If you’ve been following this series, so far I’ve covered:

• Part One.  The timeline of events as they unfolded in Cyprus to the present day.
• Part Two.  The impact on the Cypriot people and decimation of the small/medium business segment.  This also looked at the corruption that got Cyprus into such a mess in the first place and the loopholes in the system that allowed the elites to withdraw their assets even as ordinary Cypriots were under oppressive capital controls.
• Part Three.  The fact that bail-ins, as they occurred in Cyprus, will happen in other countries as the global financial crisis picks up steam.

In this final post of the series I want to focus on why Canadians should take the lessons of Cyprus to heart.  The reality is that the 2013 Canadian budget specifically called out how the bail-in model will be used if any Canadian banks get into trouble.

So What’s in the 2013 Canadian Budget?

I have linked to the entire 2013 Canadian budget here but the section that is relevant for our discussion today can be found on pages 144 and 145 in the section titled ‘Establishing a Risk Management Framework for Domestically Systemically Important Banks‘.  The entire section reads as follows:

Canada’s large banks are a source of strength for the Canadian economy.  Our large banks have become increasingly successful in international markets, creating jobs at home.

The Government also recognizes the need to manage the risks associated with systemically important banks—those banks whose distress or failure could cause a disruption to the financial system and, in turn, negative impacts on the economy. This requires strong prudential oversight and a robust set of options for resolving these institutions without the use of taxpayer funds, in the unlikely event that one becomes non-viable.

The Government intends to implement a comprehensive risk management framework for Canada’s systemically important banks. This framework will be consistent with reforms in other countries and key international standards, such as the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions, and will work alongside the existing Canadian regulatory capital regime. The risk management framework will include the following elements:

• Systemically important banks will face a higher capital requirement, as determined by the Superintendent of Financial Institutions.

• The Government proposes to implement a ―bail-in regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada.  Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants.

• Systemically important banks will continue to be subject to existing risk management requirements, including enhanced supervision and recovery and resolution plans.

This risk management framework will limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are “too big to fail”.

To their credit, even the mainstream media reported on this with concern since, in bank parlance, deposits are considered liabilities.  Thus, the statement ‘rapid conversion of certain bank liabilities into regulatory capital‘ certainly could imply deposits would be used as part of this recapitalization – exactly what we saw take place in Cyprus.

Move Along.  Nothing to See Here

Immediately following this controversial section of the budget going viral, Finance Minister Jim Flaherty’s press secretary Kathleen Perchaluk issued the following statement to clarify:

The bail-in scenario described in the Budget has nothing to do with depositors’ accounts and they will in no way be used here.  Those accounts will continue to remain insured through the Canada Deposit Insurance Corporation, as always.

The [Canadian] bail-in regime is to protect both taxpayers from having to bail out banks and depositors from having to take a financial hit like we’ve seen in Cyprus.  If a bank is having severe difficulties, the bail-in regime would force certain debt instruments to be converted into equity to recapitalize the bank.

This clarification was immediately used to chastise all those who had reported with alarm on the language in the budget around the bail-in regime.  The mainstream media was satisfied with this clarification and essentially reported in unison: False alarm, nothing to see here, move along.

A Clarification Not Worth the Paper It’s Not Written On

The first thing to point out is that it is the budget that is read before, and passed by, parliament.  Once passed, these budgets form the basis for legislation.  Conversely, random statements by MP’s press secretaries don’t in any way shape the laws that ultimately go onto the books.  Such statements are, practically speaking, completely irrelevant.

That said, let’s analyze Kathleen Perchaluk’s statement.  The thrust of her statement is: “Those accounts will continue to remain insured through the Canada Deposit Insurance Corporation, as always.“.  Ok, two big problems with this:

1. The Canada Deposit Insurance Corporation (CDIC) is woefully underfunded (like all national deposit insurance schemes).  In the event of a true crisis at one of the big six systemically important Canadian banks the CDIC is going to fold like a cheap lawn chair.  This is a topic I’ll be exploring further in a future post.
2. Only funds below $100,000 are insured by the CDIC.  Thus, Kathleen’s statement does not in any way give comfort to those with accounts holding more than $100,000.  Since those deposits are, by definition, uninsured, they are specifically excluded from Kathleen’s reassuring statement.  This, to me, is more worrying than if no clarification had been made at all.  Recall that in Cyprus it was an identical situation where only uninsured deposits over €100,000 got hit.

So, I must respectfully disagree with the conclusion of the mainstream media.  Kathleen Perchaluk’s statement simply does not address the risk of a Cyprus-style confiscation of uninsured deposits at Canadian banks during a bank failure.

