Saturday, 30 March 2013

08:35 – The situation in Cyprus is rapidly turning worse, a lot worse. On Thursday, the government was saying that capital controls would be in effect for a week; on Friday, they were saying capital controls would be in effect for a month. In reality, they’re likely to be in effect forever. I’m trying to think of even one example where capital controls were removed once implemented. The most recent close example is Iceland, which announced “temporary” capital controls at the start of its banking crisis. Five years later, they’re still in effect. And the knock-on effects of Cyprus imposing capital controls is already being felt in Malta, which also has an out-sized banking sector. Even Luxembourg, which has the highest GDP in the world, is extremely concerned, and rightly so since its banking system is more highly leveraged than any other in the world. And capital flight from southern-tier banks continues to accelerate. No sane person wants to keep their assets in southern-tier banks, so they’re moving them to German, Dutch, and other northern-tier banks as fast as they can, making the imbalance steadily worse.

And the situation in Cyprus itself continues to deteriorate quickly. The second-largest bank, Popular Bank, is in the process of being shut down. Accounts of €100,000 and under are being transferred to Bank of Cyprus, the largest bank. Equity and bond holders in Popular Bank lose 100% of their investment, except the ECB, which holds about €9 billion of Popular Bank debt. That debt is also being transferred to Bank of Cyprus, and is sufficient to doom that bank. Meanwhile, Cyprus announced yesterday that the “haircut” to be suffered by unsecured Bank of Cyprus creditors (other than the ECB) will be a nominal 62.5%. It’s actually much worse than that, because the remaining 37.5% will be converted to shares in the Bank of Cyprus at an inflated valuation, which shares are already nearly worthless and will quickly become entirely so. So, excepting of course the ECB, unsecured creditors in Popular Bank will suffer a 100% haircut, while unsecured creditors in Bank of Cyprus will suffer a nominal 62.5% haircut, which in reality is a 100% haircut, or so close to that as not to matter.