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Bailout For Cyprus Is Bailout For The Big Brothers In Euro Zone

I have written before that the various "bailouts" for American corporations are in reality not a bailout. The bailouts typically wipe out shareholders' equity. If they are bailouts, they are bailouts for the counterparties of the "rescued" companies--which is sometimes necessary, but certainly not for the shareholders. With this understanding, the headline "Rescued by a Bailout, A.I.G. May Sue Its Savior" in New York Times is completely unfounded and is entirely based on a misunderstanding of the nature of the "rescue" operation.

The "Bailout" for Cyprus is an equally striking illustration of the misleading nature of the term. The "bailout" essentially aims at ensuring that creditors who had loaned to Cyprus will recover their money: if the bailout deal did not work out, Cyprus would default on money loaned. So the bailout is actually a bailout for the creditors on Cyprus. Because the operation is meant to help the creditors and not the Cypriots, the Cypriots would be better off without the bailout, and the creditors on Cyprus banks would be worse off without the bailout.

Iceland is a case in point. The Global Financial Tsunami had rendered the Iceland economy bankrupt, whose outlook was extremely bleak. As any bankrupted entity would do, Iceland defaulted on its international creditors, who suffered deep losses. For example, the supreme court of Iceland ruled that loans indexed in foreign currencies were illegal, effectively causing huge losses on foreign creditors. As a result of much lighter debt load, and with assistance aimed at relieving the household sector, Iceland began to enjoy economic growth from 2011.

In sharp contrast, the Cyprus "bailout" did not make life any easier for Cypriots. Quite apart from the absurdity of the deal-which makes a mockery of the European monetary union, calling it a bailout is to add insult to injury. The operation prevented an exit from the Euro zone of a member, which could lead to a break-up of the Euro zone altogether. Preserving the euro benefits Germany the most. No wonder Germany is so much behind the deal. But the short term benefits notwithstanding, the deal has really undermined the credibility of the ECB, which has engineered effectively a partial confiscation of bank deposits which are supposed to be secure and under prudential supervision and regulation. Despite claims to the contrary, the Cyprus deal will be taken as a precedent, and investor confidence has been shaken up forever. The outlook for the euro has dimmed forever.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.