The Key to It All

So, the language in the budget is pretty concerning.  It seems to specifically say that the same mechanism that occurred in Cyprus could be applied here.  But where is this methodology of stealing deposits coming from?   Why does it seem to be coordinated between countries?

The answer is in the above quoted section of the budget where it says:

This framework will be consistent with reforms in other countries and key international standards, such as the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions…

It would seem that this document from the Financial Stability Board (FSB) is key to understanding the true intent of the language in the Canadian budget.

You can get the entire document for yourself here.  I provide my analysis of the document below.  I can’t begin to stress how important it is for Canadians to understand this.  Adoption of this framework by the Canadian government guarantees that what happened in Cyprus will happen here in the event of a failure at one of our major banks.

What is the Financial Stability Board (FSB)?

So just what is the Financial Stability Board?  You can hit their website here but essentially the FSB is an international working group of central bankers whose goal is to propose and promote methods for consistent regulation of the financial sector.  Virtually every country’s central bank belongs to the FSB.

Canada is particularly well represented on the FSB with our Central Bank, Department and Finance and the Office of the Superintendent of Financial Institutions all being members.  In addition, the outgoing Governor of the Bank of Canada, Mark Carney, has chaired the FSB since 2011.

What is the Key Attributes of Effective Resolution Regimes for Financial Institutions?

This 2011 FSB document presents a framework for how to address failures at systemically important banks.  This document has been ratified by all members of the G20 (including Canada) meaning that these countries all agree that the principals laid out in this document are the correct way of handling future bank failures.  Canada has re-affirmed its commitment to abide by this framework by stating explicitly in the 2013 budget that this is the model it will use moving forward to deal with any banking crises.

Understand this FSB document and you understand Canada’s official policy on bank failures and whether Canadian depositors are at risk.

The document itself is very clearly laid out.  There are over a dozen sections that specifically talk about imposing loses on unsecured creditors.  Rather than iterate through these ad nauseam, let me simply show you the smoking gun that ties everything together:

Bail-in within resolution
3.5 Powers to carry out bail-in within resolution should enable resolution authorities to:
(i) write down in a manner that respects the hierarchy of claims in liquidation (see Key Attribute 5.1) equity or other instruments of ownership of the firm, unsecured and uninsured creditor claims to the extent necessary to absorb the losses; and to
(ii) convert into equity or other instruments of ownership of the firm under resolution (or any successor in resolution or the parent company within the same jurisdiction), all or parts of unsecured and uninsured creditor claims in a manner that respects the hierarchy of claims in liquidation;

I’m not sure how this could be any more clear.  3.5(i) clearly states that uninsured creditors (i.e. deposits not covered by CDIC) are to absorb losses.  3.5(ii) grants the ability to convert  these same uninsured deposits into shares in the bank.

These two things are EXACTLY what happened in Cyrus.  Uninsured deposits were made to absorb losses both directly and through conversion to worthless shares in the Bank of Cyprus.

Conclusion

People who insist that the Canadian budget does not sanction Cyprus style uninsured deposit confiscations are just plain wrong.  Both the language in the budget and the referenced FSB document clearly indicate that bail-in by imposing losses on uninsured deposits is the preferred approach to resolving failures of systemically important banks.

And, the FSB’s document is not just some pie-in-the-sky proposal – the G20 has already agreed that this is the model to use moving forward.  It clearly lays out the blueprint for exactly what happened in Cyprus.  Cyprus wasn’t a one off – it was following the new global formula for dealing with bank failures.  That same policy is now Canada’s model for resolving bank failures.

As the international crisis continues to unfold we now know exactly what to expect.  If you have uninsured deposits in a Canadian bank those funds are at risk and will be confiscated in the event that bank fails.  There is no gray area here.  It isn’t a maybe.  Your uninsured deposits will be made to absorb the losses in the event your bank fails.

Protect yourself.  Get you money out and into hard assets or, at the very least, open accounts at separate financial institutions.  CDIC will insure up to $100,000 per financial institution.  So, while opening two accounts at RBC and putting $100,000 in each will result in only $100,000 insured, opening one RBC and one BMO account and putting $100,000 in each will result in the full $200,000 being insured.

In part one of this series I laid out in detail the timeline of events leading up to, and through, the recent crisis in Cyprus.  Part two delved into both the impact on regular depositors and small businesses as well as the unbelievable corruption that got Cyprus into this mess in the first place and the loopholes that allowed the elites to escape the financial carnage (even as ordinary Cypriots faced draconian capital controls).

I now want to focus on what comes next: The application of the Cyprus bail-in template to other EU countries as their banks fail.  But first, let’s take a quick look at the state of the periphery of the EU and why more collapses are inevitable.

