Cyprus Bailout Revisited

A couple months ago Cyprus sent a quake through the world financial system. What has Cyprus done for us lately? Given us an example of what a "bail-in" as unprincipled as previous bailouts looks like. Cyprus was supposed to be either a "one-off" or a "new template," depending on which European official you listened to. Either it would be a model for holding creditors responsible for the losses of banks in the proper legal priority, or it was a special punishment applied only to Cyprus because Cyprus is small and its banks contained Russian money.

Which is it? Increasingly, the latter. A few weeks ago, the Central Bank of Cyprus published a curious set of "clarifications for the better understanding of the resolution measures." The principle of a bail-in—that uninsured creditors should suffer losses before taxpayers are on the hook—turns out to contain a few lacunae. "Financial institutions, the government, municipalities, municipal councils and other public entities, insurance companies, charities, schools, and educational institutions" will be excused from contributing to the depositor haircuts, though insurers later were removed from the exempt list. That means, of course, the remaining depositors must take a bigger haircut. But even this calculation gives the "bail-in" too much credit. The EU money went to Cyprus, not its banks, and money is fungible. So when the Cypriot finance minister assures powerful unions that losses to their provident funds will be made up later from the EU loan, in essence that's another hit on depositors. When the government brags of jawboning down an EU demand that it raise the health-care contributions of civil servants and working hours of teachers, or impose layoffs on the powerful banking union, or carry out privatizations opposed by labor, or expedite foreclosure on delinquent borrowers, depositors are implicitly paying for that too. There will be no haircut on the €9 billion ($11.8 billion) the European Central Bank injected, for political reasons, in 2012 to keep Cyprus's Laiki Bank temporarily afloat—€9 billion that has now somehow become a liability of Bank of Cyprus depositors, whose losses are bigger as a result. There are other mysteries. The dictated sale of Bank of Cyprus's Greek assets to a Greek competitor, at what a director reportedly said was a "ridiculous price," was a benefit to someone at the expense implicitly of Bank of Cyprus depositors.

The biggest mystery is why Cypriot banks were holding so much Greek debt when the EU reversed course and ordained a Greek default on bonds in hands of private creditors. A leaked report by forensic accountants looking into the Bank of Cyprus failure frankly states "people within the Bank were able to delete data and have attempted to ensure the deleted data could not be retrieved by the Investigative team." The report also indicates that Bank of Cyprus was speculating on Greek debt with money borrowed from the ECB. We should mention another possible offense, in a sense, against creditor priority in reports that certain connected customers withdrew funds just before the haircuts. A daughter and son-in-law of Cyprus's president seem to make a good case that their transfer of €10.5 million to a London bank was a coincidence, but then they proffered a "voluntary haircut" anyway via a donation to a church fund for the poor. Hmm. In retrospect, a great irony is that the originally proposed Cyprus bailout, which would have imposed an across-the-board deposit tax of 6.75% (9.9% above €100,000), probably would have been a better deal for the island. Though denounced as an insult to the sanctity of deposit insurance and potentially heralding bank runs across Europe, a relatively flat deposit tax would have been less corrupting, less arbitrary and stood the Cypriot banking system, on which so much of the island's prosperity has depended, a better chance of rebuilding itself than the politicized mess Cyprus got instead. Haircuts of anywhere from 60% to 100% will now apply to all depositors over €100,000—that is, except those who wangle an exemption or backdoor bailout. Even from a human perspective, a small ding on every depositor might have been preferable to wiping out the life savings that families, retirees and small businesses were depending on, and even the settlements of children orphaned by a 2005 Greek airline crash. Cyprus got a bad deal because it was small and, perhaps stupidly, didn't use its clout to oppose the original Greek haircuts, which had to be unanimously approved by EU members. But we have to chuckle when legislators on Capitol Hill talk about ending "too big to fail"—as if there is any chance of stopping politicians from bailing out whatever institutions politicians decide their own interests require bailing out, or any chance of imposing legal order on what are invariably chaotic, highly politicized decisions in the heat of crisis.

