Aubyn Hill, Financial Gleaner Columnist
THE CRISIS in Cyprus is grave and has ushered in a new template as to who will carry the risk and financial burden of banks which face financial difficulties.
Recent history has some significant lessons which investors, depositors and shareholders need to learn.
In the late summer of 1998, after President Boris Yeltsin devalued the Russian ruble and Russia defaulted on its ruble debt, the small but influential American investment bank, Long-Term Capital Management (LTCM), staged a spectacular collapse.
LTCM was essentially a club for very rich people and wealthy and powerful institutions. It had only about 100 clients. It traded ordinary and some quite esoteric derivatives that allowed it to intertwine itself with every major Wall Street bank such as Chase Manhattan, Goldman Sachs, Bear Stearns, J.P. Morgan, and nearly all the big continental European banks.
LTCM had bet heavily on Russian bonds. When its arcane trades based on equity volatility exploded, the Federal Reserve and the big Wall Street bankers, many of whom did not like quite a few of the partners at LTCM, refused to bail out John Meriwether and his super-smart co-owners, some of whom were Nobel laureate mathematicians and other Wall Street numbers jocks.
It is reported that the US Federal Reserve, headed by the then famous Alan Greenspan, had to arrange with other major European and Japanese central bankers to make available a liquidity pool said to be in excess of US$80 billion to stabilise banks and markets around the world.
LTCM investors lost their investments in LTCM in September 1998.
One unstated consideration at the time among prospective banking and official rescuers of LTCM is this was a small group of wealthy and even cocky investors who should bear the consequences of their risk-taking adventures.
All the big banks which invested with them also had to swallow big losses. Exactly 10 years later to the month, on September 15, 2008, the 150-year-old Wall Street investment bank, the quite venerable Lehman Brothers, folded under the weight of sub-prime mortgages and precipitated a near-universal banking and financial sector meltdown.
The US Treasury led a US$700-billion bailout of its financial services industry. Other central banks around the world followed suit when their local banks ran into trouble.
Iceland was somewhat of an exception in that it used the concept of 'investor bail-in' to force foreign depositors and bondholders, both lenders to Icelandic banks, to bear the pain of complete collapse of the Icelandic banking sector in September that year.
SAVERS, BONDHOLDERS BEWARE
The economic dictum 'caveat emptor' - buyer beware - always did apply to depositors. But the debacle faced by the Cypriot banks in recent days has rendered a more potent, poignant and urgent translation - depositor beware.
Up to the time last month when the banks in Cyprus came to the public as being under severe financial strain, two outcomes of bank failures were quite certain.
First, depositors money would be safe and, second, taxpayers, local or foreign - depositors and bondholders were indifferent as to which - would foot the bailout bill.
Bankers were relatively free to take as much risk as they wished. Well, no more.
To borrow a phrase, the banking crisis in Cyprus is a game-changer.
The Dutch head of the Eurogroup of finance ministers, Joroen Dijsselbloem, depicted the Cypriot deal as a bail-in of bank creditors, including uninsured depositors. He tried to tone down the comment and backtrack a bit, but the genie was out of the bottle.
The Dutch finance minister was simply voicing publicly what most Northern European politicians had been saying behind close doors. The German Finance Minister Wolfgang Schauble was unequi-vocal when he declared that he considered the 'Cyprus Solution' fair, despite the massive burden on owners, creditors and customers of Cypriot banks.
While the Eurogroup moneymen protected, wisely, the Cypriot deposits that were less than, €100,000, they made an import policy change.
Bankers, lenders to banks such as bondholders and depositors, were put on clear warning that Eurozone taxpayers - meaning mainly German and Nordic ones - will no longer carry the albatross known in economics as 'moral hazard', that is, insurers of last resort, and that burden of risk will be transferred to banks' bondholders and depositors.
Many who watch financial markets for new developments believe that this change is Cyprus is a fundamental and far-reaching phenomenon.
WHERE'S MY MONEY INVESTED?
The fact that German Chancellor Angela Merkel, and many Germans, including some who did not vote for her, disliked the uninviting scent of Russian depositors' money which had flooded into Cypriot banks, stiffened her resolve to back the 'Cypriot Solution'.
Russians were, luckily, not Eurozone depositors and in any event many of those sources of Russian money were questionable, according to popular thinking in Germany and elsewhere.
Russian and other depositors in local Cypriot banks were not thoughtful or vigilant enough to monitor where their bankers in Cyprus were investing their cash.
If they were, they would have known that a vast majority had gone into Greek securities and that category of investment had lost credibility many months before.
In the same manner, depositors in Spanish banks had failed to notice that their bankers had created a real-estate bubble similar to the sub-prime version in the United States some years before.
Depositors and investors need to look at the kind of sovereign paper or commercial risks in which their bankers choose to invest. As a country, Cyprus looks a lot less inviting to depositors - especially Russian ones.
Central banks will have to be even more vigilant in a globalised world as it seeks to protect depositors' money in banks to which these central banks have issued deposit-taking licence and which, as regulators, they must monitor closely.
Since our financial meltdown in the mid to late 1990s, the Bank of Jamaica has been a quite exemplary regulator and our banks have rebuilt their balance sheets and equity bases.
In a dynamic world, the bank crisis in Cyprus presents a new set of challenges for central bankers, depositors, commercial bankers and their bondholders.
Aubyn Hill is the CEO of Corporate Strategies Limited and was an international banker for more than 25 years.Email: firstname.lastname@example.orgTwitter: @HillAubynFacebook: facebook.com/Corporate.Strategies