Sigrún Davíðsdóttir's Icelog

For the time being the topic of capital controls in Iceland seems shrouded in silence. Yes, recently yet another MP banker was added to the controls steering committee, the prime minister mentioned the controls in a speech without maligning creditors or talking about the billions the state could derive from the bank estates. In other words, so far so little, which means that little is changing from what it has been.

“Lifting the capital controls is the single most important issue for Iceland,” prime minister and leader of the Progressive party Sigmundur Davíð Gunnlaugsson said in a speech recently. Gunnlaugsson has mostly just made stray comments on the controls, lately far from his earlier so belligerent tone and no mention of the funds that could be derived from the estates.

The force minister of finance and leader of the Independence party Bjarni Benediktsson seemed to be putting into control-lifting late last year seems to have seeped out of him as he could not deliver on his promise: to present a plan by the end of 2014.

There is now little apparent energy behind this issue. Compared to same time last year the progress is that there are now foreign advisers working on capital controls and a new steering committee, the third such advisory group. In addition to hiring foreign advisers Benediktsson’s major achievement last year was pulling through the Landsbanki bond agreement. But instead of being the agreement being first it has remained the only step so far.

“I fully expect something to happen regarding the capital controls after the next election, in 2017,” was the wry comment from one Icelandic observer some days ago expressing the sentiment that this single most important issue seems to be devoid of all political urgency. The third Thursday in April is the Icelandic first day of summer when parents give their children something seasonal for summer presents such as a ball to play outside. Spring might also be the time when some next step might be taken towards lifting the capital controls.

The young and yet so lethargic power-players

The left government, in power from spring 2009 until spring 2013, surely got some things done such as targeted debt write-down for households, steering Iceland through an IMF program and dragging the country back to growth already by mid-2011. However, it was consumed by infighting and was its own worst enemy. Following this government an energetic government focusing on growth of opportunities and ideas, as well as growing the economy would have been a great asset.

A government led by two young coalition leaders – the youngest ever prime minister and a young minister of finance – seemed indeed very promising. However, in many ways the duo seems be heading towards the past rather than the future. The language of the prime minister’s tends to echo patriotic language harking back to the mid 20^th century. New appointments often seem to smell of nepotism and old ties.

The Icelandic media has at times focused on the prime minister’s somewhat erratic behaviour; apparently he often goes on un-announced trips abroad. He has the habit of making remarks that then turn out to be factually wrong or misleading. Words seem to come very easy to the prime minister but all too often the substance is doubtful.

With the prime minister as a comparison Benediktsson strikes a more serious and competent tone and demeanour. His approach is conciliatory and he seems widely liked, except by the old guard in the party who still mourns the, perceived by them, golden age of Davíð Oddsson. It has been apparent time and again that Morgunblaðið, with Oddsson as its editor-in-chief seems to side more with Gunnlaugsson than Benediktsson reflecting that the paper is owned 50-50 by companies with ties to the Independence party and the Progressive party. A powerful person in the latter camp is Þórólfur Gíslason, a relative of Oddsson. (If blood ties matter or not is unsure but most Icelanders will see this as relevant).

The two coalition leaders come from families at the heart of the Icelandic power structure. Benediktsson’s family is the core of the Independence party story of power. His namesake, the brother of his grandfather (if my genealogy does not fail me) was a legendary leader of the party from 1963 to 1970, the party’s glorious age. “It’s not enough just to carry this name,” one Independence voter remarked sardonically. Gunnlaugsson’s political family ties only goe back a generation: his father was briefly an MP and his business interests allegedly rose from political connections.

Political deadlock

Although the government tension is not apparent on the surface the tension shows in the fact that amazingly little seems to get done. The government is i.a. hovering as to breaking up the EU membership negotiation or not. A recent example is a draft proposal for a new Act on fishery management, expected to be introduced to Alþingi before its summer recess; the proposal’s course is now uncertain. Another topic is the Interconnector, i.e. a cable connecting Iceland to the UK: UK has shown interest in buying Icelandic electricity but the government seems unable to act on this interest, i.a. due to deep-running political and interest divergences on this issue.

On the whole, the government is seen as moving slowly, even remarkably slowly, considering that is has a strong majority and no internal opposition, at least not on the surface. It is also blessed with an opposition, which for a long time seemed to be waking up every day from a crushing defeat the previous night. Only recently the leaders of the Left Green and the social democrats have made a bit of a splash in the political debate.

There are no apparent explanations as to why the government is so lethargic. It is not so much words as action that “don’t come easy:” the prime minister is good at making speeches about the promising future of Iceland but moving beyond the words is difficult.

