Vultures of Liquidity Descend On Cyprus
It’s always nice to be right! Just about a month ago, after Cyprus froze bank accounts and announced its intent to seize deposits, I noted a great arbitrage opportunity:
If capital controls are likely to be temporary, you should see a flood of Europeans with suitcases of dollars landing at Nicosia. They will be exchanging cash for checks written on (temporarily frozen) accounts in Cypriot banks at a large discount to par – Cypriots will give up anything for liquidity right now. The entrepreneurs will just have to wait for capital controls to be lifted, and they’ll have made enormous profits. If capital controls are likely to be permanent, then the discount to par will be much greater because of the perceived likelihood of confiscation, forced conversion to Cypriot drachmas/rubles/whatever, and being locked in Cyprus.
Well, that day has arrived. Distressed-debt investors (the pirates of the financial world) have seized the opportunity. According to one Cypriot quoted, currently the going rate for Cypriot cash is around 20% of face value. It might be a fair price given liquidity constraints and policy uncertainty, it might be price-gouging on a vulnerable population, or it might well be both. That’s the beauty of highly volatile and illiquid assets – there are huge returns to having even a slightly better idea of what’s going on than your counterparties. I suspect that two “…former Lehman Brothers distressed-debt traders [who have] traded Icelandic bank claims and claims on the bankrupt Lehman…” are probably smarter, better-informed, and under less duress than their Cypriot counterparties.
The main issue for real traders is scalability – landing in Nicosia with ten thousand dollars cash in exchange for Cypriot checks can’t provide a channel for a hedge fund to invest large amounts of cash. Actually making this a large enough investment opportunity for an institution, as opposed to an individual, requires channels for moving institutional amounts of money millions at a time. If those channels existed, then the arbitrage opportunity wouldn;t.