Cyprus and Capital Controls

Having failed to agree a bank resolution regime more than four years into the Eurozone banking crisis, the EZ authorities have, at the second attempt, come up with a resolution of the Cypriot banks. The haircuts of uninsured bank creditors appear to be 60% and more.

After a bank resolution, the surviving banks are solvent. Naturally, depositors may feel sore, and there could be deposit flight as soon as they re-open, even where the haircuts have been severe enough to make them adequately capitalised again. But not to worry, the central bank is there to deal with irrational deposit flight. It is after all the lender of last resort.

But lo and behold, the Cypriot government has imposed capital controls – even insured deposits not facing a haircut are restricted. But since the written-down assets of the surviving banks are now in excess of their liabilities (they have been resolved) these assets will be money-good at the central bank.

Not so apparently. If the ECB believes that the surviving Cypriot banks are now solvent, why is there any need for restrictions on depositor withdrawals? Is the ECB prohibiting liquidity provision through ELA after a bank resolution to which it has been a party? 

Of course the haircuts may, in the eyes of the ECB, be inadequate to ensure solvency. In which case why is the deal not modified further? Capital controls effectively create an inconvertible currency trapped in Cypriot banks, a precedent likely to be remembered when trouble strikes elsewhere. Do re-opening US banks decline to release deposits after the Feds have done their work, for the want of a lender of last resort?

Simon Wren-Lewis on Buti and Carnot

Simon Wren-Lewis has a typically thoughtful post on the European Commission’s approach to fiscal adjustment as set out by Buti and Carnot in a post linked to by Philip a couple of weeks back.   In the context of the zero lower bound constraint on monetary policy, it is hard to disagree with him on the inappropriate aggregate stance of eurozone fiscal policy.  

But I think his discussion neglects an important second dimension of the challenge faced by the Commission (and indeed the ECB).   In addition to being in recession, the fiscal lender of resort (LOLR) function is still a work in progress.   This function has come a considerable way since early 2011, when a hard line on official creditor seniority, and the threat of a low trigger for PSI in future bail out programmes, pushed Ireland  and Portugal – followed not far behind by Italy and Spain – deep into “bad equilibrium” territory.   (Some thoughts from the time here.)   In strengthening the lender of last function, the Commission is constrained by the concerns of stronger countries about the fiscal risks they are taking on, which they see as further aggravated by moral hazard.  

(Sometimes I do wonder if the reluctance on LOLR can be fully explained by conflicting interests.   Although it relates more to banking side, the recent comments – even if partially retracted – by the new Eurogroup head does give cause for concern about the appreciation for the importance of the LOLR for avoiding a serious escalation of the eurozone crisis.)   

The Fiscal Treaty, for example, must be seen as part of the quid pro quo for developing the LOLR.   The ESM – absent some of the more damaging elements of the original proposal – and the ECB’s OMT programme would be unlikely without the strengthening of the rules-based framework.    This must be balanced by the Commission against unwelcome implications of the rules for the aggregate fiscal stance.  

Given their advocacy for a strengthened LOLR, I do think the Commission sometimes gets a bum rap.

Political asymmetries and EMU

In a must-read article, Chris Pissarides states that “far from the currency bloc acting as a partnership of equals, it is a disjointed group of countries where the national interests of the big nations stand higher than the interests of the whole.”

This sums up perfectly where the European project is today. Indeed, there isn’t even solidarity among the smaller countries, as Malta and Luxembourg seek to distance themselves from Cyprus, reminding us of many similar protestations by individual PIIGS in the past, Ireland included. Not that it did any of them any good.

Was it not bizarre to see so many anti-German posters in Nicosia last week, when by all accounts it was the Cypriot President (among others) who wanted to see small depositors hit? Actually, no, it wasn’t. We have seen several statements by German politicians saying that the Cypriot business model is dead, and I’m sorry, but irrespective of the rights and wrongs of the issue this is simply unacceptable. The IMF has the right, and duty, to opine on such matters. So does the ECB, which is supposed to care about financial stability, whatever about how it behaves in practice. Perhaps one could find a rationale for the Commission, or maybe even the Eurogroup, to express an opinion on matters such as this. But an individual member state? Formally speaking, and in any club such formalities matter, it’s none of their business. Even if it is an election year.

