1. Private creditors of euro area sovereigns are safer now than before, because they are politically senior to most unsecured bank creditors, including unsecured senior bond holders, but excluding depositors.
Buiter does not appear to make a bold call that Cyprus will fall off the euro cliff anytime soon. Instead, he emphasizes the risk of OSI/PSI under the current trajectory. The fact an economic depression is likely whether the sovereign remains in the common currency bloc or not. And that Cypriot banks will need massive injections of extra capital.
While the possibility of anticipating future gas revenues is an upside risk to sovereign solvency, the downside risks, from much weaker than officially projected economic activity to the risk of a potential Cyprexit, dominate, in our view, and a restructuring of Cypriot sovereign debt, both through PSI and through OSI (the 2.5bn Russian loan and the 10bn ESM-IMF loan) during the next year or two is very likely. Statements from Eurogroup finance ministers, heads of state and heads of governments, from EC officials and from central bankers that there will be no more PSI for sovereign debt are simply not credible, in our view, because the arithmetic of funding needs, political limits to austerity and political limits on mutualisation through the front door (fiscal facilities like the ESM) or through the back door (quasi-fiscal transfers by the ECB/ Eurosystem) are still likely to leave a gap that can only be filled by sovereign debt restructuring.
Two other take-aways. Firstly, be under no doubt: rest in peace: democracy. ECB rules the roost over eurozone exit risks:
the ability of a two-thirds majority on the ECBs Governing Council to stop ELA funding means that the continued membership of Cyprus in the Eurosystem is dependent on it maintaining the support of a blocking minority on the ECBs Governing Council. Without the access of its banks to the balance sheet of the Eurosystem, either through the normal liquidity facilities or through the ELA, we believe Cyprus would have no choice but to exit from the Eurozone. Even though political pressures no doubt have been, continue to be and will be brought to bear on the Governing Council as regards Cypriot bank access to the facilities of the Eurosystem and the ELA, we find it extraordinary that so much political power rests with unelected technocrats. It is reminiscent of the Emminger letter episode, when in a secret document drawn up in 1978, the German Bundesbank President Otto Emminger was granted power by the German Chancellor Helmut Schmidt to ignore formal obligations to support weaker countries via (potentially open-ended) foreign exchange intervention during European currency turmoil.
Secondly, there remains a hole in the heart of the EU's cross-border banking supervision plans.
Under EU rules, domestic banks and subsidiaries of foreign banks domiciled in the EEA (European Economic Area) fall under the domestic/host country regulator and supervisor and are covered by the domestic/host country deposit guarantees. Branches of foreign banks are not. Specifically, they are regulated and supervised by home country regulators and supervisors and are covered by home country deposit insurance. Depositors of foreign branches of Laiki and the Bank of Cyprus therefore should have been treated the same way as depositors of these banks at branches in Cyprus. Yet depositors of the Greek branches of Laiki will be spared because these branches were, at the last minute, taken over by a Greek bank Piraeus Bank. Even if the letter of the law and the rules were observed, we feel the spirit was not upheld here.
And the godfather of sovereign debt restructuring Lee Buchheit weighs in on Cyprus bailout II: