Cyprus : Capitalism is back

After long negotiations, the EU group, IMF and Cyprus announced the deal in early hours to resolve the ongoing crisis which engulfed the tiny country for last 10 days. The financial systems were shut down, banks were locked, money was rationed, credit card payments ground to halt and all commercial activity virtually stopped.

On many counts this deal is lot better than how earlier bailouts were handled and the cost of collapse has been put on parties which should take up the cost in true capitalism instead of distributing the pain on wider tax payers. For a long time the bailouts were handled in socialist way where by the losses were spread around, to tax payers, to govt debts and to general public. Creating a skewed risk reward. Privatised gains but public losses. In the name of contagion or systemic failure, banks were bailed out with public money with minimal pain to the parties which should be first in line. The Cyprus rescue changes few things fundamentally:

1- The deal is structured as bank collapse/restructure instead of bailout. The stock holder, bond holders and even large uninsured depositors will take the main hit. This should send the much required caution to risk takers who would rely on state bail out. If state stops meddling this should allow true cost of capital to be reflected in the investments instead of complacency which was creeping in.

2- Thanks to bold step by cypriot parliament which rejected the earlier "share the pain deal" which was suggesting to impose 6.75% on ALL depositors below 100,000 EURO in every bank irrespective of its health. That rejection resulted into common sense to return and losses were attributed where due.

3- In the Cyprus rescue process EU has sent a very wrong signal that deposits under 100,000 insured limit are not safe. Even though in new deal they are protected but EU should come out in clear words guaranteeing the deposits insurance or else at any new sign of trouble a bank run would start.

4- In the same light a clear message is sent to large depositors that amounts above 100,000 are not safe. They should plan now to distribute money around or invest in other avenues including Gold or mattress or whatever they consider risk free. A high yield bank account is certainly not risk free anymore.

5- Bond holders and stock holders should now get clear message that they will be hit first and therefore they should take better care in controlling the institutions they invest in. This should ensure proper risk premium is assigned to such investments.

All in all this is welcome return of Capitalism which was missing for last 5 years in the centrally planned economies. The bail out fatigue is setting in and people should re-evaluate the risks they are taking in these markets.

I will be travelling for next few weeks so there will be no regular updates to this blog. Happy Easters every one. Be safe and be secure.