger than any deal, and the Russians are also angling for a role in the development of gas reserves near Cyprus, so there are other considerations at work here.
My belief is that there are a lot of moving parts, and while it is perfectly rational for everyone to come to some sort of deal, the principals have a lousy negotiating dynamic at work. Russia has been excluded and is feeling angry and abused, and the Wall Street Journal description of the 10 hours negotiations that led to the original deal sound nightmarish: confused, chaotic, dysfunctional. It’s proof of the old notion that people (in this case finance ministers) should never negotiate their own deals unless they are super experienced negotiators (and pretty much everyone overestimates their negotiating skills). And these all-over-the-map negotiations took place when the principals were in the same location. It’s worse doing this sort of things by phone and e-mail.
So the odds are not trivial that a deal fails to come together, not because a pact is impossible (as in there is appears to be a bargaining space where everyone could find a solution they could swallow) but that the key actors will be unable to get to that agreement before time runs out. Stay tuned.
Update 8:30 AM: As I was drafting this post, Reuters released a story quoting President Anastasiades saying Parliament was likely to reject the revised bill. This is not what either Mr. Market or the Eurocrats anticipate. They assumed Anastasiades’ Hank Paulson armageddon speech plus rational self interest (as in recognizing that blowing up the entire banking system would cost the citizenry more) would lead to sullen acceptance of the inevitable, just the way the Greeks (and to a lesser extent, the Portuguese and Spanish) have accepted being put on the rack. Apparently a fast seizure of funds is harder for the public to accept than a sustained grind-down into penury. From Reuters (hat tip Richard Smith):
“The feeling I’m having is that the house is going to reject the bill,” President Nicos Anastasiades told reporters. Asked why, he added: “Because they feel and they think that it is unjust and it’s against the interests of Cyprus at large.”
Asked what he would do next, he said: “We have our own plans.”
Unless Gazprom is about to ride in to the rescue, this is trying to make the best of an empty hand.
Update #2 It appears that there will not be enough votes for the revised bailout, either (in fact no-one’s going to vote for it). Let’s see what the trailed ‘Plan B’ is, if the Eurogroup bailout isn’t going to fly. The Cyprus Finance Minister, Sarris, has reportedly resigned (funny, thought he was flying to Moscow today). There are rumours that the President has not accepted his resignation. The Euro is sharply weaker. UK’s Ministry of Defence making sure that the 3,500 British servicemen stationed in Cyprus have some spending money despite the bank holidays, by flying EUR1Mn over, in a jet.
Update #3 Revised bailout terms have been rejected by the Cyprus Parliament, as expected; 36 (or so, reports vary) vote against, 19 abstain. So now we really are on plan B, whatever that is. Meanwhile, the Cyprus Finance Minister, Sarris, denies having resigned. And he’s in Moscow. That gives a hint about Plan ‘B’…