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The Dance Continues



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The FT reports that the Cypriot president has flown to Brussels for ‘last-ditch’ talks:

“The negotiations are at a very delicate stage. The situation is very difficult and the time limits are very tight,” said Christos Stylianides, a government spokesperson [injecting a note of ‘tick tock’ for the ‘tick tock’ watchers I see in the comments section…]

After a tumultuous week, Cypriot officials believed they had reached a tentative deal with their lenders on Saturday. A centrepiece of that agreement was a 20 per cent levy on deposits of more than €100,000 at the country’s largest bank, Bank of Cyprus, as well as the winding down of the second-largest bank, Laiki.

But those parameters now appear to be in flux, Cypriot officials acknowledged on Sunday. “It seems that every time there’s an agreement on something, the troika opens something else,” one said. “It’s total confusion.”

Also in the FT Gavyn Davies sets out a strong argument for the notion that Cyprus is a ‘special case’:  

After all, everyone knows that Cyprus is a special case, given the size of its banking sector relative to GDP, its exposure to foreign depositors of questionable virtue and its concentration of bank lending to the collapsed Greek economy.

No other economy has that combination of disadvantages, which has made a conventional bank rescue impossible for the Cypriot government, and unacceptable to the rest of the eurozone, especially Germany. Bank depositors in Spain and Italy will presumably be aware of these unique features, and therefore more willing to view it as a special case.

Time will tell, but depositors everywhere now know that their “insurance” was not as good as they might have once hoped.

Back to Davies:

German Finance Minister Schauble even went as far as to say that in other countries small deposits are safe “only on the proviso that the states are solvent”. Does that not drive a coach and horses through the separation of banks and governments, which was one of the principal promises made by eurozone leaders at their crucial summit of June 29, 2012?

Depositors also know that capital controls within the euro zone are no longer the stuff of euroskeptic fantasy.

That’s why the folks over at Brueghel  are asking for something different:

By agreeing to capital controls, the Eurosystem is avoiding taking its responsibility as a liquidity provider of last resort to the banking system. In addition, Europe is breaching the Treaty which prohibits capital controls inside the monetary union.

 What should be done instead? The eurosystem should provide liquidity to replace all outflowing deposits as long as collateral is available. Collateral standards would certainly have to be lowered significantly as otherwise collateral standards would limit the amount of liquidity that could be provided, a point I made almost 2 years ago in this letter to FT (Lack of collateral will stop euro flows). At the same time, the Eurogroup should agree to an ESM programme similar to the one in Spain with very intrusive European Commission powers in bank restructuring.  De facto, the European institutions should take control of those banks in Cyprus that run out of eligible collateral. They should then do gradual bank resolution by selling assets of banks at an appropriate speed. Alternatively, if the value of assets is high, then the bank could also be sold to new investors. This will mean putting up more resources upfront but it may be not a big loss in the end as Cypriot bank assets cannot evaporate over night. If the ESM is effectively in control, it will improve confidence of the Eurosystem and allow for the type of liquidity provisions that will be necessary. Eventually, it will ensure that even in case of a collapse of the Cypriot financial system, the ESM would ensure the proper functioning of the payment system and essential banking services.

And that route is not impossible, particularly given the fanatical determination of the EU’s leadership to keep the euro going at almost all costs, a determination that helps explain why I went into the dread auditorium that is the NRO predictions symposium, and ‘forecast’ the single currency’s survival for 2011, 2012 and, yes, 2013.

One of the biggest risks to that survival has been the return of democratic politics to the euro zone. And, for the moment, that is (as the Daily Telegraph’s Liam Halligan notes) gathering pace:

The 36-0 rejection of Germany’s “savings tax” proposal by the Cypriot parliament amounted to a two-word message, the second part of which was “off”. Not only in Cyprus, but in Italy and Spain too, even in Germany itself, populist politicians are promoting “anti-euro” messages with growing confidence as patience with the “European project” wears thin.

So it will become even more difficult over the coming months for an insolvent eurozone nation to accept ultra-tough bond-buying requirements, or for Berlin to ease those conditions. If investors perceive the divide as too wide, and judge the activation of [ECB President] Draghi’s bond-buying as politically impossible, then all bets are off.

Tick tock (oh yes!)



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