Cyprus debt-for -equity swap: update

Mike "Mish" Shedlock in the comments at Golem XIV links to his own blog where he in turn posts an email from somebody who has done his homework:

I read with interest your article on the Cyprus bailout deal. After a quick review of the most recent financial statements of the four publicly listed Cypriot banks as shown on their websites, it is notable that a simple alternative proposal could protect the country from bankruptcy and make its depositors whole.

By wiping out 100% of the equity, 100% of the bondholders, and 17% of the banks’ liability to central banks, the Cypriots could stabilize their banking system (based on the 5.8Bn EUR figure being discussed) without penalizing local savers.

Instead of raising 5.8Bn EUR from depositors, it could raise 1.4Bn from combined market cap, 2.0Bn from bondholders and preferred shareholders, and 2.4Bn of the 14.3Bn in combined Central Bank loans (Cypriot and ECB) it has on its books. This assumes zero contribution from the Cypriot subsidiaries of foreign banks so it may be conservative.

If the banking system is bankrupt, anything other than an Alice-in-Wonderland recovery system suggests that the order of liquidation is shareholders, preferred shareholders, debt holders, Central Bank creditors, and THEN depositors. If 10Bn or even 17Bn EUR is truly required, then coincidentally up to 17.7Bn EUR is available from equity holders, debt holders, and Central Bank creditors without impairing a euro cent from depositors.

That's much the same picture as with UK banks. Their losses (i.e. bad debts) so far as a percentage of total assets were relatively small (certainly less than 5%, even in the case of Northern Rock) and they could have been straightened out by converting a proportion (about a quarter or a third) of the bonds they have in issue to share capital. This might or might not involve cancelling existing shares, that's a minor issue. There was no actual need for the taxpayer to pay for bank bail-outs, that was just pilfering and looting on a grand scale during the smokescreen of a recession.

The idea of cancelling loans from the government is a bit off piste, because that's effectively saying that income taxpayers should pay it. I think that the general idea here was that they didn't want Cyprus to do like Ireland, have the government underwrite the banks and then go even more horribly bankrupt itself.

Writing down deposits and/or converting them to share capital is also a kind of tax (some have described the Cyprus idea as a "wealth tax") but even then, to the extent that a share capital and bond capital write-off won't cover the losses, it is far better to have a one-off specific "tax" on depositors (or pro rata write down of deposits) and have done with it*, than it is to bail out banks via inflation, low interest rates (these two are also "wealth taxes") and taxes on earned income (the worst kind of tax), which is what they have been doing in the UK (as Philip Inman says in The Guardian).

* Or even better, convert everything back to deposits, sack the top echelons of "management" and turn the bank into a building society again.