As one source in the Icelandic business community said there are plenty of examples in the world of countries with natural resources and other advantages that still do not manage to harness what they have. “Capturing the possibilities doesn’t happen automatically.” In Iceland, it seems not to be happening at all.

The latest polls show that the government now has support of 36.4% of the voters, compared to 34.1% end of January and 34.8% mid January. The top line figures are Independence party 25.5%, compared to 24.9% earlier and the Progressive party 13.1%, compared to 12.7%. Hovering around 25% is the Independence party’s destiny now, far from the around and above 40% at the time of Benediktsson’s namesake in power, last seen in the elections in 1999, 40.7%, under Oddsson’s leadership. – The fractioned opposition, four parties, are not moving the voters much.

Yet another committee

Following the meeting between the Winding-up boards and their advisers with the government’s advisers in December the feeling was one of cautious optimism among creditors. At the time, Benediktsson had for months boldly been announcing “a plan” by the end of the year.

Unofficial announcements following the meeting were that everything should be in place to proceed early in the New Year. In his end-of-year interviews and statements the prime minister, in his freewheeling mode, drummed up the optimism by first talking about “a plan” soon, then by the end of January. This has to be seen in context with statements after coming to power in summer of 2013 as to how easy and quick the lifting of the controls would and could be.

The only thing that January brought was a new committee. As earlier, Glenn Kim is the chairman. Others are Benedikt Gíslason, adviser to Benediktsson, and Eiríkur Svavarsson, by now veterans in this field, together with Sigurður Hannesson from MP Bank, a close friend of Gunnlaugsson and two from the CBI, Ingibjörg Guðbjartsdóttir and Jón Sigurgeirsson.

Gíslason used to work at MP Bank and now just recently MP bank’s chief legal officer, Ásgeir Helgi Reykfjörð Gylfason (this long names are uncommon in Iceland) has been added to the committee.* The CEO of MP Bank is Gunnlaugsson’s brother-in-law but as the bank stated in its press release on Gylfason it is proud that the bank’s expert are sought to work on such important issues.

Svavarsson, Hannesson and Gylfason are seen as close to the prime minister. Sigurgeirsson is close to the governor of the CBI, who shares a good understanding with Benediktsson. Apart from speculations of intimacy and allegiance, it is worrying that none of the Icelandic lawyers on the committee has any international experience.

This is the third group set up to work on the capital controls. The feeling is that previous groups have broken apart because of differences of opinion on how to approach the resolution of the three bank estates, a necessary step towards lifting the controls.

What could come next, apart from more procrastination?

Glitnir has made news in Iceland following a leak that Íslandsbanki might be sold to Middle Eastern investors. Earlier, Chinese interest had been in the air. Certainly, selling Arion, owned by Kaupthing, and Íslandsbanki would make a composition easier.

The estates have had plenty of time to calculate a positive outcome. Although no decision was announced for a next meeting after the December meeting it is expected that another meeting will or would follow soon.

Some weeks ago Víglundur Þorsteinsson, an old businessman who lost his company into bankruptcy following the banking collapse, made allegation about wrongdoing regarding the splitting up of the banks, i.a. that creditors had profited unduly. This was not the first time he stated these claims and he has never found any serious support for them. This time the prime minister sided with him, saying this should be investigated.

Brynjar Níelsson, an Independence party MP, got the task of reviewing the claims, which he did by utterly rubbishing them. It is not clear if the prime minister will see this case as a reason to move slowly regarding the estates, probably not, but his support to Þorsteinsson was much noted.

As far as is known the new group is working on proposals towards lifting the controls. The two coalition leaders have often spoken about a “holistic solution,” a “framework” etc. Considering the fact that the two estates ripe for composition, Kaupthing and Glitnir, have very different problems – Kaupthing with no ISK assets beyond its ownership of Arion but Glitnir with ca. ISK100bn in addition to Íslandsbanki – the framework might turn out to be of a general nature so as to accommodate tailored solutions for the estates.

The much discussed exit tax might be pressed for, in order to get the funds the prime minister seems to think can be had from the estates. However, as I have pointed out earlier exit tax does not solve the ISK problem, unless used in a targeted way, as did Malaysia in the late 1990s. Possible solutions have been dealt with in earlier blogs.

The business community is up in arms about the stalemate on controls but the voters do not really sense the effect of the controls, meaning there is only a moderate pressure on the government to act. As pointed out earlier it seems that the two coalition leaders do not proceed on the controls because they really are at loggerheads on how to go about it. There really is no longer anything unknown in this issue. It has all been mulled over, no stone is unturned. What is lacking are decisions, not more analysis etc.