The EU is supposed to work according to a set of well-understood principles. If we want to re-regulate the banking sector, and we should, then the recent decision to cap bankers’ bonuses is an example of how the system is supposed to work (again, irrespective of the merits of the issue). There are proposals, there is a vote, there is a decision. Fine. I’ll have more of that please.

But that is not what we are seeing here.

It might be less difficult to swallow if the German government were caped crusaders seeking to bring the entire European financial system to heel. But we all know who has been undermining the drive to have a meaningful European system of banking supervision, and it isn’t Cyprus. And is Mr Schaüble really going to try to prevent German banks from touting for business in that island, as the FT recently reported? I don’t think so. None of this means that Merkel and Schaüble are any worse than anyone else’s politicians, but if you are the arbiter of other countries’ fates, and you aren’t any better either, then there’s going to be a backlash. Which is terrible news for Germany in the long run.

My quote of the week is from another must-read article, this time by Wolfgang Münchau, who says that

I have believed for some time that it is impossible for Germany, Finland and the Netherlands to be in a monetary union with Cyprus, Greece and Portugal. Either the two sides agree to adjust more symmetrically, politically and economically, or this experiment should end.

The argument about economically asymmetric adjustment has at this stage been done to death, and almost everyone understands it, although the German government remains resolutely, proudly, and vocally, macroeconomically illiterate. Another reason why anti-German posters at mass demonstrations are something that we will have to get used to, which is tragic. But Wolfgang’s point about politically asymmetric adjustment is just as important, and gets to the heart of the matter.

When the EU club works according to its rules, people accept the outcomes, but in crises policies are made on the hoof, and it is the powerful who call the shots. This is inevitable, but it is also very dangerous, especially since the decisions that are made at times like this have a much bigger impact on peoples’ lives than anything that typically comes out of Brussels. We have been in crisis mode for much too long now, the crisis shows no signs of going away any time soon, and the political asymmetry is becoming intolerable.

A meaningful banking union, that had the power to stick its nose into the German banking system, and had a set of ex ante mutually agreed principles regarding how to resolve banks in all member states, would help reduce political asymmetries. More expansionary monetary and fiscal policies would help make economic adjustment more symmetric. I suspect we’re going to get neither, in which case we need to end the EMU experiment before it drags the broader European project down with it.

The political benefits of staying in the Euro

On balance I agree with Paul Krugman’s views on whether Cyprus should leave the euro or not. And most people seem to also agree with him that there will be a Cypriot public debt crisis in the not too distant future. Given what is about to happen to their GDP, how could it be otherwise?

As regards the political benefits to Cyprus of staying in the Eurozone, which Paul advances as a possible counter-argument: the Telegraph links to a piece from the Netherlands suggesting that the EU is contemplating earmarking those future Cypriot gas revenues the island has been looking forward to, to ensure that the Troika gets its money back.

Completely logical, and utterly destructive.

There’s a Hole in the System (Gavin Kostick)

For those unfamiliar with the original – see here.

Gavin Kostick’s latest:

There’s a hole in the system, dear Draghi, dear Draghi,
There’s a hole in the system, dear Draghi: a hole.

Then fill it dear Olli, dear Olli, dear Olli,
Then fill it dear Olli, dear Olli: fix it.

With what shall I fill it, dear Draghi, dear Draghi,
With what shall I fill it, dear Draghi: with what?

With taxes dear Olli, dear Olli, dear Olli,
With taxes dear Olli, dear Olli: try tax!

But the tax take is falling, dear Draghi, dear Draghi,
But the tax take is falling, dear Draghi: it falls!