Are Things Really That Bad In the EU?

Yes, things really are that bad in the EU.  Let’s forget about countries that have already completely capitulated (Ireland, Greece, Cyprus) and look briefly at just one of the prime candidates for collapse:

Spain

First, a couple of shocking charts about what’s happening in Spain.  Let’s start with the official unemployment readings:

Yes, you’re reading that correctly: 27.2% official unemployment. This doesn’t even include the millions of Spaniards who long since gave up trying to find work (only people actively seeking employment are included in the official measure).  And, it’s clear that unemployment is still trending up – it will get worse.

Think it couldn’t possible get scarier than that?  Wrong.  Check out what youth unemployment looks like:

In Spain over 55% of those 15-24 who are in the labour force and looking for work can’t find it.  Note that students are not included in the measure.

And what about Spanish debt to GDP ratio?  Surely all the austerity has gotten that under control, right?

Ouch!  I don’t know about you, but that looks completely out of control to me.  Even the politicians have revised the GDP estimate for 2013 to -1.3% and indicated that they expect unemployment well above 25% through 2014.  I suspect the reality is much worse.  Spain has been caught in the vicious austerity cycle I’ve talked about before: Austerity leading to increased unemployment which reduces tax revenue causing an increase in the debt to GDP ratio requiring more austerity.

And what about the banks?  While true bank risk tends to be highly obfuscated, some data is known.  Bad loans (those loans behind or delinquent on payment and subject to loss) is one key metric used to assess the health of a banking system.  But ‘healthy’ is not a word I’d use to describe the picture of Spanish bad loans:

But I hear some of my readers asking the legitimate question: But, if things are really so bad, why have Spanish bond yields (which breached 7% in the summer of 2012) been so tame lately and trading under 4.5%?

An excellent question.  The answer to this is that, in the crisis of last summer, two actions were taken to drive down the run-away Spanish bond yields:

1. The first was the announcement of the OMT (Outright Monetary Transactions) program by the ECB.  This program, obfuscated with complexity, is really just the ECB buying distressed bonds to push down yields.  This is the definition of monetization of debt.
2. The second was the astonishing use of the Spanish national social security pension fund to purchase Spanish bonds.  At this point, the pension funds has been completely raided with 97% of the fund used to buy domestic bonds.  Any increase in bond yield (which would drive down the price of those bonds) will devastate the pension fund.

Note that both of these bond buying programs were aimed at circumventing the market price by creating artificial demand.  It’s not that things in Spain have improved – as I showed above, the situation there is clearly continuing to deteriorate.  Thus, the fall in Spanish bond yields is simply an exercise in can-kicking that has ensured that the pending disaster will be that much bigger.

And It’s Not Just Spain

No, it’s not just Spain.  Far from it.  I could run through a similar exercise showing how Slovenia, Italy, Luxemburg, Malta and several other peripheral countries are every bit as vulnerable to collapse as Spain.  Heck, with the most recent numbers from France I could even put together a compelling argument that Hollande will very soon sufficiently destroy the French economy so as to put it at serious risk.

There are clearly many more dominos in the EU waiting to fall just like Greece and Cyprus.  Will it be bail-in or bailout?

Cyprus IS the Template For Future Bank Crises

But don’t take my word for it.  Here’s what Jeroen Dijsselbloem (Dutch Finance Minister, President of the Eurogroup and President of the Board of Governors for the European Stability Fund aka the EU bailout fund) had to say on March 25th as the final deal with Cyprus was announced:

If there is a risk in a bank, our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?’. If the bank can’t do it, 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…

Bear in mind, Dijsselbloem was the lead negotiator for the EU during the Cyprus bailout talks.  He does represent the opinion of the EU and would likely lead negotiations for future bailouts.

And, he further justified the Cyprus bailout as follows:

I’m pretty confident that the markets will see this as a sensible, very concentrated and direct approach instead of a more general approach…It will force all financial institutions, as well as investors, to think about the risks they are taking on because they will now have to realise that it may also hurt them.

You can find the whole transcript of the enlightening interview here.  It’s worth a read.  But, the main take-away is yes, the EU will use the Cyprus model as a template moving forward.

Of course, Dijsselbloem quickly found himself at the center of a firestorm once people started to react to that fact that their uninsured deposits were considered investments and would be confiscated in any future crisis.  That same day (March 25th) he issued a clarifying written statement.  Here’s that statement in its entirety:

Cyprus is a specific case with exceptional challenges which required the bail-in measures we have agreed upon yesterday.  Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.