At the core of that dispute is really if lifting the controls is a gain in itself or if Benediktsson is willing to help Gunnlaugsson find a way to lift the controls in such a way that he, the prime minister, can proclaim victory.

*As reported earlier, the appointment of Sigurður Hannesson was first announced by MP Bank, not confirmed by the government until days later. Now the saga is being repeating by appointment of Gylfason: the bank announced his secondment on February 13 but no official announcement has yet been made by the Ministry of Finance. Another indication of the lackadaisical attitude for formalities.

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Why do the inhabitants of an EU country prefer to keep cash amounting to ca. 6% of GDP hidden at home? Badly burnt after the banking collapse in March 2013 Cypriots neither trust their government nor banks to keep their money safe. After following from afar the events in Cyprus I recently visited the island. Many Cypriots feel that the banking collapse is now only history and no point thinking about it. But that is far from the truth: as long as neither Cypriots nor the other EU countries know the whole Cypriot saga it can neither provide lessons nor a warning; and the mistrust lingers on. In addition to a public investigation of what really happened and why, write-downs of household debt and a functioning insolvency framework Cypriots desperately need one thing: hope for the future.

Crisis-stories are a plenty in Cyprus and the islanders are more than willing to tell them. During the traumatic days in March 2013 when the banks were closed for ten long days people called the Central Bank of Cyprus, CBC, crying. “The bail-in wasn’t fair because it hit depending on with which bank you were banking,” one Cypriot said. “And look at what it’s done to us, all the empty space in the centre,” said the owner of a small business. “One of my clients,” said a man working in finance, “had a loan of €5m and €7m in deposits. Next day, he still had a loan of €5m but only €100,000 in deposits.” The client, of course, banked with Laiki Bank, also known as Cyprus Popular Bank and Marfin Popular Bank. Then there was the man on the beach in Paphos, selling boat trips. He now owns 500,000 shares in Bank of Cyprus worth quite a bit less than the €500,000 on his account until his funds, together with all other deposits above €100,000, were converted into shares.

In March 2013 Cyprus stared into the abyss of financial collapse. In order to qualify for a €10bn Troika loan, the absolute maximum the Troika – i.e. the European Union, EU, the European Central Bank, ECB and the International Monetary Fund, IMF – was willing to lend, Cyprus had to raise €5.8bn. After the Eurogroup threw out its first rescue plan, which included a levy on guaranteed deposits, i.e. less than €100.000, the Cypriot government grabbed deposits above €100,000 in Laiki to merge it with Bank of Cyprus where non-guaranteed deposits were turned into shares. This bail-in came as a surprise but had indeed been worked on since summer of 2012 by a small group of Cypriot officials.

From the Cypriot point of view it seems unfair that whereas Cyprus had to find own funds other hard-hit European countries – Ireland, Greece, Portugal and Spain – got Troika loans to bail out banks. The overwhelming feeling in Cyprus is that the island’s 1.1m inhabitants and an economy contributing 0.2% of the euro zone economic output was too small and insignificant to matter to the Troika. Abroad lingers the suspicion that Russian money in Cyprus were unpalatable to the Troika.

However, the reason for the misery seems more complicated and closer to home: the government of Demetris Christofias was adamant not to enter a Troika programme; a noble aim in itself but the government’s manoeuvres to avoid it seem less noble. CBC officials fed incomplete if not misleading information to the ECB. Fragments of this story have emerged only recently, not from the two attempted public enquiries but from a secret report done at the behest of president Nicos Anastasiades, later leaked to the New York Times.

“People want answers,” one Cypriot said but so far, there are few answers but plenty of questions, the most pressing being why there is no wish for  a proper investigation on the events leading to the drama in March 2013. The Special Investigative Committee, SIC, set up in Iceland after the Icelandic collapse in 2008 would be an ideal inspiration.

The story of the Cypriot collapse has many intriguing aspects. One of them is the sale of Greek branches of Cypriot banks, i.a. Bank of Cyprus’ Greek operations; another is the purchase of Greek sovereign bonds (mainly from German banks, which had a high exposure on Greece) by Cypriot banks, possibly seeking high-risk high yield investment to cover earlier disastrous lending.

Below, two further aspects are scrutinised: why the bail-in happened and why the Troika accepted, though only for some hours, a crisis levy on guaranteed deposits.

The rumours before the collapse and the hope that this time, it would be different

As in Iceland, the Cypriot banking sector was far too large – seven times the island’s GDP – for Cyprus to support it on its own. Its destabilising core was Laiki Bank,. The bank had for a long time offered higher interest rates than other banks; only ever attractive to risk-takers and naïve investors who do not recognise it as a warning sign. In the summer of 2012 the Cypriot government attempted to solve the Laiki problem by nationalising the bank.