Increase them dear Olli, dear Olli, dear Olli,
Increase them dear Olli, dear Olli: whack’em on!

But tax take falls more now, dear Draghi, dear Draghi,
But the tax falls more now, dear Draghi: it fell!

Squeeze the sovereigns, dear Olli, dear Olli, dear Olli,
Squeeze the sovereigns dear Olli, dear Olli: squeeze them!

But the sovereigns are bursting, they’re bursting, they’re bursting,
But the sovereigns are bursting, they’re bursting: some burst!

Try the savers, dear Olli, dear Olli, dear Olli,
Try the savers dear Olli, dear Olli: try them!

The hole just got bigger, got bigger, got bigger,
The hole just got bigger, got bigger: it grew!

Then the bondies, dear Olli, dear Olli, dear Olli,
If you must it’s the bondies, it’s the bondies: burn them!

Now the system is creaking, is creaking, is creaking,
Now the whole system is dear, dear Draghi: it creaks!

[female voice]

Inflate it dear Draghi, dear Draghi, dear Draghi,
Inflate the system it dear Draghi, dear Draghi: inflate!

But I don’t have a mandate dear Christine, dear Christine,
But I don’t have a mandate dear Christine: don’t ask!

Well then print it, dear Draghi, dear Draghi, dear Draghi,
Well then print it dear Draghi, dear Draghi: please print.

But we don’t have a printer, dear Christine, dear Christine,
We don’t have a printer, dear Christine: there’s no ink!

Well who make money, dear Draghi, dear Draghi?
Well who can make money, dear Draghi: who can?!

Well the banks are supposed to, dear Christine, dear Christine,
Well the banks are that system, the banks: that’s who!

[All together now]

But there’s a hole in the system, dear Draghi, dear Draghi,
There’s a hole in the system, dear Draghi – a hole!

Dijsselbloem on bail-ins (or not)

Some comments made today by Eurogroup President Jeroen Dijsselbloem reported here are worth reading.

We should aim at a situation where we will never need to even consider direct recapitalisation…If we have even more instruments in terms of bail-in and how far we can go on bail-in, the need for direct recap will become smaller and smaller

Now we’re going down the bail-in track and I’m pretty confident that the markets will see this as a sensible, very concentrated and direct approach instead of a more general approach…It will force all financial institutions, as well as investors, to think about the risks they are taking on because they will now have to realise that it may also hurt them. The risks might come towards them.

A subsequently released statement suggested some draw back from his earlier comments.

Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.

Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.

Save the Date Reminder: May 23rd Conference on Bank Resolution Mechanisms

Co-organizer John Cotter and I are pleased to announce a superb line-up of speakers for the FMC2 half-day conference on bank resolutions mechanisms on Thursday, May 23rd at the Irish Institute of Bankers. To sign up for attendance at the conference, please contact Admission is free.

Continue reading “Save the Date Reminder: May 23rd Conference on Bank Resolution Mechanisms”

Are we not already seeing the mother of all financial crises?

A genuine question, to which many reasonable answers are no doubt possible:

If this is the cost of leaving the Euro, then what is the opportunity cost of Cyprus leaving the Euro now?

(I mean the opportunity cost to Cyprus, not the rest of us, which is the only thing that should concern Cypriots in a union where it is every nation for itself.)

Cyprus: Plan B

The Eurogroup statement following last night’s meeting on Cyprus can be read here.

Laiki bank is going to put into resolution with shareholders, bondholders and uninsured depositors taking the hit.  The losses for depositors will be determined over the coming weeks but could be up to 40%.

Insured deposits of less than €100,000 will be moved to the Bank of Cyprus.  Bank of Cyprus will be recapitalised via a debt-for-equity swap with bondholders and uninsured depositors.  Junior bonds will be cut.

The official loans to be provided remain at €10 billion though no contribution from the IMF is currently in place.  Some financial assistance from Russia is expected.  Capital controls will be implemented.

