Cyprus and the loss of faith in unified Europe
Five European sovereign bailouts, five ways of doing it – but one thing is common to them all: reckless lenders are spared (except in the last Greek round) and hedge funds rewarded. This time, even the smallest deposit holders are hit. One clear consequence: the European Union is rapidly losing support in its member states.
Now, with the experience of five European bailouts it is safe to say they come in different sizes – from the Greek one now totalling €240 to the latest, €10bn for Cyprus. Apart from the Greek haircut (finally after two attempts to stabilise Greece) bondholders have not been touched. In Cyprus where 48% of public sector debt is held by domestic banks, a haircut à la grecque would have felled the banks and not been of much help.
One particularity of the Cypriot banks is that although their assets are roughly eight times the island’s GDP they are mostly funded by deposits, not by whole-sale loans like i.a. the Icelandic banks were. After being badly hit by the Greek haircut last year – more like the last drop rather than the real reason for their troubles – equity in Cypriot banks has evaporated.
Laiki Bank is a case in point: its assets and liabilities is €30.4bn, its equity paltry €1bn. By turning 10% of deposits into equity, as the stability (or more sweetly, solidarity) levy roughly does – bingo, the equity is miraculously a much more sustainable 8% and the troika doesn’t need to provide lending to save the banks. Assuming there will be any deposits left in the Cypriot banks when banking resumes after an, apparently, prolongued bank holiday later this coming week (the banks were due to open on Tuesday, after a long weekend, but there is now rumour they will not open until Wednesday or even later).
By looting bank accounts the total sum needed is brought down: instead of a bailout sum of one Cypriot GDP, ca €17bn, “only” €10bn will be needed.
This is a drastic measure. If this could solve the problem it might have some merit – it would be a quick stab instead of the lingering pain in Greece – but that is more than uncertain. I find it very difficult to stomach that there was not a minimum sum left untouched. Let us say a pensioner with €30.000 would have kept his savings unscathed. Or even holding a sum equivalent to the minimum deposit guarantee of €100.000 untouched but putting a levy of 15% on everything above that. Perhaps none of this would have sufficed to bring the total loan down but yes, I still find this measure extremely brutal and this measure needs to be strongly underpinned and justified. The FT (paywall) has an account on how the deal was reached – it will not make the Germans more popular and it is still incomprehensible how this part of the bailout packet could end where it did.
It follows from the way Cypriot banks were funded that they have been stuffed with money, not from Cypriot pensioners and small savers but with Russian money and other foreign money hiding from attention. It has been known for a long time and what did the European Union or the ECB do about it? Not very much or at least nothing that drove this money away. Now, both Russian oligarchs and a Cypriot olive farmer are hit by the same measure. How fair is that?
One frequently mentioned thing over the last months is if Cyprus should chose the Icelandic way in terms of deposit holders. This advice normally comes without any explanation as to what was done in Iceland and seems to imply that deposit holders should or could be treated differently according to nationality. However, what was done in Iceland can’t possibly apply to Cyprus.
The deposits the Icelandic Government refrained from saving were deposits in Icelandic branches abroad, in reality so-called Icesave internet accounts in Landsbanki branches in the UK and the Netherlands. When deposits were moved into the new banks, where deposit holders could then access the funds previously held with the old banks, only deposits in Iceland were moved. – The Cypriot Government could not, on the basis of the Icelandic way, differentiate between, let us say foreign and Cypriot depositors in Cyprus. For the Cypriot Government, the problems relate to deposits in Cyprus, not abroad. Suggesting that the Cypriots follow the Icelandic course of action seems based on some ignorance about or misunderstanding of what was done in Iceland as the three banks collapsed in October 2008.
Interestingly, I am told that Greek and the Cypriot officials did ask the European Commission informally if the Icesave judgement – where the Icelandic state was not deemed to be obliged to guarantee the Deposit Guarantee Fund nor was it seen to have discriminated against deposit holders abroad (because deposits in Iceland were moved to the new banks, without the use of the Icelandic DGF) – could be of any consequence, i.e. use for them. The answer was a succinct “no.” The EU and the ECB firmly believe that the sovereign is the last guarantor of the financial system in each country – and now, in one case, a state has been allowed to confiscate money from depositors, olive farmers and oligarchs alike.
Cypriots are understandably furious – but the Cypriots, just like Icelanders some years ago, should be furious with their own politicians. There is little point in talking about neo-colonial powers. The EU, the ECB and the IMF have a say over the Cypriot economy because the way things were run in Cyprus. Being mired in debt – no matter if it is a person or a sovereign – leads to a loss of independence. That is the harsh and painful reality.