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New partnership, old conflicts

Recently-elected president of the Republic of Cyprus (RoC) Nicos Anastasiades, elected in January 2013, spoke at Tel Aviv University’s Faculty of Law Tuesday evening following an official visit that included meetings with both Prime Minister Benjamin Netanyahu and President Shimon Peres. His talk was a full-throated call to nurture the budding friendship it has sparked with Israel despite the recent thaw in Israel’s relationship with RoC’s long-standing nemesis, Turkey. With Israel and Turkey hopefully on the road to repairing relations, there are sure to be ramifications for international cooperation on the enormous cache of hydrocarbons discovered over the last few years beneath the seas of Cyprus and Israel. Cyprus might be edgy about where Israel’s loyalties lie. Perhaps this is part of the timing of the visit. Cyprus became the new friend when Israel’s long-term partnership with Turkey was in the doldrums. The Republic of Cyprus was the perfect candidate for a rebound relationship: the country is the heart of a long-running conflict between Greece and Turkey, and between their respective ethnic kin on the island who are pitted against each other: Greek Cypriots in the “south” – the UN and EU member state known as Republic of Cyprus, and Turkish Cypriots in the north, who under the protective patronage of a Turkish military occupation (and in some ways, an economic one) since 1974, declared themselves the Turkish Republic of Northern Cyprus in 1983 – recognized only by Turkey.

Israel and the RoC suddenly found they had at least one very important mutual strategic interest: the exploration, extraction and distribution of natural gas reserves, discovered neatly during the phase Israel-Turkey relations hit a nadir. The new friendship was thus another way for Israel to salt the wound with Turkey, which was already angry over the notion that the spoils of gas would all flow to the Greek government in the south and surely even more disturbed by Israel’s plans to enable that. After a brief introduction about Cyprus, in which the bailout crisis that has rocked his country these last two months made barely a cameo appearance, Anastasiades seems to have taken a cue from President Obama in declaring everlasting love and friendship with Israel. He noted proudly that ties between Jews and Cyprus are ancient, and that in the biblical times Cypriot wine was used for the Temple(Cypriots of all stripes diligently maintain the role of wine in their culture to this day). He then jumped to more recent history: “No quick reference to the historic relations of the peoples of our two nations could obviously be completed” said the president with a flourish, “without mentioning the role that Cyprus played in the establishment of the State of Israel.” Like Obama, he suffered through a Hebrew word (“Haganah”) while reminding the audience that Cyprus assisted in the smuggling of Jewish refugees to Palestine after World War II (this part did not appear in the prepared remarks, available here). Some sharp adviser must have conveyed the soft-spots of Israeli identity, because he explained that both Cyprus and Israel share a history of “struggle for survival,” and identified the main regional threats today as Iran and Syria.

The president was clearly most interested in conveying the intention to upgrade relations between Cyprus and Israel and “embark on a new era of partnership.” That mainly meant cooperation on the hydrocarbon issue, and contributing to stability in the eastern Mediterranean. He clarified that Israel-Turkey and Israel-Cyprus relations are not mutually exclusive – but that only highlighted the fact that trilateral cooperation seems a long way off. “Stability” leads to questions about the elephant in both rooms: the two unresolved political conflicts in which both Cyprus and Israel are engaged but which also drag major regional and international players into their vortex. Anastasiades apparently did not wish to distract from Israel-wooing by discussing Israel’s elephant, but he did touch momentarily upon the Cyprus conflict. His did so by repeating the standard Greek-Cypriot line now 40 years old: that 37 percent of Cyprus and 57 percent of its coastline is under foreign military occupation and resolution is in everyone’s interest. But he offered no insight as to how such resolution might come about. It was an ironic moment that was met mainly with blank stares. Does Anastasiades really expect Israel, whose military occupation is so deeply ingrained in policy and life that it is almost transparent, to take up the gauntlet on behalf of its new friend Cyprus? Admitting that military occupation hurts Greek Cypriots (who hardly live in the north anymore) would open to the door to admitting that it hurts Palestinians in the territories, who are all living under some form under Israeli military occupation. Anastasiades would do well to remember that political friendship has its limits.