This agreement does not require a vote in the Cypriot parliament and, although not confirmed, it is likely that the amount to be raised from the banking measures is greater than €5.8 billion.  All insured deposits of less than €100,000 will be protected. 

So how does Plan B compare to Plan A?

The Cypriot fiasco

Colm McCarthy has a terrific piece in today’s Sunday Independent.

To his comments about money laundering hardly being something confined to Cyprus, I would add the following link.

It seems that we still don’t know how this crisis is going to end. But here is one big dilemma that I see. Implicit in Colm’s article is a recognition that a meaningful banking union is a pre-requisite for a sustainable EMU. That means common supervision, a centrally-funded deposit insurance system, and a common, tax-payer-friendly, and (where necessary) jointly funded resolution system. The core reference on banking union remains this piece by Pisani-Ferry, Sapir and Véron. This past week’s events have clearly reinforced the case for such a banking union, which necessarily involves some element of fiscal union. Without it, EMU is a dangerous place to be.

And here is the dilemma (aside from the fact that it is being made increasingly clear that the Germans are never going to be convinced that such a system would be one involving mutual insurance, rather than one-way transfers, and that the idea of a meaningful banking union may therefore be dead in the water in any event). Do the rest of us want to get even more deeply involved with a Eurozone whose decision makers are as incompetent as this lot? And do those of us who live in small countries really want to get more deeply involved in a club in which big, powerful countries and small, weak countries are not treated as equal members?

Update: according to the FT, German banks (among others) are going after the Russian business that has up to now been located in Cyprus.

Whatever it takes to save the euro?

This interview with Athanasios Orphanides will ring a few bells in Dublin. I remember in the autumn of 2010, when the ECB in a similar fashion threatened to pull the plug on the Irish banking system, thinking that this was not a credible threat, since such action would de facto mean expelling Ireland from the Eurozone. Would an unelected bunch of central bankers really be willing to do something so political?

I can understand why Irish policymakers were not willing to test this logic at the time, even though I was very angry with them for giving in to ECB pressure not to burn the Irish banking system’s creditors, and still think they shouldn’t have done so.

One thing seems certain however. The ECB cannot have it both ways. It cannot simultaneously threaten to expel a member state from the Eurozone, and also expect us to believe that it will do “whatever it takes” to save the euro.

What investors (and, to be honest, I) have forgotten is that Draghi qualified his pledge: the ECB would do whatever it takes “within its mandate”. It isn’t clear that investors will continue to believe that “it will be enough”.

Spring 2013 Brookings Panel on Economic Activity

papers here.   Includes:

Portuguese Economic Slump Caused by the Large Capital Inflows that Came with the Euro
Clues as to What is Happening Europe-wide; Outlook for the Future is Grim
by Ricardo Reis

Over the past 12 years, Portugal has been in a severe economic slump—growing less than the US during the Great Depression and Japan during the Lost Decade—and that slump was mainly caused by the country’s inability to efficiently allocate the foreign capital inflows it received after joining the Eurozone in 1999, according to “The Portuguese Slump and Crash and the Euro-Crisis.” Because Portugal was one of the first countries where the symptoms of the sovereign debt crisis were initially identified, it can help macroeconomists understand what has been happening in Europe more broadly. Portugal did not have a housing boom like Spain and Ireland, nor as rampant an increase in public debt as Greece, nor does it have Italian political instability: yet, since 2010, all five countries have been in a similar crisis.

2012 National Accounts data

The new release is here.

  • 2012 nominal GDP and GNP ahead of projections used in December’s budget  (163,595/133,403 versus 163,150/130,850)
  • 2012 real growth rates were 0.9% for GDP and a remarkable 3.4% for GNP
  • Caveat –  GNP is not straightforward to interpret.  A quirk of national accounting is that the overseas profits of a firm that is headquartered in Ireland are included even if all of the shareholders are foreign. In relation to portfolio shareholders (ie holding less than 10 percent stake), GNP is then reduced when dividend payments are made to shareholders.  So,  GNP can be temporarily boosted if such a firm chooses to retain earnings rather than pass along earnings to shareholders through dividend payments.  This may be empirically relevant for Ireland in view of the pattern of some global firms opting to establish headquarters in Ireland.