With Ireland, Portugal, Greece and Spain struggling there had been little focus on tiny Cyprus but its problems were evident to anyone who bothered to look. After the nationalisation of Laiki there were talks with the Troika in late summer and autumn 2012 as to what should be done. No one, least of all the Cypriots, expected any drama. My Cypriot contacts kept telling me that the talks would no doubt end quietly in a negotiated bail-out of some sort. After all, Cyprus was a small economy, the Troika had by now some practice in dealing with failing banks threatening an entire economy; and there was also a growing awareness that private debt should not be shifted on to the state. Compared to the on-going Greek drama his would go well, I heard.

There were however rumours that this time it would indeed be different. In January 2013 Landon Thomas wrote in the New York Times of “Questions of Whether Depositors Should Shoulder the Bill:” officials in Brussels and Berlin were said to be working on “a controversial plan that could require depositors in Cypriot banks to accept losses on their savings. Russians, holding about one-fifth of bank deposits in Cyprus, would take a big hit.” Truly a radical departure from bailouts in Portugal and Ireland and a haircut, albeit only after an earlier bailout, in Greece – so far, bank deposits had been held sacrosanct.

Considering the delicate situation CBC governor Panicos Demetriades gave a rather remarkable interview to Wall Street Journal on March 5 2013 where he rejected the idea of haircut on depositors. Instead, he aired the idea of a “special solidarity levy” on interest income, which could give the state an annual income of as much as €150m – a risible sum compared to what was needed – but hoped that privatisation would gather €4.5bn. Alex Apostalides lecturer at the European University Cyprus has recently written about an encounter with Demetriades on the fateful 15 March 2013: when asked, Demetriades said that any haircut on deposits would be a catastrophe for the banking sector.

At the beginning of 2013 all the Cypriot political energy was in the presidential election campaign. But some were more aware than others that something might happen; there are still rumours of people who emptied their bank accounts just before the bail-in. ECB data shows that deposits were seeping out. In June 2012 they stood at €81.2bn. In January 2013 they were €72.1bn, down by 2%, in February at €70bn, 2.1% month on month and in March €64.3bn. According to the Anastasiades report €3.3bn were taken out of Cypriot banks March 8–15, the week up to the bail-in.

Capital controls, i.e. limits on amounts taken out from deposits or moved between deposits, were part of the package in March 2013. Yet, money did allegedly seep or even flow from certain deposits in spite of the controls. In Cyprus stories are told of private jets clouding the skies over Nicosia on and after 18 March, carrying neck-less black-clad men accompanying their angry-looking masters to the banks; all returned smiling with bursting hold-alls. List with names of people said to have taken out money in spite of the controls circulated in the media. – All of this is part of the still unwritten report of what really happened.

What seemed like good idea at the time: ‘un-guaranteeing’ the €100,000 deposit guarantee

On Friday March 15 2013 the Eurogroup met in Brussels at 5pm after markets closed. In the wee hours of March 16 the Group published a statement and its representatives held a press conference. The statement itself was short but not sweet, at least not for the Cypriots who had hoped and believed that their island would be assisted like other troubled euro-countries.

The press release stated (emphasis mine in all quotes):

The Eurogroup further welcomes the Cypriot authorities’ commitment to take further measures mobilising internal resources, in order to limit the size of the financial assistance linked to the adjustment programme. These measures include the introduction of an upfront one-off stability levy applicable to resident and non-resident depositors. Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders. The Eurogroup looks forward to an agreement between Cyprus and the Russian Federation on a financial contribution.

The Russian loan never materialised any more than a Russian loan promised to the governor of the Central Bank of Iceland, CBI as the Icelandic banks collapsed in October 2008. (Cyprus’ relationship with Russia was long-standing Iceland was not known to have any particular relationship with Russia, which meant that this promise seemed very much out of the blue.) However, just as the Christofias government was against a Troika programme the governor of the CBI and a few others were equally against seeking assistance, in Iceland’s case from the IMF.

Interestingly, neither the March 16 press release nor the statement specified what ‘an upfront one-off stability levy’ implied. Those who gave the 4AM press meeting seemed  ill at ease and unwilling to spell out the action. Christine Lagarde director of the IMF only talked of “burden sharing.”

According to Reuters, citing an unnamed source, Cyprus “agreed a one-off levy of 9.9 percent to apply to deposits in Cypriot banks above 100,000 euros and of 6.7 percent for deposits below 100,000 euros…”

With this fundamental diversion from earlier policies the Eurogroup agreed that an EU country could touch deposits below the guaranteed €100,000. In other words: depositors in EU now knew that in a financial crisis their guaranteed deposits were no longer untouchable.