Amazingly people seemed to simmer down after this two-line clarification was issued.  First of all, this was clearly issued to prevent a massive uproar and even bank runs.  Second, read the statement; It doesn’t say bail-ins would not be used moving forward, just that there is no template.

Not Confined to the EU

Think this risk is confined to the EU?  Think again.  In December of 2012 a report was released by the FDIC (Federal Deposit Insurance Corporation in the U.S.) and Bank of England titled ‘Resolving Globally Active, Systemically Important, Financial Institutions’.  This paper discusses the plans for dealing with the too-big-to-fail banks when they become insolvent.  Read the full report for yourself here if you’re interested but the main proposal is presented in paragraph 12:

12 Under the strategies currently being developed by the U.S. and the U.K., the resolution authority could intervene at the top of the group. Culpable senior management of the parent and operating businesses would be removed, and losses would be apportioned to shareholders and unsecured creditors. In all likelihood, shareholders would lose all value and unsecured creditors should thus expect that their claims would be written down to reflect any losses that shareholders did not cover. Under both the U.S. and U.K. approaches, legal safeguards ensure that creditors recover no less than they would under insolvency.

Thus, it all comes down to what an ‘unsecured creditor’ is since it is they that will be eating any losses after the shareholders are wiped out:

34 …But insofar as a bail-in provides for continuity in operations and preserves value, losses to a deposit guarantee scheme in a bail-in should be much lower than in liquidation. Insured depositors themselves would remain unaffected. Uninsured deposits would be treated in line with other similarly ranked liabilities in the resolution process, with the expectation that they might be written down.

So, clearly today’s planning for bank failures in the U.S. and UK have uninsured deposits subject to the same type of bail-in that happened Cyprus.  It doesn’t matter which side of the pond you’re on – if you’ve got uninsured deposits in a bank you need to read this report and think long and hard about your risk tolerance.

And, there are similar documents and legislation springing up around the globe as the Cyprus style bail-in is acknowledged to be the model moving forward.  New Zealand, as one example, currently has legislation before parliament to adopt a bail-in strategy.  For Canadians this model is already law having been include in the recently passed 2013 Canadian budget (which will be the focus of my next post).

Not Confined to Bank Failures

And, it’s not just bank failures that carry the risk of deposit confiscation.  Check out what Joerg Kraemer, the chief economist at Commerzbank, recently had to say about how to get Italy out of its sovereign debt crisis:

So it would make sense in Italy to raise a one-time wealth tax.  A tax rate of 15 percent on financial assets would probably be enough to push the Italian government debt to below the critical level of 100 percent of gross domestic product.

Think this could never happen?  The fact is these types of ‘capital levies’ have been used extensively in the past by many different countries.  After both World War I and World War II levies were imposed through Europe and Asia as high as 50%.  Even as recently as 1992 there was a small (0.6%) levy imposed in Italy with deposits withdrawn overnight.  For a primer on the history of capital levies, check out this article.

So, there is a precedent for unilateral wealth confiscation by governments to combat financial crises.  The worse the crisis, the higher the levies used to combat it.  I would argue that the world today stands on the precipice of an unprecedented global financial meltdown.  People should be losing sleep over the very real possibility of capital levies.

Get Your Money Out!

It should be obvious to anyone with a modicum of common sense that the precedent has been set.  Certainly uninsured deposits are at risk of from bail-ins or capital levies.  At a certain point I would suspect that even insured deposits will be at risk.

It amazes me that the events in Cyprus and subsequent statements out of the EU did not cause a full scale bank run in countries like Spain and Italy.  What the heck are these people waiting for?  Cyprus showed clearly that when the system fails it does so suddenly and with capital controls imposed.  Further, there is clear historical precedent for capital levies to be imposed by these governments in times of crisis.  Now is the time for these people to get their money out while they still can.  The writing is on the wall – it doesn’t get more obvious.  Learn from the suffering of the Cypriots – protect your assets!

In part one of this series I laid out a complete timeline for the recent bailout\bail-in that occurred in Cyprus.

In this post I want to look at the real-world impact of these events on regular depositors and small businesses in Cyprus.  I will then dig into the loopholes that were intentionally left open to allow the large investors and economic elite to quietly remove their exposed deposits at the same time Cypriots were faced with draconian capital controls.

Finally I’ll dig into a leaked report from the firm commissioned by the Cypriot Central Bank in the summer of 2012 to investigate how the Bank of Cyprus wound up holding such a high percentage of risky Greek bonds.  This document is unbelievably damning to senior officials at the Bank of Cyprus.  I’ll show sections from the document detailing how:

1. The Bank of Cyprus intentionally mislead regulators with respect to its Greek bond exposure.
2. Senior officials (including the former CEO) destroyed emails and other electronic information after a preservation notice was issued by the investigative team.
3. These same senior officials, and the Bank of Cyprus in general, did not cooperate with the investigation and actively covered-up various aspects of their activities regarding the Greek bond purchases.

