If the Cyprus drama making headlines this week feels like a throwback to the days of the United States financial crisis, it should. Stories of racing the clock, last ditch efforts, eleventh hour behind-the-scenes meetings and news wires lighting up with headlines, have all been part of the mix this week. Don’t feel bad if you’re confused. The masterminds behind all this are as well. At any rate, here’s where we stand.
The ill-conceived plan to seize (tax) citizens’ assets was voted down. Now the Cypriot government is more or less a laughing stock for suggesting such a plan in the first place. The European Union even came out and said, “We told them not to do it.”
However, the EU has held firm on its demands; it is not backing down. Cyprus has to pitch in, and not just because the EU doesn’t want to bailout a bunch of Russians who stashed their ill-gotten gains in the country, but because Germany isn’t far from an election, and Angela Merkel isn’t about to spend any more of her country’s money on some tiny island nation full of insolvent banks and laundered money.
The EU Ultimatum
Now Cyprus is in a race against time. It has to come up with 5.8 billion euros (US$7.5 billion) by Monday in order to receive 10 billion euros from its eurozone friends. If it does not, the European Central Bank will stop the flow of emergency support to the Cypriot banks and let them collapse Lehman Brothers style. So, what are the country’s options?
Laiki Bank is one of the two largest banks in Cyprus. If ECB cuts off funding, the bank goes bankrupt and all jobs there are lost. This will likely send the whole Cypriot banking sector into a meltdown. The Cypriot Parliament plans to pass legislation that allows the bank to split into a good bank and bad bank. The bad bank would be set up to take over the bad investments and the good bank would manage the profitable investments. This, according to The Associated Press, will raise about 2 billion euros toward the goal.
Sound like a familiar strategy? Not only have Ireland and Spain used the same strategy, but during the American financial crisis, citizens quickly learned the definition of toxic assets and how banks removed them from their balance sheets.
Why not? Russia made it a cultural norm to send money to Cyprus to avoid political unrest and hide assets gained by activities that weren’t exactly legal. Russia has already pumped a large amount of money into the country. Cypriots would argue that the money was in the form of loans to Cypriot companies of Russian descent, which some say are shell companies for illegal activities, but that’s not important. As the Cypriot finance minister continues to beg for help, he’s in no position to argue semantics. Instead, he’s offering “opportunities” like natural gas and banking assets.
Investment Solidarity Fund
Something akin to IOUs, the Cypriot government may nationalize some pension funds and rely on investments based on “the patriotism of Cypriots.” Along with individuals, international investors and Cyprus’ ultrawealthy Orthodox Church could help in the cause. This, according to officials, would be structured like a government bond, but its attractiveness to outside investors may be limited.
What’s Most Likely?
According to AP, Russia is likely to take up the cause, especially if it is offered interest in newly found natural gas deposits. Even without that deal-sweetener, when everything is totaled, Russia has about 68 billion euros tied up in the country. It doesn’t want to see Cypriot banks collapse. Although Laiki executives don’t want to see the bank restructured, that’s probably going to happen. It will not, however, be enough. Has anybody asked Apple (Nasdaq:AAPL) for help? They have 13 times more cash than Cyprus needs. (Probably not likely, huh?)
This island nation has less than 800,000 people but in international financial markets this week, Cyprus has taken center stage. This is proof that the eurozone, even the smallest of EU countries, is able to rock the markets. Investors have made the mistake of getting complacent when it comes to the eurozone. Being 100% long in this environment is a bad idea. Hedge your portfolio - especially equities and ETFs with large-scale international exposure.