A much better alternative for Cyprus

March 19, 2013

Andrew Ross Sorkin defends the Cyprus deal today, on the grounds that (a) Cyprus is “tiny”, and “largely irrelevant to the global economy”; (b) Cyprus is a genuinely unique case; (c) it would be grossly unfair not to bail in Russian depositors, who are generally losing less than they’ve made in interest over the past few years; and (d) the Greek alternative “will not work in Cyprus”, and that therefore (this last bit is only implied, never stated outright) the current plan is really the only option.

Notably, Sorkin doesn’t attempt to defend the most indefensible part of the plan — the confiscation of wealth from depositors with sovereign deposit guarantees. While hedge-fund bondholders will get paid their full $1.4 billion on June 3, the date of Cyprus’s next coupon payment, small depositors with just a few hundred or a few thousand euros in savings will lose money which the Cypriot government had promised them was safe. Why is the government’s promise to foreign hedge funds more important than its promise to its own citizens? Sorkin never attempts an answer to that one.

And even if Cyprus is tiny and irrelevant to Andrew Ross Sorkin, it most certainly isn’t tiny and irrelevant to the hundreds of thousands of people who live there, and deserve for their government to deliver the best possible plan it can.

Which raises the single biggest question facing the Cypriot parliament as it prepares to vote today: should it accept the deal on the table, or should it hold out for something better? And if it chooses the latter option — as seems likely — should it simply fiddle with the tax-rate percentages, much as one might fiddle with the Breakingviews Cyprus calculator, or should it try to build something which is more different and more fair? Most importantly, what alternatives does Cyprus’s parliament have?

This is where Sorkin’s column is (at least in its implication) wrong: there is an alternative. It is clearly better, in every regard, than the option currently on the table. And it most emphatically is workable. We know that it’s workable because it has been put forward by none other than Lee Buchheit, the godfather of sovereign debt restructuring, and for decades, in dozens of sovereign contexts, every time that Lee Buchheit has said something can be done, he’s been absolutely right.

Here’s the short, three-page paper: it’s called Walking Back from Cyprus, and it’s authored by Buchheit and his frequent collaborator, Mitu Gulati of Duke University. Their plan is simple:

First, leave all deposits under €100,000 untouched. Hitting those deposits was by far the biggest mistake of the Cyprus plan as originally envisaged, and everybody would be extremely happy if guaranteed depositors could be kept whole.

Second, term out everybody else by five years, or ten if they prefer.

That’s it! That’s the whole plan, and it’s kinda genius. If you have bank deposits of more than €100,000, they will be converted into bank CDs, with a maturity of either five years or 10 years — your choice. If you pick the longer maturity, then your CD will be secured by future Cypriot gas revenues, which could amount to hundreds of billions of dollars.

And if you have sovereign bonds, they too will be termed out by five years, giving Cyprus a bit of breathing room to get its act together.

Do that, say Buchheit and Gulati, and you manage to reduce the size of the needed bailout by more than the €5.8 billion that Cyprus is currently planning to raise with its tax on bank deposits — and you don’t touch anybody’s principal at all. To be sure, the new CDs, which would be tradable, would surely trade at less than par: there would be a present-value haircut on deposits over €100,000. But that’s going to happen anyway. And at least in this case patient depositors will have a chance of getting all their money back in full — with interest. And, most importantly, guaranteed depositors will remain unscathed.

This is the deal that no one had the imagination to put on the table during all-night negotiations last week, and it makes a lot more sense than what we’re looking at right now. In the first round of negotiations, the Germans had the upper hand, presenting Cyprus with a take-it-or-leave-it deal. Buchheit and Gulati have now given the Cypriot parliament the opportunity to turn the tables: pass a bill along these lines, and tell the Germans to take it or leave it.

The Buchheit/Gulati plan would cost Germany no more than the current plan, so the Germans would have no good reason to veto. But if the Germans did veto, then the result would be a sovereign nation being forced to exit the Eurozone: the worst possible outcome of all. Given that kind of ultimatum, I suspect the Germans would sign on to the Cypriot plan.

The ball is in the Cypriot parliament’s court today, and most observers are expecting the current plan to go through, with a tweak here or there to the tax rates and the points at which they kick in. But Buchheit and Gulati have now given Cyprus’s parliament a clear Plan B. If the lawmakers want to reject the Eurogroup’s plan, they know what they must do.


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