MacroScope

Europe’s ‘democratic deficit’ evident in Cyprus bailout arrangement

The problem of a “democratic deficit” that might arise from the process of European integration has always been high on policymakers’ minds. The term even has its own Wikipedia entry.

As Cypriots waited patiently in line for banks to reopen after being shuttered for two weeks, the issue was brought to light with particular clarity, since the country’s bailout is widely seen as being imposed on it by richer, more powerful states, particularly Germany.

Luxembourg has accused the Germans of trying to impose “hegemony” on the euro zone.  The country, whose banking system, like Cyprus’, is very large relative to the economy’s tiny size, fears that similarly harsh treatment could be imposed on its depositors.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, says the broader point about the need for popular buy-in of economic policies is a crucial one:

Cyprus 2.0 was constructed in a way that allows an end-run around parliament. This is a shame and ultimately counter-productive. The lack of democratic legitimacy means that it will always taste like foreign imposition. It means that parliament will not take ownership for the program. It also shows that European officials to be still tone deaf, seemingly failing to realize monetary union is an elitist project and without strong public support is vulnerable to various populist movements from both the right and left.

One-off or precedent?

Cypriot banks were supposed to reopen today but they won’t and when they do capital controls will be slapped on to prevent money fleeing its borders (was that how the single currency zone and single market was supposed to work?) The controls are supposed to be temporary but the Icelandic experience showed that once imposed they can be devilishly hard to remove. It seems pretty certain that there will be a bank run when the doors are reopened, which is now slated for Thursday.

Dutch Eurogroup chief Jeroen Dijsselbloem gave markets a jolt yesterday. In an interview with Reuters he said in future, the onus would be put on banks to recapitalize and if they couldn’t “then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders”. He added that he wanted to get to a situation where the euro zone never needed to use its ESM rescue fund to recapitalize banks directly – a plan that was created last year at the height of the crisis. That all seemed crystal clear but after some adverse market reaction a later statement was put out on his behalf reverting to the earlier line that Cyprus was a one-off case.

So which is it? One-off or precedent? With a banking system eight times the size of its economy and awash with foreign money Cyprus clearly is unlike any of its euro zone peers. But it’s been also clear for some time now that Germany and other northern Europeans don’t want taxpayers to be on the hook for future bailouts and are not keen on using the ESM to recapitalize banks (that was supposed to break the doom loop between weak banks and sovereigns but maybe not any more). German Finance Minister Wolfgang Schaeuble was explicit after the bailout was agreed in the early hours of Monday morning, saying with the bail-in “we got what we always wanted”. As such, the Bundestag is almost certain to vote for it.

Cyprus Plan B – phoenix or dodo?

They’ve only been looking for it for a day but Cyprus’s Plan B has already taken on mythical status. A myth it might remain.

Ideas being floated include nationalizing the pension fund (back of the envelope calculations suggest that will raise less than a billion euros) and issuing bonds underpinned by future natural gas revenues (but no one is really sure how much they are worth). So to avoid default it still looks like the Cypriots may have to return to the bank levy they rejected so decisively in parliament on Tuesday, to raise the 5.8 billion euros the euro zone is demanding in return for a bailout.

Finance minister Sarris is still in Moscow hoping for some change out of the Russians and is out this morning saying discussions are ongoing about banks and natural gas.

What now?

 

The slow motion Cypriot car crash of the past five days reached impact point last night when not a single lawmaker voted for the bailout with bank levy attached – the first time a euro zone legislature has simply said no.

So what next? The finance minister is in Russia, ostensibly to seek an extension on an existing 2.5 billion euros loan on better terms, but could there be more on offer besides? The Eurogroup made clear last night that the 10 billion euros bailout was still on the table but that Nicosia had to come up with 5.8 billion euros of its own – the sum that a levy on bank depositors was supposed to raise. Could Moscow fill that gap, maybe in return for a slice of the island’s untapped offshore gas reserves? It looks unlikely but not impossible and there are powerful geopolitics at play. That there will be no more money from the euro zone looks like a given and there seems to be a resolve that it would be better to let Cyprus default then buckle at the last moment.

Finance minister Sarris has just said he hopes for a deal on the existing Russian loan today. In Nicosia, the president is meeting party leaders.

Cypriot crunch point

Cypriot lawmakers are supposed to vote today on a bailout that hits at least some of its bank depositors but the president’s spokesman has said any such legislation is unlikely to pass. This could be brinkmanship but it doesn’t sound like it.

Last night, euro zone finance ministers urged Nicosia to spare depositors with less than 100,000 euros in the bank and hit the richer harder, in order to raise 5.8 billion euros to free up a 10 billion euros bailout. Without it, Cyprus will surely go bankrupt but that is a deal that President Anastasiades baulked at in Brussels over the weekend. The government faces a stark choice: hit those who vote for it and rip up the deposit insurance they thought they had, or clobber the richer (many of them Russians), thus threatening the meltdown of its banking model.

Despite their belated support for the little guy, the euro zone will accept pretty much anything that raises the requisite cash. Germany and others insist the days of bailouts funded solely by taxpayers are over and the Bundestag probably wouldn’t sanction any other sort of deal.

A Rubicon crossed

What a weekend. The euro zone crossed a dangerous Rubicon by whacking Cypriot bank depositors as part of a bailout – a dramatic departure from previous aid programmes. The finance ministers insist it is a one-off (as they did for Greece) but if investors and bank customers fear a precedent has been set, there could yet be a serious backwash for the euro zone. And all this for six billion euros? It seems perplexing to say the least although our trawl of the streets of the euro zone periphery has detected little alarm so far.