Impact on Regular Depositors

As my previous post detailed, as it stands today, depositors with more than €100,000 in deposits stand to lose a total of about 70% of the value of those deposits.  It could wind up being as high as 80% or even more depending on what happens to the Bank of Cyprus share price (since most of these confiscated funds get converted to shares in the Bank of Cyprus).  But, a good estimate right now is probably 70% gone.

But let’s put this into a real world example.  Imagine that you’re in your 60’s and have just retired or are about to retire.  You worked hard for 40+ years putting money away when you could and managed to build a nest-egg of €500,000.  A modest sum, but enough to support you in retirement.  Being risk adverse you have all that money in a savings account at a large bank – what could be safer?

Now imagine that you wake up one morning and discover that of your €500,000, only €220,000 remains (€100,000 + (€400,000 * 30%)).  This is exactly what happened to an entire middle class in Cyprus.  Apart from the obvious rage you would feel, one thing would be clear – you can’t live another 20 years on €220,000.  Assuming you were able, you need to get back into the workforce ASAP or you’ll live out your twilight years in abject poverty.

But can you even find work?  Before the crisis hit Cyprus already had over 14% official unemployment (and this doesn’t include the workers who have gotten discouraged and simply stopped trying to find work).  There was already a glut of young, able-bodied workers looking for any work they could get.

Impact on Small and Medium Size Businesses

But the situation gets much worse for our hypothetical retiree.

I would expect shockingly higher unemployment numbers out of Cyprus over the next few months.  The reality is that many of the impacted accounts were corporate accounts holding payroll, accounts payable, and other business assets.  As a result, many of these businesses will clearly be forced into bankruptcy or, at the least, massive layoffs.

This genocide of the entire small\medium business segment in Cyprus and its horrifying implications has been largely unreported.  Think about the consequences of this.  Not only is there the immediate implication of higher unemployment but with all these layoffs and business closures, total GDP will plummet and this will cause a corresponding drop in tax revenue.  Thus, like Ireland, Portugal, and Spain before it, Cyprus gets caught in the vicious cycle of austerity leading to economic contraction leading to lower tax revenue requiring more austerity.  And all the while our hypothetical retiree is left without enough savings to live out his retirement and is unable to find work as unemployment explodes.

Here’s a great example of the real impact on a small business in Cyprus.  This was originally posted in the Bitcoin forums and went viral:

My bank account’s got robbed by European Commission. Over 700k is lost.

The most of circulating assets on our business Current Account are blocked. Over 700k of expropriated money will be used to repay country’s debt. Probably we will get back about 20% of this amount in 6-7 years. I’m not Russian oligarch, but just European medium size IT business. Thousands of other companies around Cyprus have the same situation. The business is definitely ruined, all Cypriot workers to be fired. We are moving to small Caribbean country where authorities have more respect to people’s assets. Also we are thinking about using Bitcoin to pay wages and for payments between our partners. Special thanks to: – Jeroen Dijsselbloem – Angela Merkel – Manuel Barroso – the rest of officials of “European Commission”.
Original Post: https://bitcointalk.org/index.php?topic=160292.

 It Pays to Known People in High Places

Of course, while most people knew a bailout was coming, no one expected a bail-in and confiscation of depositor funds right?

Well, not so fast.

Leaked bank documents show that a business belonging to family members of Cyprus President Nicos Anastasiades moved upwards of €21 million out of Laiki bank in the week leading up to the bailout. The President and his family are claiming these to be standard business transactions.  For now these are just allegations so we need to be cautious about jumping to conclusions.  But these transactions are highly suspicious to put it mildly.  A national investigation headed by two retired Supreme Court justices has been started to look into the matter.  It will be interesting to see if anything turns up or this simply becomes a whitewash.

International Banking Anyone?

But there’s more than one way to skin a cat.  In a simply unbelievable act of corruption, international branches of Laiki and Bank of Cyprus remained upon throughout the crisis and imposition of capital controls.  That’s right.  At the height of the crisis, with Cypriots unable to cash cheques or withdraw more than €100, you could walk into the London branch office of Laiki and withdraw without restriction.  Same goes for Bank of Cyprus which conveniently had a subsidiary bank in Russia (in addition to it’s London branch) and which also did not impose any withdraw limits.

