CYPRUS CORRECTS COURSE AND GETS IT RIGHT

CYPRUS CORRECTS COURSE AND GETS IT RIGHT

Matt HealeyTuesday,26 March 2013

The Snap:

Last week I was very critical of the proposed bailout plan for Cypriot banks. Turns out the rest if the world was also critical, and Cyprus ended up backing down and coming up with another plan. I have looked at the new plan. This time they got it right.

The Download:

Bailouts are hard. Bankruptcies are hard. They hurt people who did nothing wrong. So it is not possible to come up with a plan that spares everyone. So the only question is how to distribute the pain. Fortunately there is a template that could and should be followed. First the equity holders get wiped out, then the unsecured creditors, then the secured creditors, and finally, in the case of a bank, the un-insured depositors. The reason for this is the returns to these stakeholders. Equity holders take the greatest risk and thus they have the highest returns. So when the company has problems, they need to take the first wave of losses. Unsecured debt holders get the next highest return for lower risk and thus take the second wave of losses. This continues down to the un-insured deposits. Finally, there are the insured deposits, which take the last wave of losses but need to be backstopped by the government to prevent contagion and runs on other banks.

After trying every other approach, and having them rejected — including raiding the national pension funds, an even more spectacularly bad idea — Cyprus finally decided to follow this template. The large depositors are yelling, but they bear some responsibility. If you have deposits over the insured limit, you need to research the solvency of the bank. Or you can reduce you deposits to under the limit. It is not like there are not alternatives, like money market funds, bond funds, equity funds, or, here is an idea, splitting the money up into deposits in multiple accounts and banks. So there are options for these depositors. They did not take them, either because they were lazy, or because they could not because they had to dodge banking regulations because the money was questionable. In either case, I am not too concerned that the large depositors are taking losses. The other group that is yelling are the employees. There will be a lot of layoffs. I feel sympathetic for this constituency. They are the ones that should receive some help from the government in terms of placement and job training.

Hat Tips:

Cyprus, Image Credit: Wikimedia Commons

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