Q4 National Accounts/Preliminary 2012 Results

The CSO have published the Q4 2012 Quarterly National Accounts and Balance of Payments both of which contain preliminary full-year results for 2012.

In Q4, it is estimated that real GDP was flat (though is recorded as –0.0% and it can seen that the reported decline is –0.047%), while real GNP fell 0.8% in the quarter.  The first estimates of the Q3 changes published in December have both been revised down, from +0.2% to –0.4% for GDP and from –0.4% to –0.8% for GNP.  Two GDP contractions in a row mean that Ireland once again satisfies the technical definition for a recession – for the first time since Q4 2009 (though only because of the very small decline in Q4 which is subject to revision).

The preliminary estimate is that annual real GDP growth in 2012 was 0.9%.  Real GNP was 3.4% higher in 2012.

For debt contracts, the level of 2012 nominal GDP is estimated to be €163.6 billion.  Nominal GDP is estimated to have grown 2.9% in the year.  Nominal GNP is put at €133.4 billion, up 5.0% on 2011.

In real terms, Personal Consumption Expenditure fell 1.6% in the year, Investment rose 1.2% and there was an 3.7% annual fall in the measure of Government Expenditure included in the accounts.

The measure of real Final Domestic Demand fell 1.2%, the fifth consecutive annual decline.  This measure is sometimes used to reflect the performance of the “domestic” (i.e. non-MNC) economy but it includes the Investment of MNCs which is volatile due to the purchases of aircraft by aviation leasing firms based in Ireland.  By definition, Final Domestic Demand omits the export performance of indigenous Irish firms.

Exports in 2012 were 2.9% higher than in 2011. Goods exports were down 2.8% while service exports rose 7.9%.  Imports were 0.3% up in 2012.  Goods imports were down 2.7% with service imports up 2.0%.

Exports are 108% of GDP; imports are 84% of GDP.  Although not in these figures we know that around 90% of exports are created in the MNC sector, with the top 10 companies accounting for one-third of the total.

In the Balance of Payments the estimated current account surplus for 2012 is 4.9% of GDP up from a 1.1% of GDP surplus in 2011.

Ireland continues to be a massive importer of intellectual property with Royalties/Licenses contributing €32.0 billion to service imports (€29.2 billion in 2011).  On the other side €36.5 billion of Computer Services exports were recorded, a 14.7% increase on €31.8 billion of such exports recorded in 2011.  The balance of services improved from -€1.8 billion in 2011 to +€2.9 billion in 2012.  This has driven the increase in GDP.

GNP is up by more because net factor outflows improved from –€31.7 billion in 2011 to -€28.9 billion in 2012.  The driver of this change was an increase in the inflows of factor incomes from €55.9 billion to €58.1 billion.  Outflows of income went from €87.7 billion to €88.2 billion.  The residency of companies may be a factor in explaining the rise in income inflows.

Separately, Eurostat has released regional GDP figures (albeit for 2010).  Per capita GDP in the Border, Midlands and Western region was 85% of the EU average.  For the Southern and Eastern region per capita GDP was 145% of the EU average.

Bank guarantees: how to make matters even worse

I can’t quite believe that the EC has said this, but they apparently have. Unbelievable. Its obvious implication is that bank runs in troubled countries, if they ever happen, now risk being nation-wide, rather than limited to failing banks. Hat tip Eurointelligence, who call the statement hugely damaging, and Gavin Kostick in the comments.

Gary O’Callaghan on conveniently flexible moralising

I thought I would hoist this comment by Gary O’Callaghan onto the front page:

Karl observes in his article that Ireland’s citizens must be feeling foolish today: “After being reassured time and again that all depositors and senior bond creditors of … Anglo Irish Bank must be saved in the name of European financial stability, they find out that Europe’s leaders now believe hair-cutting depositors is fine and fair and doesn’t cause contagion.”