So, international investors swarmed through this loophole pulling out all their exposed funds and leaving the ordinary Cypriots to face the music.  That’s why the percentage of funds to be confiscated kept on rising as the crisis progressed – all the big players were pulling their money out through the backdoor which was conveniently left wide open for them.  Remaining depositors then had to make up the shortfall to raise the €4 billion required by the Troika for the bailout deal to go through.

The question becomes: Was this done intentional or by incompetence.  I find it simply impossible to conclude that this was a mistake given:

1. This would have been completely obvious to those running the banks.  Would the president of Laiki really be so stupid as to forget that he had an international branch in London?
2. This vulnerability was left in place for more than a week.  Clearly these banks, under tremendous pressure and scrutiny would have noticed the daily outflow of supposedly frozen bank deposits – yet they did nothing to stop it.

So, one in forced to conclude that this was done intentionally to allow large investors, and specifically the Russian oligarchs/mafia, who were some of the largest depositors in Laiki bank, to get their money out.  After all, if you’re the president of Laiki would you rather have to explain your actions to the Cypriot people or to pissed off Russian mobsters?

Some Depositors are More Equal Than Others

But the corruption gets even more in-your-face.  Shortly after the bailout terms of March 25th, 2013 were agreed to, the Bank Of Cyprus issued a press release to clarify some of the terms of the agreement.  In that statement was the following nugget:

Moreover, the following points are clarified:

· All insured deposits (individuals and legal entities) up to €100.000 have, as of 26 March 2013, been transferred from Laiki Bank to the Bank of Cyprus. In addition, the entire amount of deposits belonging to financial institutions, the Government, municipalities, municipal councils and other public entities, insurance companies, charities, schools, educational institutions, and deposits belonging to JCC Payment Systems Ltd have been transferred to the Bank of Cyprus.

Read that carefully.  Deposits belonging to financial institutions (banks), governments, etc. got exempted.  This of course includes the bandits at the ECB (who also famously exempted themselves from taking any losses during the Greek bondholder ‘haircuts’).  What the heck makes them so special?  Why do they keep getting prioritized ahead of other depositors?

Since that statement was released, the Central Bank of Cyprus has decided to strike insurance companies, private schools and charities from the list of the exempted “so as to lighten the burden on affected (large) depositors in the Bank of Cyprus“.  Great sentiment – but why just remove all the exemptions if they are really so concerned about reducing the burden?

Records?  What Records?

Even before the crisis blew sky high in March, there was an investigation launched last August (2012) by the Cypriot Central Bank to determine exactly how the two banks wound up holding such a large amount of risky Greek bonds.  There are very specific rules for how much of a bank’s capitalization can be allocated in risky assets.  Bank holdings are supposed to be disclosed to regulators periodically so the regulators can ensure banks are sufficiently capitalized.  The mandate for the investigation was to determine whether the Bank of Cyprus was properly reporting its holdings to regulators.  Or, was the Bank of Cyprus playing fast and loose with the rules to squeeze out extra profits from the high yield Greek bonds (which would lead to larger bonuses for the bank executives).

To complete the investigation an independent firm (Alvarez and Marsal) was hired.  As it turns out, a copy of their final report to the Cypriot Central bank got leaked and boy, is it a doozy.  This report is unbelievably damning to the Bank of Cyprus and documents a pattern of market manipulation, misreporting of Greek bond holdings (including outright lying to their own board of directors about Greek bond exposure), and, most damning of all, evidence of key data being systematically deleted to prevent it from falling into the hands of investigators.  The full report can be found here – I would encourage everyone interested in a detailed look at exactly what went on inside the Bank of Cyprus to read it.

By way of summary, here is a smattering of some of the more shocking revelations included in the document:

• Christakis Patsalides is the former senior executive in the bank’s treasury department.  He is named in the report as the key figure pushing for the Greek bond purchases.
• Andreas Eliades is the former CEO of the bank during the period in question.

So, here we have the CEO and another senior bank official caught deleting their email to cover their butts.  And guess what the happened when investigators questioned these guys about their missing records?

4.7.1.1 The former BOC CEO, Mr Eliades, did not participate or assist in the Investigation. This was despite significant effort, including the assistance of the BOC and its external counsel to contact and request a meeting with Mr Eliades. Mr Eliades did not respond to our email requests and calls until the end of the Investigation, on 26 February 2013…

Bottom Line

The entire middle class of Cyprus has been decimated.  Retirees, or those nearing retirement, will not be able to recover from this unprecedented wealth confiscation.  The Cypriot economy has been ruined.  Expect to see an even worse depression than the hell that is currently unfolding in Greece.

