The Takeaways on Cyprus

What exactly is Cyprus?  According to Wikipedia, it’s a tiny island nation of approximately one million people located in the eastern Mediterrean.  It’s the long-term home of a small UN monitoring force that has been in place since the 1970s when Turkish troops invaded the island during a dispute between the Turkish-descent Cypriots and Cypriots of Greek descent.  The response of most Americans during that time was The Turks invaded Cyprus?  What would they want with a tree?  But I now have a different response from a kitchen desk thousands of miles away and weeks after the journalists descended.  Despite the multitude of articles about what all of it means, there are three simple takeaways and none involve alphabetic European mechanisms.

The core issue around Cyprus is how to pay for additional bailouts for insolvent institutions that – like occurred in Iceland – threaten to drag down the economy.  The government was offered over 10 billion Euros as a bailout by the "Troika" (the European Commission, the International Monetary Fund and the European Central Bank) but a quid pro quo for the bailout was that the Cypriots themselves had to put up a certain percentage of that money; and if you’re looking for money in the first place, how do you come up with money?  When someone once asked John Dillinger why he robbed banks, he retorted because that’s where the money is and the eyes went to the banks themselves because, well…that’s where the money was.  But the only money in the banks, which needed money to survive, was with the people who actually used the banks for deposits – the customers.  So the first proposal was that the bank depositors, people like us who simply deposit our paychecks in the various saving accounts, wouldbe legally required to "contribute" a specific percentage of their savings deposits to the bank to keep the bank afloat and there was no hope of any return of that money.  In terms that stuff-happy Americans will understand, if the owner of the storage rental units ran into financial problems, he could legally get out of the scrape by simply confiscating and selling 20% of the stuff that people store in their units.  When the Cypriot parliament unequivocably nixed the plan, the Cypriot Prime Minister and Finance Minister met with the Troika representatives and pulled a sleight-of-hand manuever that bypassed the need for the legislature’s approval for implementation. By the wave of the magic administrative wand, the depositors suddenly found themselves creditors.

You need to understand that there is a hierarchy to the ownership of any corporate entity, banks included, and this hierarchy is layered by exposure to risk.  The core of any corporation is the capital put there by the investors but not all investors are created equal and if the firm has major problems, the investors will lose their money; but there are levels at which capital is exhausted.  The shareholders of the stock have the greatest volatility of return and are lowest in the hierarchy; congratulations, you could really do way better than the bondholders but that’s at the risk of a wipeout.  The next level of the hierarchy, whose money is protected in terms of wipeout by the shareholders, are the unsecured creditors.  These are folks who lend to the bank and expect to have their money repaid, but their lending isn’t protected by any claim on collateral.  The next level are the bondholders and even they aren’t equal as the Junior bondholders – presumably named Skip, Corky and Brittani – come before the Senior bondholders.  The difference between the two is that the interest paid on the bonds is higher for the Juniors than the Seniors with the extra money meaning that they bear the higher risk if things truly go south and the capital is threatened.  What the new plan did was to magically alter the status of the depositors, promoting them from simple customers to an actual place in the ownership hierarchy as unsecured creditors who’ve now apparently lent money to the bank by dint of simply opening an account and getting the free toaster (if we were in Spain, we’d actually be getting a Spiderman towel – no crap).  Were this happening here, we’d suddenly find ourselves on the hook for our own bank, even if all we did was open an account.  The hit was minimized for people by making it only for account-holders with more than 100,000 Euros in their accounts, which in Cyprus meant that the majority of those accountholders were Russians using Cyprus for an offshore tax-haven.  See, the only people who have to worry are those nasty Nouveau-Riche Russians who earned their money via kleptocracy…

Both takeaways are inextricably linked to debt levels.  The first takeaway of this story is that the financial/political leadership is aware that the debt levels are too high and is looking for new pools of money to tap into to help ease the debt burden.  But those pools now seen are with the savers, those who have continually set aside money to provide for themselves, and those pools are within the banks.  There are trillions of dollars and Euros in banks that can be used but there has to be a means to access them and the Cyprus situation is the first effort to gain access to those pools of funds.  Because we have yet to see a door close once it’s been opened, expect that the entry will be widened as the situation worsens; the likelihood exists that it will not only geographically spread across borders to this country, but that it will spread across product lines to pension funds, 401ks and IRAs.  There has been a brushfire war against savings in our consumption based economy and this carries it to a new level as the search continues for funds.

The second takeaway is that we now serve the system instead of the system serving us.   Politics and money are inextricably linked and the present political-economic structure now exists to serve itself at the cost of the individual, whose voice resides in the legislature.   When the Cypriot legislature voted down the initial proposal, it was altered so that it no longer required legislative approval and summarily implemented against the will of the people.  Several years ago, Iceland’s legislature told the political-economic structure to pound sand and opted to take the economic hit without a bailout.  It was allowed to do so because it didn’t use the Euro and it’s collapse wasn’t injurious to the European financial structure.  But because of Cyprus’ status as a member of the European Community and it’s use of the Euro, failure was not deemed to be an option.  A Cypriot scenario already occurred in the United States in late 2008.  After the collapse of Lehman Brothers, the Bush Administration proposed a bailout and was rebuffed by Congress; but it went back again and when the Treasury Secretary warned of possible martial law should it fail.  With the apparent fear that Stryker Assault Vehicles would take up too many parking spaces at the neighborhood convenience stores, Congress folded and approved TARP. 

The third takeaway is that any action here will be clothed in terms of class-warfare.  As measures are implemented that access privately held funds, the refrain for the masses will be that it’s against the rich alone.  The middle class and poor will supposedly be protected, but the definition of who is rich will be arbitrary and will ultimately shift downwards as the dysfunction continues and the rot deepens.  Again, the first efforts are being made as the proposed budget by President Obama proposes limits to how much "the wealthy" can keep in IRAs.  But the fact is that there’s now an overt definition of wealthy and a unilateral presumption that they don’t have the right to have more there than a specific amount.  This is the economic equivalent of German theologian Martin Niemoller’s famous comment: 

First they came for the Socialists, and I did not speak out– Because I was not a Socialist. Then they came for the Trade Unionists, and I did not speak out– Because I was not a Trade Unionist. Then they came for the Jews, and I did not speak out– Because I was not a Jew. Then they came for me–and there was no one left to speak for me.

So…first, they came for Cyprus, and I cared nothing…

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