In a related dynamic, there appears to have been a subtle turn by many commentators (including on this site) from the “serves them right” school of economics. That School, most righteously established by LBS, argued that Irish taxpayers should carry the can for bank losses because they “should have” sought better supervision on banks. Many from the same School now appear to argue that depositors (creditors) “should have” been more careful in the Cypriot case and deserve to suffer for their stupidity. Serves ‘em right!

Of course, there is a practical limit on the burden that Cypriot taxpayers can bear in this case but such considerations never bothered the LBS School before. Do they now grant that Irish taxpayers were not fully “to blame” (and that burden-sharing from bondholders was warranted)?

Would they now agree with Karl that “the moral grounds for a retrospective compensation deal for Ireland have increased substantially with this new development?”

The problem with theorizing from morals, of course, is that the ground can shift (and come back to meet you).

I am tempted to add that if we ask “cui bono”, there may be less inconsistency here than at first glance meets the eye.

The Value of Foreign-Currency Deposits

There are many angles to the Cyprus events.  One issue is the value of foreign-currency deposits:

1.  for a euro area investor, there will be some range of judgements about the relative safety of euro-denominated deposits in different euro area countries. If one wishes to shift into a non-euro deposit, currency fluctuations map into volatile returns once the conversion back into euro is taken into account (unless a currency hedge is also purchased).  Since summer 2012, both the dollar and sterling have depreciated by about 9 percent against the euro so foreign-currency deposits can experience significant capital losses (or gains).

2.  for a non-euro investor, holding a euro deposit carries the symmetric currency risk. For example, the rouble has appreciated by about 11 percent against the euro since summer 2009 (so that Russian investors in Cyprus have already experienced a significant capital loss over that time period). [The rouble depreciated by about 29 percent in late 2008 / early 2009, so euro deposits provided a very good hedge for Russian investors during the worst phase of the global crisis.]

3.  currency movements are not predictable so ex-ante expected returns can look similar across currencies (interest rate differentials are typically small across the major currencies) but ex-post realised returns can be very different.

Solvent countries are all alike; every insolvent country is insolvent in its own way

You leave the computer switched off during the holiday weekend, and look what the Eurozone does while you’re away! I guess we don’t know yet what the final outcome is going to be in Cyprus, and I fully share Sharon Bowles’ hopes that we haven’t seen the final word yet.

But if small depositors are going to take a hit, then, as a reminder of what we will have lost, here is a handy set of links to various EU documents and regulations regarding banking deposits. This citizen’s summary which reflects the media reports of the time helps explain why people have persisted in leaving their money in peripheral European banks for so long. It seems mad to tear this guarantee up on the grounds that Cyprus is sui generis, since as Tolstoy (almost) said…

Update: Tuesday morning, and we still don’t know what is going to happen; maybe the guarantee for savings of less than €100,000 will be honoured. But I fear that Karl and the many other commentators weighing in on the issue this morning are right, and that the long run reputation of the EU’s claim to guarantee such deposits will suffer a big hit as a result of this debacle, no matter what ultimately happens.

The Special Case of Cyprus

The deposit levy in Cyprus is a remarkable step in the management of the euro crisis – FT report here. Research on contagion indicates that it is limited if the ‘ground zero’ is sufficiently differentiated (and sufficiently ringfenced) from other potential targets.

Update: the WSJ provides a ‘blow by blow’ of how the deal was decided here.

By the way:  St Patrick’s Weekend / Ides of March is a regular date for crisis events

St Patricks Day (March 17)   (or I suppose the Ides of March – March15)

2006:  Icelandic banks under pressure

2008:  March 16/17 Bear Sterns takeover; also Anglo Irish shares fall 30% in one day (St Patricks Day Massacre)

2013:  Cyprus!