Life after Cyprus

Bond market calm ignores Cypriot lessons

Bondholders don't seem to have noticed, but Cyprus has changed their world. It's a cause for good cheer, and for worry.

The most positive thing to emerge from the Cypriot crisis is that bank creditors, including senior bondholders, are finally bearing the cost of failure. It would have been better if the Euro zone had taken this line earlier, for example in 2008, when the Irish government indebted the nation to restrict the losses of providers of bank capital. But better late than never. More discerning investors in bank bonds should force bankers to be more disciplined. It's a step forward, even if weaker lenders will suffer.

While this "bail in" of lenders is welcome, the post-Cyprus new world has some more alarming features. The potential departure of Cyprus from the euro zone makes the single currency look less unified, as does the discussion of capital controls within the euro zone.

The willingness to question the shibboleths of irreversible membership and capital freedom could lead investors to panic faster in future. Also, politicians in northern Europe, emboldened by their success in bringing Cyprus to heel, may force enough austere rigour to foment popular rebellion. The imposition of expert advice without much in the way of democratic approval is a dangerous business. That applies not just to Cyprus, where bank restructuring will severely damage the economy, but to the Euro zone's drive to create a single bank regulator.

For investors, the most worrying aspect of the Cyprus crisis is the authorities' willingness to change the rules of the game in the middle of play. It is hard to know what to make of the first bailout proposal, which reversed the legal hierarchy of creditors by sparing senior creditors whilst forcing losses on bank-insured depositors. And investors should worry about the insistence that Cyprus' government debt should be 100 per cent of GDP in 2020, not Greece's 120 per cent. Where does that leave Italy, currently just shy of 130 percent of GDP, if it needs help?

Cyprus is unique in the size of its banks and its ties with Russia. But it is just like any other Euro zone member when it comes to a rescue: it and its creditors need to agree. Next time will be different, not necessarily better.