The bankers took huge risks in order to maximize profit and, more to the point, their bonuses.  Then, when things went south, those same bankers walked away leaving the ordinary depositors to foot the bill for their greed.  When people tried to look into what happened the bankers lied and otherwise attempted to cover-up the truth.

As the crisis unfolded, and with ordinary Cypriots under complete financial lock-down, intentional loopholes were left open in the system to allow the uber-rich to get their cash out increasing the burden to be ultimately borne by the little guy.  Then this inequality was further thrown in the face of Cypriots by outright exemptions being granted to special interests including other bankers.

I continue to be amazed that these events unfolded without wide-spread civil disobedience.  What unfolded was nothing less than government sanctioned theft and the wholesale rape of a nation.  At some point, as more and more countries come into the cross-hair’s of these thieves, people are going to need to say enough.  Until people stand-up en-mass and refuse to be victimized, the bandits at the EU, IMF, and central banks around the world are going to continue to rob we, the people, blind.

This is the first of a four part series that will deal with the recent bail-in that occurred in Cyprus.  This pivotal, watershed event is absolutely vital for everyone to understand.  There are huge systemic risks built into the banking system that too few people comprehend.  Cyprus is simply the first domino to fall.  It is the proverbial canary in the coal mine.

This post will focus on documenting exactly what happened in Cyprus and laying out the timeline of events.  Future posts will then analyze the impact of the crisis, how the system made sure the burden was borne by ordinary depositors (and not the very wealthy or large corporations) and how this bail-in sets a dangerous precedent for future bank failures in Europe and elsewhere (including Canada).

The Timeline

Although most people only learned of the financial crisis in Cyprus when it blew sky high in March 2013, the reality is that, as with most peripheral countries in the Eurozone, things had been deteriorating in Cyprus for some time before that.  Starting from 2009 here’s how events unfolded in Cyprus:

• Like most countries, Cyprus’ economy was hit hard by the recession in 2009 and experience a strong contraction of over 1.5% GDP.

• During 2010 and 2011 Cyprus’ economy experienced tepid growth and failed to recover to the pre-2009 levels.  During this same period the large Cypriot banks amassed a huge amount of high-yield Greek bonds.  While the GDP of Cyprus was under €20 billion, the banks had accumulated over €22 billion in Greek bonds.  For a while this worked out great: The Greek bonds had long since been downgraded to junk status meaning that they paid high interest to the banks.

• But with such high returns came risk.  And, in October 2011 Greek bond holders got burned – big time.  As part of Greece’s second bailout, Greece agreed to impose a 53.5% haircut on bond holders (except for the European Central Bank which was exempted from taking any loses; coincidentally the ECB was part of the so-called Troika that drafted the terms of that bail-out).  In an instant, the Cypriot banks had just shy of €12 billion wiped off their balance sheets.  These banks were instantly insufficiently capitalized and in dire straits.

• By January 2012 Cyprus was relying on a €2.5 billion emergency loan it had secured from the Russians to cover the growing deficit and refinance existing bonds as they rolled over.

• By March 2012 Moody’s (one of the major rating agencies) had downgraded Cypriot bonds to junk and then in June Fitch followed suit.  These rating downgrades disqualified Cypriot bonds from being accepted as collateral by the ECB.  It also meant that many mutual funds, pension funds, ETFs, etc., which have rules about the rating of the bonds they purchase, could no longer purchase or hold Cypriot bonds.  This instantly and severely reduced demand for Cypriot bonds.

• On June 25, 2012, the same day as the Fitch ratings downgrade, Cyprus formally requested a bailout from the EU.

• Throughout the rest of 2012 and into March 2013 negotiations between the so-called Troika (ECB, IMF, European Commission) and Cyprus continued.  The glimpses the public saw of proposals all centered around conditions similar to previous EU bailouts – namely tax hikes and austerity.

• On Saturday March 16, 2013 the final terms of the bombshell deal were announced.  Rather than a pure bailout (in which funds from the outside are used), these terms required a partial bail-in where assets (i.e. deposits) from inside the failing banks would also be used.  In exchange for the €10 billion in bailout funds, Cyprus would raise an additional €6 billion by imposing a one time bank levy of 9.9% for uninsured deposits (i.e. those over €100,000) and 6.75% for insured deposits (i.e. those under €100,000).  ATM withdraw limits of €400 were imposed as Cypriots flocked to ATMs trying to withdraw money.  Many ATMs in the country simply run out of cash even with the €400 limit.

