ROB Insight is a premium commentary product offering rapid analysis of business and economic news, corporate strategy and policy, published throughout the business day. Visit the ROB Insight homepage for analysis available only to subscribers.
The Cyprus bailout is only the latest example of an absurd European trend. Namely, hedge funds earning outsized profits on bets that taxpayers would suffer to protect institutional bondholders. It's not the hedge funds' fault, and there's no hint of illegal activity. The blame lies with the eurocrats, whose solutions to financial crises have become so predictably undemocratic that the hedgies would be fools to stay away.
Reuters reports that hedge funds are set to realize big gains on Cyprus government bonds. The funds bought up half of one entire issue, with a 3.75 per cent coupon maturing in June of this year. They paid about $0.80 per dollar, according to the report, and will book a 20 per cent profit in June of this year when the principal is repaid with funds scalped from Cypriot bank deposits.
Fund managers added the Cyprus debt position with the expectation that bondholders would not be forced to take any form of hair cut as part of an EU bailout. The precedent, which was first set in Ireland in 2008, is that institutional debt holders would be paid in full with bailout funds while taxpayers would be forced to foot the bill. It appears the bet on Cyprus' debt will be successful. Although the final bailout details are still being debated, the possibility of debt restructuring is not part of the discussion.
Paying off bondholders while forcing the general populace to bear the brunt of austerity measures and new taxes was the very first response to the growing Irish financial crisis. The government at the time guaranteed that bond holders would receive all interest payments and 100 per cent of their principal back. The state would shoulder the debt load, and ultimately forced the economy into a recession in order to pay for it.
European parliament continued its slap-the-citizens policy in Greece. In December of 2012, the Greek government attempted to force a retirement of public debt at $0.30 per dollar. After a concerted lobbying effort by hedge funds, European officials dictated a much smaller discount. The result, according to the New York Times, was that while most institutions took writedowns, hedge funds Greylock Capital, Fir Tree and others reaped 100 per cent profit "in yet another Greek bailout financed by European taxpayers."
EU leadership is no doubt concerned that deep creditor haircuts will cause a region-wide financial panic but still, this is madness. Aggressive investors can buy bonds in any financially distressed country, fully confident that any pain resulting from financial support will fall exclusively on innocent civilians. The EU must send a shot across the enemy's bow and make bondholders contribute to bailout efforts — even if only in nominal amounts. Otherwise, it's too easy for the hedge funds, who face only the appearance of investment risk.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow Scott on Twitter at @SBarlow_ROB .
Scott Barlow