Troika Tough Love

The news out of Cyprus this morning is not encouraging. Proposals -- such as issuing new bonds based on the confiscation of state-run pension funds or using Church of Cyprus property as collateral to issue new bonds or selling offshore gas exploration rights to Gazprom -- cobbled together to satisfy troika (ECB, IMF and the European Commission) demands to raise 5.8 billions euros seemed to have fallen flat. The ECB, from a story this morning by Liz Alderman, proclaimed that if by Monday there is no deal it will cut off funding. According to a naked capitalism post this morning, "ECB to Push Cyprus over the Brink,"

This is tantamount to cutting off its central bank and pushing it out of Eurozone if it does not capitulate. 

During the day yesterday, Eurozone officials made it clear that they would not accept some other ideas that Cyprus had developed to try to shield depositors, such as accessing pensions fund assets, restructuring the two largest banks, and selling its gas rights to Russia. This was deemed unacceptable in that it would increase debt levels. The fallacy, of course, is that the Trokia is unduly obsessed with the numerator of this equation (the borrowings) and not the denominator (the impact on the economy). Cyprus.com estimates the impact of trashing the banking system to be a minimum 20% contraction of GDP in two years. And mind you, this is after Cyprus was a good Eurozone citizen and sent €3 billion to help the Greek government.

The ECB has given Cyprus virtually no runway. It’s a deal by end of Monday or off with their heads. Given the difficulty of cobbling anything else together, this would seem to force Cyprus into only being able to structure yet another variant of the “rape depositors” plan. They seem either to rely on a reaction like the US had to the TARP, to having Congress capitulate after the markets swooner, or perhaps they sincerely believe that even a worse case scenario, of dumping Cyprus out of the Eurozone, is acceptable because it will tell all those lazy Latins that they’d better not even think of crossing the Troika. (It’s inconceivable that a forced Cyprus exit would not lead to deposit flight from Portugal and Spain, which will pressure the Eurozone tremendously. They’ve really drunk their own “Cyprus is a special case” PR if so.)

According to Alderman people are already queuing up in front of ATMs this morning in Nicosia:

Meanwhile, the mood turned sour on the streets of Nicosia, the Cypriot capital, where people flocked to cash machines Thursday morning to withdraw as much money as possible after the government declared that banks would remain closed until next Tuesday to give officials time to renegotiate the bailout deal.

The tough love approach that the troika is taking with Cyprus only makes sense as homeopathic quakery. Take a tiny member of the eurozone and implement a bank levy. When the patient, the eurozone, survives the patient will be healthier. Then move on to the next country and repeat the cure. The gamble here is that bank runs can be contained.