Markets are voting with their feet. The euro has dropped well over one percent, European stock futures are pointing to losses of two to three percent and the safe haven Bund future has leapt a full point at the open. Italian bond futures have done the reverse, suggesting that in the bond market at least, there is more than a little concern about contagion from Cyprus. “The crisis is back,” one bond trader told us. “Precedent” is the word on everybody’s lips. I’ve used it before but Bank of England Governor Mervyn King produced the definitive line on bank runs – it’s never logical to start one but it sure could be logical to join one.

To muddy the waters further, the Cypriots are trying to renegotiate the deal to ease the 6.5 percent burden on smaller depositors and raise it on the richer (from 9.9 percent). This suggests that the president fears that today’s parliamentary vote may be lost without changes. If it is lost – no party has a majority and three of them said yesterday they wouldn’t support the programme – we’re in for a real rollercoaster as everyone scrambles to avoid a default, with all the reputational damage that will do to the euro zone. At that point, we could probably kiss goodbye to the five months of calm imposed by the European Central Bank and its “do whatever it takes” pledge.

Euro bailouts — one out, one in

We had thought the end-of-week EU summit was going to be a lacklustre affair but things are starting to bubble up.

Ireland announced last night it would issue its first new 10-year bond since it was bailed out in 2010. It sounds like the books on the syndicated issue will open today with dealers predicting strong demand. This is a crucial step in Dublin becoming the success story the euro zone desperately craves. Some European Central Bank policymakers have said the bank’s bond-buying programme could be deployed to help Ireland once it has demonstrated its ability to issue debt in a variety of maturities. Others, notably Bundesbank chief Jens Weidmann, appear less keen on the idea.

With yields below four percent (they peaked above 15 percent in 2011) and needing to raise only a few billion in debt this year, it’s not clear that Ireland even needs ECB help to put the bailout behind it, but bond-buying support would certainly seal its exit and also show the ECB’s intent to markets. Further down the line, it will be worth pondering whether Ireland’s journey demonstrates that austerity was the right medicine. Plenty of euro zone policymakers will say so. The interesting question to address would be whether Dublin could have got there faster with more leeway to boost growth and therefore tax revenues.

Euro zone week ahead

Italy will continue to cast a long shadow and has clearly opened a chink in the euro zone’s armour. It looks like the best investors can expect is populist Beppe Grillo supporting some measures put forward by a minority, centre-left government but refusing any sort of formal alliance. That sounds like a recipe for the sort of instability that could have investors running a mile. The markets’ best case was for outgoing technocrat prime minister Monti to support the centre-left in coalition, thereby guaranteeing continuation of economic reforms. But he just didn’t get enough votes. Fresh elections are probably the nightmare scenario given the unpredictability of what could result.

The story of the last five months has been the bond-buying safety net cast by the European Central Bank which took the sting out of the currency bloc’s debt crisis. But now it has an Achilles’ Heel. The ECB has stated it will only buy the bonds of a country on certain policy conditions. An unwilling or unstable Italian government may be unable to meet those conditions so in theory the ECB should stand back. But what if the euro zone’s third biggest economy comes under serious market attack? Without ECB support the whole bloc would be thrown back into crisis and yet if it does intervene, some ECB policymakers and German lawmakers will throw their hands up in horror, potentially calling the whole programme in to question.

In other words, until or unless a durable government is formed in Italy which can credibly say and do the right things, the euro zone crisis is back although not yet in the way it was a year ago when break-up looked possible.

Italy gives new bite to euro zone crisis

Don’t start putting out the tinsel yet. Just when we thought we had a smooth glide path into Christmas the euro zone has bitten back.

Over the weekend, Italy’s Mario Monti called Silvio Berlusconi’s bluff and said he was pulling the government down which will mean early elections in February. The budget bill will be passed and then the country will be in a potentially precarious state of limbo as parliament is dissolved. Italian bond futures have opened more than a point lower, which denotes a reasonable measure of alarm, although the safe haven Bund future has only edged up so we’re far from panic mode.

The big question is whether a government results that will stick to Monti’s agenda and whether he himself will have a prominent role to play in the administration. There are constitutional difficulties to keeping Monti as prime minister since he has said he would not stand at the election, though he has also said he would be prepared to step in again if no stable government is formed. Most likely, presuming a government is elected that supports his reforms, is that he will play a key role but not take the top job.

Calm after the storm

After months of bickering and struggle, the euro zone and IMF have agreed on a scheme which will notionally cut Greece’s mountainous debt to a level they view as sustainable in the long-term. Athens has now launched a buyback of its debt at a sharp discount from private creditors which should wipe 20 billion euros of its debt pile – a key plank of the plan.

Is the problem solved? Absolutely not. But has Germany achieved its goal of delaying any disasters, or really tough decisions, until after its elections in the Autumn of 2013? Almost certainly. So we could (famous last words) be in for a period of relative calm on the euro zone crisis front.

German Chancellor Angela Merkel and her finance minister have begun quietly hinting that euro zone government and the European Central Bank may eventually have to take a writedown on the Greek bonds they hold to make Athens’ debt controllable. That won’t happen for at least two years but in the meantime, bailout money will flow and Greece will survive.