• Sunday March 17th starts to see the vehement reaction of Cypriot people to this unprecedented seizure of deposits.  As the deep unpopularity of the levy becomes clear, the Cypriot government postpones the emergency session of parliament that had been scheduled to vote on the bailout terms from Sunday to Monday.  A bank holiday is declared for Monday meaning that, aside from limited ATM withdraws, Cypriots will be unable to remove their exposed funds from the banks,

• On Monday March 18th the Cypriot government is in panic as the rage of both the people and Russian government (many of whose wealthy citizens have large holdings in the Cyprus banks) reaches a crescendo.  The decision is made to again delay the parliamentary vote until Tuesday and it is announced that the bank ‘holiday’ is being extended until Thursday, March 21st.  The run on ATMs continues and banks start to unilaterally reduce the maximum withdraw below the government imposed €400.

• Tuesday March 18th sees the Cyprus politicians bow to the overwhelming public pressure and reject the bailout terms from the Troika.  Cyprus desperately seeks alternative investment from the Russians and wealthy Middle Eastern investors.  On Wednesday it announces another extension of the bank holiday until at least Tuesday, March 26th.  The prospect of Cyprus exiting the Euro starts to be openly discussed amongst Troika officials.

• For the remainder of the week (March 19th until the 24th) ATM withdraw limits remain in place eventually dropping to €100.  Bailout terms gradually start to turn away from applying a levy against insured deposits and towards applying a larger levy against uninsured deposits.

• On March 25th bailout terms are agreed upon by the Cypriot government and the Troika.  The deal essentially separates the two largest banks at the center of the crisis (the Bank of Cyprus and Laiki Bank) into a ‘good’ bank and ‘bad’ bank.  Under the deal, Laiki becomes the bad bank that will be wound down.  Its bond holders are to be completely wiped out (i.e their bonds are worth €0).  All good assets and insured deposits are to be transferred to the Bank of Cyprus.  Uninsured deposits at both banks (those greater than €100,000) are to remain completely frozen until it is determined how much must be confiscated for Cyprus to raise the €4 billion required under the deal.  Capital controls are also imposed including a €300  daily withdraw limit from banks and ATMs, a €2000 per month limit on transfers out of country and an outright ban on cashing cheques or opening new accounts.  It is announced that these capital controls will be in place for a limited time (2 weeks) while the terms are finalized and Laiki wound down.  Banks are reopened under the new capital controls March 28th having been closed since March 16th.

• Throughout the rest of March and April 2013 the capital controls are repeatedly extended and the estimated hit against the frozen uninsured deposits creeps from 20% up to more than 80%.

• On April 30th the final bailout terms are approved by Cyprus and the exact terms of the bail-in announced (see below).

The Current Situation

With the final approval of the bailout and bail-in on April 30th, here’s where things stand today for the uninsured deposits:

• 37.5% has been converted to shares in the Bank of Cyprus (at a nominal value of €1).  
• 22.5% will remain frozen pending an updated audit of the Bank of Cyprus expected at the end of June.  This 22.5% may then also be converted to shares in the Bank of Cyprus depending on the result of the audit.
• 30% will remain temporarily frozen.  These funds may also be converted into shares at a later time or otherwise confiscated by the Bank of Cyprus.

It is important to understand the game that is being played with converting cash into shares in the Bank of Cyprus.  The shares are converted at a nominal value of €1.  That’s great except the Bank of Cyprus share price is only around €0.20 these days.  So, if you had €10,000 converted to shares under these terms and then sold your shares you’d only get €2000 – thus you’d realize an 80% loss.  In other words, the ‘converted’ funds are almost entirely written off due to the nominal value chosen for the conversion.

So, uninsured depositors have already effectively lost 30% (37.5% * .8) and have an additional 52.5% frozen for the foreseeable future and subject to loss.  Assuming the share price doesn’t drop further (not something I’d bet on) another 42% (52.5% * .8) will be stolen.  This gives us a grand total 72% loss imposed on uninsured deposits.

In the meantime there continues to be draconian capital controls imposed on Cypriots – an indication the worst may not yet be over.  Here’s a summary of those capital controls still in effect today:

• €300 per day withdraw limit (at ATM or bank teller).
• €5000 per month in transfers outside the country.
• €3000 per month can be taken out of the country by travellers.
• Cashing of cheques not permitted (but depositing of cheques is).

Expectations are starting to be unofficially set that these capital controls will likely remain in place through the summer.

Next Up

The next post in this series will look at some of the impacts from these events.  I’ll look at both the impact on the ordinary Cypriot as well as the impact on the wealthy foreign depositors and institutions with funds in Cypriot banks.  As you might expect, there is a large discrepancy between how these two groups were treated.  I’ll try to expose some of the ways in which the banksters and uber-rich were allowed to circumvent the system and ultimately ensure that the ordinary Cypriot depositor would be the one left holding the bag.

Stay tuned…