That said, it is interesting to reflect on the role of the European Union in the five bailout countries. All these countries, as well as some other Eurozone countries, made a huge effort during the 1990s to meet the EMU criteria and join the euro. But once these countries had cut off a heel there and a toe here, to fit the euro shoe the EU stopped being strict. As late as 2011, Mario Monti wrote a brilliant article in the FT, blaming the euro troubles on the EU being too deferential and too polite to its member states. The powerful states, i.a. Germany, have time and again intervened to prevent monitoring etc. (Icelog on Monti’s article here.)
Five countries have suffered from this laxness in the EU, apart of course from mistaken domestic policies. As Mervyn King wrote to his Icelandic opposite number in April 2008, explaining that the Bank of England refused to do a swap: “among friends it is sometimes necessary to be clear about what we think.” – Brutal clarity is sometimes needed but the EU failed to behave like a true friend.
And yet, there was all the time abundant evidence of things heading in the wrong direction. Olivier Blanchard, the chief economist of the IMF, lately berated by EU commissioner Olli Rehn for unhelpful additions (read “clarity”) to the debate, ended an article on Portugal in 2007 thus:
I began by arguing that Portugal faced an unusually tough economic challenge: low growth, low productivity growth, high unemployment, large fiscal and current account deficits.
I then examined various policy choices, from reforms increasing productiv- ity growth, to coordinated decreases in nominal wages, and the use of fiscal policy in this context. I want to end on a more positive note. There is a large scope for productivity increases in Portugal, and a set of reforms which could achieve them. A decrease in nominal wages sounds exotic, but is the same in essence as a successful devaluation. If it can be achieved, it can substantially reduce the unemployment cost of the adjustment. Fiscal policy can also help. While deficits must be reduced, temporary fiscal expansion could be part of an overall package, facilitating the adjustment of wages. The challenge is there. But so are the tools needed to meet it.
The first decade of the new millennium – and incidentally the first decade of the euro – is turning into a lost decade for Europe. The European Union, with its new currency, allowed the periphery – earlier with understandably high interest rates – suddenly to bask in low euro rates with the unrestrained banking systems in i.a. Germany and France only too happy to lend. When worst came to the worst, the lenders have (mostly) been spared and the inhabitants punished. No wonder the European Union is losing popularity in all of Europe as fast as the money flows out of Cypriot banks. It is painful to see that in spite of its rich intellectual heritage, Europe is now governed by extremely by narrow-minded policies and no understanding for their social consequences.
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A collection of info and blogs/articles on the Cyprus bailout at Sigrún Davíðsdóttir's Icelog
17 Mar 13 at 8:53 pm
Hi Sigrún,
I can’t say I was dismayed, shocked or angered by the EU’s Cypriot “bailout” proposal (it does seem to be a proposal, since the numbers are being shuffled, apparently to try to find something less suicidal [something like “let’s try a 9mm instead of an 11mm, maybe we will be less dead…or maybe a 7mm…?”]), but I was more than a bit stunned. Even with my more than a bit cynical view of the EU. Now I am analyzing to determine, one, what the EU fools were thinking, vs. what they were not thinking of, and, two, what the gamut of results may be, from worst to best, and what the results of those results may be, also from worst to best.
Somehow every possibility seems to be, ultimately, amusing.
A large unknown is what is to be done by the Cypriot deposite guarantee scheme? As the Iceland v. GB and NL business may have obscured, DG scheme requirements are EU mandated, and so apply, in full, in events of EU member state depositors’ deposits becoming unavailable. I don’t recall reading of any “haircut-tax” exception written in the EU rules. I don’t think the writers anticipated deposits becoming unavailable for a super-sovereign (the EU) making super-sovereign withdrawals to pay to favored “investors”, and so did not make an exception for such case. This means that bailout’s proposed siphonings-off from deposits under €100,000 should be reimbursed by Cypress’s DG scheme (remember, these guarantors are commercial, not sovereign). wherefore there should be no loss to Cypriot small-savers, or to sovereign Cypress: The guarantor should make good the unavailable percentages, and so the only payers should be the rich Russians, or “Russians”, who are, after all, the ones the EU Commercial-Elite aristocrats say they want to wring “illicit” deposit funds from (I put illicit in quotes, because it is apparently OK for David Rowland to haven moneys offshore in Guernsey and Luxembourg, and Joe Lewis to haven offshore in the Caymens and Bahama, but not for Ivan and Olga to haven offshore in Cypress), and of those, only the ones with more than €100,000 in their accounts.
