A couple of points.
All lending to a sovereign is inherently unsecured. Contracts aside, there’s the problem of guns, and the government always seems to have more of them than the creditors do. Never mind that it’s relatively rare for lending to a sovereign to be backed by anything more than the “full faith and credit” of the government itself, which it can (of course) disavow. Remember that no Congress can bind the next one; this generally applies across the globe.
Alliances are always available should you find yourself in serious trouble. Cyprus, in particular, has suspected (but unproved) massive gas reserves and happens to have territorial waters through which people may wish to pass pipelines and similar things. Europe has a wee problem with this at present in terms of its energy infrastructure and requirements, and is largely dependent upon Russia. Cyprus has quite the whip hand, should it choose to exercise it following a departure from the EU.
Sovereigns have the privilege — and duty — of seigniorage. Duty? Why, yes. Privilege in that they have the right to issue into an expanding economy in order to balance output and keep the monetary unit stable, duty in that they have the responsibility to remove same during economic contractions so as to also keep the monetary unit stable. The EU is a failed system because it does not recognize this balance of right and responsibility and due to structural imbalances creates a forced subsidy model instead. This is an inherently unstable situation but neither Brussels or the periphery want to deal with it. The periphery has enjoyed quite a bit of these effects for years, but now the costs are biting hard.
IMHO the proper action is for Cyprus to tell the EU and ECB to bite it. Germany says:
“Cyprus has it in its own hands to prevent the state’s bankruptcy but time is running out,” said Hans Michelbach, a German lawmaker and ally of Chancellor Angela Merkel.
Germany has no right to dictate anything to Cyprus. Indeed, Germany and the ECB, along with the machinery at the EU, is at least as responsible for this problem as is the government of Cyprus, if not more so, as they have all failed in their supervision of these banking institutions for sufficient capital.
Let us not forget that these banks passed “Stress Tests” from the ECB; they were thus claimed to be sound. The ECB should be told to suck it up and eat the consequence of their claimed “soundness”, in this case to the tune of the required €7 billion or so, for they did not flag the banks as unsound or demand they be closed before they exhausted their bondholder capital.
More to the point is that there is yet more gaming going on in this regard with the capital structure with the incessant reports that the real problem isn’t that the bondholder equity is exhausted — it is that with the deterioration that has occurred resolution of the institutions would cause the bondholders to take losses and that’s unacceptable. This, however, is at odds with the very capital structure and its definition.
In short this is the case of the ECB and certain EU members putting a gun to the head of a sovereign nation and demanding that they rob their people to protect those who invested knowing there was a risk of loss from the consequences of their bad investment.
Cyprus’ response to that ought to be exactly this:
And if the ECB and EU want to press the issue then do what Iceland did; tell the ECB and EU to stick it where the sun doesn’t shine, issueindictments against the Troika’s members for extortion and criminal fraud (prohibiting them from entering Cyprus — ever — unless they’d like to spend the rest of their lives in prison) and resolve the institutions forcing the losses on the bondholders but protecting the depositors.
Then trace all the criminal activity in these banks and where there is evidence of fraud or other criminal activity by other financial institutions interconnected with Cyprus issue criminal indictments against both the banks and the executives.
This has a decent shot at winding up with Cyprus leaving the EU. So what? Cyprus would get their national sovereignty back and given that they’re sitting on a bunch of natural gas deposits while the short-term pain would be considerable in the intermediate term they would wind up the winner, much as Iceland has.