Tags: Cyprus | shareholders | bondholders | troika

Lesson From Cyprus: Proceed With Caution

By    |   Tuesday, 26 March 2013 09:42 AM

Once again, events in Europe and more specifically in Cyprus dominated the markets in recent days.

On Monday, jitters reappeared when the Financial Times and Reuters published an interview, which was recorded after the Troika (ECB, IMF and EU) agreed on providing a 10 billion euro ($13 billion) rescue package to Cyprus.

Dutch Minister of Finance Mr. Dijsselbloem, chairman of Eurogroup, the group of 17 finance ministers of the eurozone that exercises political control over the euro currency and related aspects of the EU's monetary union, stated: “Taking away the risk from the financial sector and taking it on to public shoulders is not the right approach … That’s an approach that I think we, now that we are out of the heat of the crisis, should consequently take.”

When Mr. Dijsselbloem says not all risks should be carried by the state or the taxpayer and that shareholders, bondholders and depositors could also contribute and adds this is a route he can defend, even when the financial sector doesn't like to hear it, we can say we are witnessing a regime change in the eurozone investors anywhere in the world shouldn’t take lightly.

We have been warned in time for what’s likely to happen in the future when banks in the eurozone will be obliged to reveal other “black holes,” which are surely out there.

No, the crisis is not over. I’m still convinced it will remain extremely difficult for the euro, in its actual concept, to remain “irreversible.”

Imposing a Troika “diktat” out of Brussels on small countries has been relatively easy. But wait until it will be a big country that is concerned. It’s not a question of “if,” but it’s a question of “when.”

It’s not an overstatement to say from now on the European Monetary Union “will try” to protect the taxpayers (of the core Nordic member states) and put close to the full burden of future bailouts of “troubled” banks on the shoulders of the investors and depositors in these banks. The EU bail-in approach is probably on its way to become permanent.

Maybe it’s not such a bad idea investors should keep in mind that 10 days ago, on Saturday, March 16, Mr. Dijsselbloem, at one of these press conferences in Brussels, declined to rule out taxes or levies (bail-in) in countries beyond Cyprus, notwithstanding adding at that moment such a measure was not actively considered.

German Finance Minister Wolfgang Schäuble said in Berlin he considered the “Cyprus solution” fair despite the massive burden on owners, creditors and customers of Cypriot banks. He emphasized the goal has always been to involve the over-indebted banking sector in the costs: “We have achieved what we always thought was right.”

With what we know today, I can’t see anything else than the “Cyprus solution” becoming an irreversible precedent in the euro zone.

As an investor I think it’s better not to err by thinking Mr. Dijsselbloem’s comments were a “slippage” from his part.

He is not alone in his way of thinking. Christine Lagarde of the IMF wanted during the negotiations both the Bank of Cyprus and the bank Laiki, which together represent about half of the Cypriot banking sector and about four times the size of the country’s total economy, to be closed down.

This is serious stuff and is certainly not a “one-off” or “unique” bail-in operation in the eurozone. Be prepared for the tail winds that still are developing.

Banks in Cyprus will remain closed at least ‘til Thursday and capital controls will be put in place to limit capital flight.

In the context of “The provisions of the Treaty on the Functioning of the European Union (TFEU)” article 26 (2) states that “the internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured…”

I’m really curious to see how authorities will legally justify capital controls in Cyprus and what kind of exceptions to the rules of free movement of capital will be presented. Maybe we could be on the verge of the creation of “de facto” two different kinds of euros, of which one could be the core or Germanic euro and the other euro could be like those now in "circulation" in bailed-in countries like Cyprus. Let’s hope it all doesn’t come to that. Cypriots are learning the hard way the difference between a free and a “frozen” euro.

Unfortunately, there is more to come. For the near future, look out for the troubled banking sector of Slovenia where bad loans represent about one-fifth of total economic output, and which could be next and become the sixth bail-in/bail-out eurozone very small member state.

And there is Italy, which could be on its way for new elections as there are no signs emerging it has a plausible solution to the current political deadlock.

Then there will be France at some date in the future and where troubles continue deepening and divergence with Germany continues growing.

It becomes clearer by the day those investors who want to avoid nasty surprises happening to their money or investment in banks in any place on the globe will have to do their very serious and extremely difficult homework on how solid and trustworthy their bank(s) is/are as well as its/their “location.”

The United States continues growing and still presents the best safe home for investors in a not-so-friendly neighborhood.

I still see a broad-based correction, albeit in different stages spread over several years, coming our way. Of course, I don’t have a crystal ball and I could be wrong.

Everybody has to define for himself or herself what “safe” really should mean and represent in case a crisis occurs. It isn’t easy to sort that out, also because of the very simple reason that today we all live in the worldwide kingdom of the “half-truths,” or even less.

Maybe it’s not such a bad idea for long-term investors to keep in mind President Ronald Reagan’s advice he frequently repeated: “Trust, but verify…”

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Once again, events in Europe and more specifically in Cyprus dominated the markets in recent days.
Tuesday, 26 March 2013 09:42 AM
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