A much better alternative for Cyprus

By Felix Salmon
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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It does not work because a restructuring of maturity of deposits is not equal to cash to boost the capital of the banks. The banks would still be short capital and the CDs would still count as liabilities on the banks’ balance sheets.

I guess the authors did not fully take in the enormity of what is proposed. We are talking about fresh, clean and crisp cash which flows from the saver into the coffers of the banks as fresh capital. It is like a monster capital increase with fresh cash and new shares.

Posted by lisandro | Report as abusive

Odd that the bondholders are exempt from the bailout process. Could it be that the German banks figure prominently amongst them?

Posted by Biscayne | Report as abusive

Biscayne: Cyprus has no bonds outstanding or almost none. Certainly not enough to worry German bankers. Also Cyprus banks have no bonds outstanding and due to EU banks. Their liabilities are almost all with the ECB and Rusian and Greeks banks/investors…

Your angle so true with Spanish and Italian and Irish banks does not apply to Cyprus.

Posted by lisandro | Report as abusive

>Why is the government’s promise to foreign hedge funds more important than its promise to its own citizens?

Because most of Cyprus’s debt is issued under English law and default on those bonds would make them the next Argentina. They did their homework and came out ahead, simple as that.

Posted by qusma | Report as abusive

Felix, why don’t you suggest that Putin bail out Cyprus. Most of the money, more than 60%, on deposit with the Cypriot banks is Russian from his and his colleagues. Even several State owned Corporates like Transneft and Gasprom have deposits and, btw, I know several Greeks living in London who are “debtors” to the tune of hundreds of millions to the three banks and have never paid a dime in interest the last three years… They are on the other side, hoping Parliament “rejects” the levy and forces a bankruptcy.

Posted by Bludde | Report as abusive

Every solution avoids real fiscal responsibility. All we have done is engineer ways to save the bond holders. The country of Cyprus and the citizens are simply getting screwed. Make the bond holders take a loss and move forward with a real, austere solution that paves the way to a brighter future. Set the precedent. What’s the big deal?

Posted by moxsee | Report as abusive

Excellent. Disregard the naysayers, they have an agenda.

Posted by ViEm | Report as abusive

“The Buchheit/Gulati plan would cost Germany no more than the current plan, so the Germans would have no good reason to veto.”

Sadly there is still a large incentive to veto. Merkel and Schäuble wanted to show strength. Out of fear of moral hazard and shortly before the election, with a anti-Euro-party emerging, no German party wants to bail out “Russian oligarchs”. Merkel does not have an own majority when it comes to bail-outs. So she would depend on the oposition, who clearly stated that they would only agree if there is a deposit hair cut.

So eventhough I think the plan is excellent (thanks for sharing) Merkel would veto it. The following scenarios are sadly more likely: http://gqjftw.blogspot.de/2013/03/charle s-wyplosz-presents-scenarios-how.html

Posted by GQJFTW | Report as abusive

“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.”

That one’s easy: Because small depositors don’t hang out at Davos with Andrew, and hedge fund managers do.

Posted by PeterPrinciple | Report as abusive

What is it about english law that prevents them from restructuring? Becoming the next Argentina? Argentina has been doing great, thank you, since refusing to pay. Cyprus could, too. The reason they cant default is that the issue here is not sovereign debt, because the Cyprus government is not too heavily indebted, it is the banks. I would say, do not mistake Ireland made, screw the bank creditors, and so what if in this case it means depositors (russian or whoever), but once again, the government should step in and honor the guarantee up to 100K euros. This guarantee is, by the way, legally required under EU rules. So if 50% haircaut is required for big depositors so be it, it is legally and logically the only possible outcome.

Posted by Kostas74 | Report as abusive

Cyprus will ultimately be forced to default, repudiate and redenominate. The rest is theater.

Posted by nixonfan | Report as abusive

Agree with the respecting of th guarantee to €100k.

Everything else should be wiped out. Shareholders, bondholders, depositors with more than that.

Eventually cyprus must default. But so, evenetually must UK, US, Japan.

If you look at the Landesbanken, much of the German financial system is also insolvent.

Posted by Urban_Guerilla | Report as abusive

The CD plan is apparently just abandoning the bailout and putting the obligations over 100k euros on hold. It’s just a postponement – the same thing would be accomplished by saying that those big deposits just won’t be returned for five or ten years. The assumption is that Cyprus will somehow straighten things out in the meantime, despite the fact that they don’t actually have anywhere near that much money now. In order to straighten things out, that is accumulate the money to pay off the depositors, they will have to devote their income from gas – and probably anything else – to the banks for that period of time rather than to Cypriots. This may look good to Buchheit, but if Cypriots understand it they will certainly reject being slaves to the banks for the next 5-10 years. This is apparently another trick to make it look like the vanished money is really there.

Posted by ytwod3621 | Report as abusive

The bankers blew the money, but since bankers are still in control at all levels they’re going to try to make somebody else restore it. It could be in the form of bailouts from the taxpayers of rich countries – for which it would probably be a drop in the bucket – or by having Cyprus devote its GDP to restoring it. Not only may Cypriots reject this in favor of default, but others may not have perfect confidence in the ability or actual willingness of Cyprus to make up the money.

Posted by ytwod3621 | Report as abusive

What this means is the situation breaks one of two ways.

If Russia chooses they could act as a white knight and refinance their 2.5BN to say 20BN so Cyprus does not need any EU money as long as Cyprus leave private Russian money untouched and give Gasprom the gas exploration rights.

The rationale being that Cyprus is far too useful as a tax haven within the Eurozone for Russian money to be allowed to fail, and there is also a strategic advantage in securing the gas rights.

In this scenario there would be no haircuts to private deposits, and while there would probably be some short term capital controls to limit volatility there would be no losses. Also as the russians would want their set up operating asap, it would be stable pretty quickly, as the oligarchs would fall into line if the Russian Gov’t are backing cypriot economy.


Cyprus can cut all ties with Russians, meaning they would give a haircut to the Russian HNW, and also need to repay the 2.5BN EURO to the Russian Govt.

In this instance they still have to guarantee all 100k EURO deposits in order to get a vote through their own parliament, so give a haircut of prob 25% on 100k+ deposits, no longer operate as a banking haven for Russians and pay out 2.5BN loan to Russians in process

In this scenario there would be a big freeze probably between the EU & Russia and the Cypriot economy would take a hammering, and the capital controls would probably be more severe as there is little else in the cypriot economy, probably lasting years until the gas proceeds can start to kickstart the economy.

Posted by Global_Citizen | Report as abusive


Posted by SLO-CHO | Report as abusive