The question is, why did the EU-elites not advise the small-savers their ‘become-unavailable’ percents would be reimbursed, before they panicked them? Now they will have a stampede. The doleful effect on the deposit insurers will be the same, so the reason could not have been to save them from anxieties and angst. I wonder if it might have been to prevent them stampeding, perhaps to buy credit-default-swap insurance against their own DG insurance investments? They could have bought multiple policies, you know, since CDS are approved for investment as well as insurance. They could have borrowed funds to buy the CDS’s from Russian oligarchs, who could have invested their idle funds, lying dogo in Cypriot banks. That is, after all, what CDS are for.
The EFTA Case 16-11 Iceland precedents won’t come into play until after the deposit insurance drama has played through in the Cypress situation, at least to the point where the Cypriot bank’s DG schemes are broke and can’t pay anymore. Then, because the EC has stated categorically that EU member nations “will not be allowed” to referendum-renege from responsibilities for the nation’s banks debt obligations, things may become interesting. Cypress, the nation, might have to take its case to an EU Court of Justice, which will have to decide to conspire with the EC, or to give it a lump on the other side of its head, to match that it got trying to cow the EFTA Court, to help its little ESA friend.
The second half of the EFTA Court 16-11 case decision, in regard to discrimination, would only come into play if Cypress let its current banks be collapsed by the inevitable stampede-runs Cypriots are even now readying themselves to try to win-place-or-show in, which runs are pretty certain to change all the Cypriot banks from fiscal grapes to fiscal raisins within a couple of days.
I don’t know how that will play out. you may recall that the EFTA Court let the EC and ESA hang themselves on the ESA’s ill-conceived allegation, which was that Iceland had failed to provide equal treatment, but they, the EC and its clients, GB and NL, did not want equal treatment (accounts in the names of the savers whose claims they had bought out) in the new Icelandic banks, like the Icelanders got, but, instead, wanted money, which the Icelanders did not get, and in Euros, which the Icelanders were prohibited by law from getting.
In the Cypress case, if it comes to pass, the trick will be for Cypress to find a solution for Cypriots that the Russian and “Russian” (are these maybe Germans, pretending, to beat the German taxman?) and, of course, the NL and GB hedgefunds who might buy out depositors’ claims, would find unpalatable, so they might hang themselves by wanting money, not really the equal treatment they complained they weren’t given. [It was the second great disappointment the EFTA Court 16-11 case handed me, that the judges did not order the new Icelandic banks to provide bank accounts to the Bitish and Dutch depositors, like they had to the Icelandic ones: It would have forced the British and Dutch deposit guarantee schemes, who had bought out those accounts and were only pretending to be “depositors” to rush back to all the real depositors and force them to put their money back into Icelandic bank accounts, in Iceland. Or be guilty of violating the equality Directives, themselves. Not only would that result have been fun, it would have helped Iceland out of its cash-crunch; GBP and Dutch Euros pouring into the new banks from GB and NL depositors, whether they wanted to deposit them or not…]
Finally, Sigrún, I must take you to task for your suggesting the EU leadership narrow-minded: You are much too generous, and, with the EU leadership’s “Cypress Solution” manifesting the EU leadership to be completely mindless, is indefensible.
R.L.Dogh
18 Mar 13 at 12:48 am
Sigrún,
I made an error in my 18 March post: I wrote, “deposits under €100,000 should be reimbursed by Cypress’s DG scheme”, when I should have written, “deposit >losses< under €100,000 should be reimbursed by Cypress’s DG scheme". The EU Directive specifying deposit protection specifies insurance reimbursement for "unavailable deposits". Whatever of a depositor's deposit becomes unavailable, up to €100,000 is required to be reimbursed. If 10% of a €1,000,000 deposit is made unavailable, for example, the DG is responsible to reimburse that 10% (€100,000). The deposit-grabbers might wish to argue this point, but their arguing will be up-hill, because the purpose of the Directive, stated in the directive, is to assure depositor confidence. While depositor confidence may weather a worst-case scenario loss for a catastrophic failure, as is presently being illustrated, it will not weather an establishment of a precedent for periodic shearing of depositor-sheep [Wouldn't it have been nice if it was, so Landsbanki and KSF could have "temporarily sequestered" (temporarily moved from owed to owned, liability to asset, on the books) sixty percent of their depositors' deposits? They could have more than satisfied the "liquidity" demands of the FSA].
R.L.Dogh
22 Mar 13 at 10:40 pm
This actually answered my downside, thanks!
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