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Vassiliou slams treatment of Cyprus by its EU partners

CYPRUS WAS not treated fairly by its EU partners regarding the rescue package established for the country, but in no way should the island leave the eurozone, said former president George Vassiliou. In an interview with PricewaterhouseCoopers Ltd (PWC) for the new issue of Global Economy Watch, published by PWC, Vassiliou acknowledged there was a debt issue but that the way it was presented was “unfair to Cyprus”. “To start with, everybody knows that the banking crisis in Cyprus originated in Greece. If the Greek economy had not collapsed, nobody would have complained about Cyprus,” he said. When the decision was taken for private sector involvement (PSI) in Greece (a haircut of Greek debt held by private bondholders), the Greek government could have said that “Cyprus banks in Greece are as Greek as the Greek banks, so they have to be treated in the same way”, but they did not do that, noted Vassiliou.  Of course, the Cypriot president at the time, Demetris Christofias, also failed to realise the repercussions of voting in favour of the PSI, along with other EU member states, he said. “But they should have realised that the repercussions of this PSI for Cyprus would have been huge...the losses from one moment to the other for the Cyprus banks were €5 billion which was practically all of their capital,” he added.

This created the banking crisis, but unlike in Greece, the international lenders chose to treat Cyprus differently, saying the solution to the problem should be financed from Cyprus.  The former president also criticised the Eurogroup’s decision last March to offer Cyprus only €10 billion of the €17 billion bailout loan requested, citing debt sustainability issues, while ignoring the country’s “tremendous” gas and oil prospects.  He also slammed Cyprus’ EU partners for their treatment of Cyprus after coming to the conclusion they can do anything they want to Cyprus because it does not pose a systemic risk to the eurozone. Now, after the medicine has been swallowed, key officials like the German finance minister have gone on the record to say Cyprus could not be left to go bankrupt because it would hurt the eurozone and EU. “So, Cyprus became systemic,” said Vassiliou. Regarding the unprecedented haircut on depositors imposed on Cyprus, “for the first time in the history of the EU”, Vassiliou said the argument that things would have been much worse had the banks been left to go bankrupt as has happened many times in the US since 1933 was “simplistic”. He highlighted the massive role played by the Federal Reserve to help and save US banks from closure over time.  

The initial decision to impose a haircut on guaranteed deposits, despite being rectified a week later, sent a message to the whole world: “Do not trust banks in the south (of Europe), only banks in the north”.  

Even if a bank is healthy and well run in countries like Italy, Spain, Portugal, Greece or Cyprus, it has to suffer. “If a bank is not run well but lives in the North whether it’s Germany, Sweden, Finland, that’s OK because it’s northern. The message that has been sent around the world is therefore that no deposit in a bank is safe, if it is in the south...That’s why people now are afraid to make deposits.” Vassiliou pointed out that Britons, French and Germans, for example, have various ways of saving wealth. But in Cyprus, the only way to save was to buy shares or bonds in the banks, he said, referring to the wiping out of shareholders in the island’s two biggest banks. The former president said he made the point to a number of MPs around Europe, that the shareholders of Credit Agricole or Barclays or Deutsche Bank probably do not represent more than half a percent of the population of the country they are based in, if that. “In the case of Cyprus, the shareholders of the two banks, Bank of Cyprus and Laiki bank were nearly 70 per cent of the total population. So you were imposing something that was attacking not the so-called Russian oligarchs but practically every Cypriot household,” he said. Regarding talk of leaving the euro, Vassiliou was adamant, that despite the fact Cyprus was not treated fairly “and that’s my conviction”, the country must remain in the eurozone and prove it is a small but valuable member of the EU. Leaving the euro and devaluing the Cyprus pound would bring greater inflation, but not necessarily greater competition. You become more competitive by increasing your productivity and adopting advanced new technologies, not devaluing your currency, he argued. “If Cyprus or Greece or Italy get out of the eurozone, they will be less competitive, and the eurozone will disappear. Maybe that is to the benefit of some people or some countries but it is certainly not to the benefit of the world.” Asked about ways Cyprus could claw its way out of the crisis, he said the government must ensure the tourist and business services sectors remain strong and continue to develop, even with certain changes.  He slammed the decision to maintain capital controls on the banking system.  On the future of Europe, Vassiliou noted the dream of the EU was born on the graves of nearly 100 million people lost in two World Wars. “Hence the dream of the European Union became a reality. And today, within the globalised world, you understand that if tomorrow there is no European Union, there would be no Europe.”