TMM continue to be staggered by just how confused the Eurogroup policy response has been, with the Germans et al running away from the deposit levy on small depositors at an Usain Bolt-like pace. Last night's statement in particular smacked of the imperialist European leadership tampering with the evidence. TMM still cannot fathom how the Troika could not see that such a policy move would go down so badly both in Cyprus and internationally - even the German press utterly slated the deal. Another case of the Germans refusing to listen to anyone - TMM have personal experience in dealing with German Finance Ministry officials, to whom the term "arrogant" simply cannot do justice to their intransigence nor their complete inability to understand that there is no magic source of exogenous demand that will fill the gaps left by their nuclear winter-like economic prescriptions.
If the newly-elected Cypriot government were not clearly so inexperienced and naive, TMM could almost imagine that they have played the politics of this blindingly, by supposedly applying the tax to small savers, the Germans have been saddled with the blame. It is hard to imagine the political outrage being so vehement had the tax only applied to uninsured depositors, and no amount of finger pointing or insisting "it wasn't us" is likely to undo this.
But whatever. We are here now, and given the cries from both the Troika & various commentators pointing out that you can't solve a debt crisis without hitting creditors, TMM thought they'd have their own go at formulating a crisis resolution plan for Cyprus.
In the light of the EU using the explicit threat of Euro exit, and seemingly this threat not being a bluff - indeed threatening to cut off ELA access is akin to forcing Cyprus out of the Euro - TMM are going to invoke a strategy that they believe would be advocated by the great Paul Nitze who helped formulate Cold War policy. And this is to respond in a similar radical way, gradually increasing the stakes. So here goes:
Cyprus needs EUR 17.5bn - 10bn for the banks, 6bn for debt rollovers & 1bn for deficit financing. The EU/IMF will supply 10bn, but for the moment, we are going to assume they will supply nothing, as TMM believe that their plan will go down like a cup of cold sick in Brussels & Frankfurt. But hey, shit happens, and they went nuclear on Cyprus - you reap what you sow...
TMM are going to draw on a two bank restructurings that have taken place since 2008: the first, Wachovia, where creditors of the holding company were hung out to dry as Wachovia Bank was seized & given to JPM. The second, Bradford & Bingley, where the deposits of the bank were sold to Santander & the "bad" part of the bank nationalised by the British government. The reason TMM bring these two restructurings up, is that we believe that Cyprus can do something similar. And before you say "Ah... but the only creditors are depositors", this isn't entirely so: Cypriot banks have accessed the ECB's ELA to the tune of about EUR 9.2bn.
So TMM propose the Cypriot Government do the following - they'll have to do it very quickly to avoid the ECB panicking and pulling back the ELA cash lent against dodgy collateral. Once done, the ECB will not be able to do anything about it.
- Transfer all bank deposits & unencumbered assets from the existing Cypriot banks to new bank holding companies: e.g. Cyprus Phoenix Bank. This should include the transfer of IT infrastructure, the branch network & any tangible assets like real estate (e.g. the banks' HQs).
- Let the old banks go bankrupt, leaving the ECB with EUR 9bn of losses and wiping out both the subordinated & senior bondholders (EUR 1.75bn).
- These new banks are now adequately capitalised & under EU law, the ECB will not be able to prevent their participation in Target 2 via the Central Bank of Cyprus. The ECB may well kick & scream, but there will be nothing they can do about it.
- Domestic Bills/Bonds haircut by 80% for non-Cypriot banks. Although their non-bank ownership is small, every little helps, & using JPM's ownership estimates, this would produce ~EUR 820m.
- The international bonds under UK (with a 75% CAC hurdle) are certainly tough to PSI, but let's all be realistic, there's no money left & government debt is at astronomically large amounts of GDP. TMM believe that Cyprus will be more successful than market punters reckon in restructuring this debt. And of course, they can also just unilaterally default on the debt. Again, an 80% haircut here sounds realistic, producing EUR 3.04bn.
- Adding the Gas reserve privatisation (which JPM estimate at EUR 4.2bn), TMM have found EUR 18.9bn.
- Cyprus could also, of course negotiate with the Russians to restructure the EUR 2.5bn loan, and if they are able to get say 20% NPV reduction on this, they could make the terms on the international bond restructuring less-onerous.
This approach also reduces the extremely negative economic effect that an upfront wealth shock imposes upon consumption, and also will to some degree reduce the ballcrenching tightening of monetary conditions as Cyprus' deposit base flees the country. Many have pointed out that inflation (e.g. in the UK) has the same net effect in terms of imposing costs on creditors, but this is not entirely true: moderate inflation & negative real rates as seen in the UK smooth the deleveraging process so that monetary conditions remain loose and the negative wealth effect is more gradual. The Troika's proposal for Cyprus does the complete opposite as it will ensure extremely tight monetary policy as the money supply evaporates, and provide a large one of hit to consumption via the wealth effect. In TMM's view this will merely result in Cyprus' recession becoming much deeper and its debt level blowing out once more to the point of needing a second bail out programme. Once again, this is the result of the Germans' inability to understand that there is no magical source of exogenous demand.