Destruction of the Economy in Cyprus

One small Cyprus story this morning by Landon Thomas Jr., "Some Savers in Cyprus May Lose 60 Percent," buried on page B7 of the New York Times Busines section belies its importance. Deposits above 100,000 euros at the nation's largest bank, the Bank of Cyprus, will be confiscated to the tune of 60% to 77.5%. According to Thomas,

Over the past week, government officials have been saying that depositor losses would not exceed 40 percent — even though bankers and lawyers involved in the negotiations have been warning for some time that the final figure would need to be higher if the bank was to re emerge as a viable entity. 

Under the terms of the transaction, large depositors would have 77.5 percent of their savings turned into different forms of equity. 37.5 percent would be direct equity, in the bank with the rest coming in the form of securities that may convert into shares at a certain period. The remaining 22.5 percent would be a frozen, non-interest-bearing deposit that they would be able to access in the future. 

As a result of this arrangement, the bank’s largest depositors will initially become its major shareholders. 

If the bank does well, depositors would be able to sell their stock. But even in the best case, in which the bank thrives on the back of a quickly recovering economy — a long shot most economists believe — the loss is likely to exceed 60 percent and could well be much more than that. 

Lawyers and bankers who have analyzed the transaction believe the ultimate loss to the depositor could be anywhere between 60 and 77.5 percent.

To get a sense of the implications of this latest development check out today's must-read post by Yves Smith on naked capitalism, "Destruction of Cyprus Economy Proceeding Ahead of Schedule,"  which concludes as follows:

Now remember, Laiki and Bank of Cyprus were the core of the payments system in Cyprus. And it would be very difficult for a business of meaningful size not to have over €100,000 in deposits. If you freeze a significant majority of the commercial balances, how can you operate? How can these businesses even survive and pay each other? By e-mail, Antonis Polemitis of Ledra Capital teased out the implications:

If the Reuters story is correct, for the purposes of liquidity on Tuesday morning, that is a 100% haircut. 

If that is what they do, I am not sure how Cyprus can engage in economic activity on Tuesday without going to barter or scrips. 

I mean, that basically will mean 100% of the large deposits (all the business accounts) at Laiki and BoC are lost or not available as of next week. The Laiki wipe out may have been survivable. If you wipe (for liquidity purposes at least), both Laiki and BoC, then we are not talking about whether or not GDP drops X%, we are talking about ‘how do you actually engage in commerce?’ 

If they do this, there is little chance it can last more than a month — the economy will simply fail at even basic functions…

And if the plan has been accurately reported and plays out as Polemitis fears, it will undermine the “Cyprus is a special case” narrative. This Eurozone fiasco is making Geithner look good. The former Treasury secretary used the need to keep the confidence fairy alive as the excuse for any and every sop to the banks, from coddling miscreant executives to foaming the runway with mortgage borrowers to stealth bailouts. But the Eurocrats have completely ignored the impact of undermining confidence in the banking system. The fact that Cyprus has a decent-sized population of English retirees means that the British media will report on the Cyprus meltdown, which will be a stark contrast with Greece, where the economic devastation has not gotten the coverage it warrants. Grim accounts of the destruction wrought by the tender ministrations of the Troika should strengthen the position of the growing Euroskeptic sentiment in Italy, borne out by the success of Berlusconi and Grillo in the recent elections. Playing into the hands of Italian refuseniks should be the last thing Brussels and Berlin want. The cost of getting tough with Cyprus is likely to be far greater than they anticipate.

It's hard to find fault with this analysis, unless some sort of exception is made for business accounts, which is probably illegal (but capital controls in the eurozone were supposed to be illegal too). Bersani can't form a government in Italy. The next month should be a momentous one for Europe. Get those sell orders in.