Whether a momentary mental black-out or a wish to try something unorthodox this solution evaporated over the weekend. The statement released following a Eurogroup phone conference on Monday March 18 carried a very different message:

The Eurogroup continues to be of the view that small depositors should be treated differently from large depositors and reaffirms the importance of fully guaranteeing deposits below EUR 100.000. The Cypriot authorities will introduce more progressivity in the one-off levy compared to what was agreed on 16 March, provided that it continues yielding the targeted reduction of the financing envelope and, hence, not impact the overall amount of financial assistance up to EUR 10bn.

Given the fact that the Eurogroup had less than 48 hours earlier agreed to a levy on guaranteed funds the words “continues” and “reaffirms” do not quite rhyme with the earlier statement.

The banks remained closed on the following Monday, March 18 2013 as the Cypriot government under president Nicos Anastasiades, only in power since March 1, struggled to get a grip on failing banks – and to find another solution when the original idea lost its sparkle.

In a rare display of tense irritation the ECB issued a statement on March 21 saying that the ECB governing council had “decided to maintain the current level of Emergency Liquidity Assistance (ELA) until Monday, 25 March 2013. Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF programme is in place that would ensure the solvency of the concerned banks. – As far as is known, this is the only time the ECB has ever issued a statement acknowledging the end of ELA.

The Cypriot banks remained closed for whole ten days, until March 28. When they opened again there were capital controls in place to prevent a run on the banks – and depositors in Laiki and Bank of Cyprus had been singled out to carry the cost.

In hindsight, it is profoundly interesting that the Eurogroup, ECB and the IMF did indeed agree to a levy on guaranteed deposit. Allegedly, the Germans were not happy but agree they did. In the end, things did change in the coming days. Further, a general levy was voted down in the Cypriot parliament. The Cyprus collapse did not happen over a few days in March but over almost two years, from May 2011 when the island lost access to markets. The course of events cannot just be explained by panic.

Indeed the bail-in was no panic solution but had been in the making for more than half a year; only the Cypriots did not know it.

A pact with the offshore devil

Since slamming a levy on guaranteed deposits truly was a novel idea the short struggle to ram this measure through merits attention, also because it can be argued that it was indeed a much fairer financing of the crisis solution than the one used.

According to much of the media coverage the idea of a levy on guaranteed deposits came from the Cypriot government. However, sources close to these events have indicated to me that the EU commission, attempting to merge various and to some degree conflicting points of view, originally suggested a levy on guaranteed as well as non-guaranteed deposits. The preposition was that Cyprus had to fund a big part of the rescue package, banks have heaps of money on deposits – and a small percentage levy is a relatively painless way for a state to spread the burden in a crisis.

The various parties to the talks were advocating various solutions. IMF advocated the full resolution of the two banks, Laiki and Bank of Cyprus and did not seem to be opposed to a bail-out. The Anastasiades government was looking for a traditional bail-out programme apparently unaware that the Christofias government had worked on a bail-in (more on that below). The Commission was looking for a middle way where wealth tax could perhaps fill a gap if needed but sensed that a bailout was out of the question.

The country needed to raise €5.8bn in order for the Troika to lend the €10bn needed. It was a matter of arithmetic how to juggle the percentage so as to land on the right sums; it proved a struggle as Reuters recounted on 18 March. President Anastasiades and his team refused to go above 10% on the uninsured deposits and settled for 9.9%. These deposits amounted to €38bn, insured deposits were €30bn which meant that €2bn had to be taken off the latter if the government held onto 10% being the pain threshold; ergo, the percentage had to be respectively 6.75% and 9.9%.

Non-Cypriot officials wanted the percentage on the guaranteed deposits to be lower, even considerable lower. Already at the meeting the feeling was the Anastasiades was sheltering the island’s offshore status, ignoring the interest of ordinary Cypriots.

The political reaction in Cyprus drew the attention from the fact that after sleeping on it the Eurogroup woke up realising that the levy would ‘un-guarantee’ the guaranteed €100,000. The original plan must have come with some convincing reasoning (from the EU Commission, right?); otherwise, it would not have gone through. For sure, it worked like magic – but struck by daylight the carriage was again a pumpkin.

“The guaranteed deposits turned out to be EU’s sacred cow,” one source said. In a certain sense, for every country crisis is utterly unique, not in the general mechanism, but in the outward detail. If Cyprus had indeed accepted a levy on guaranteed deposits the EU would have been in a difficult position: it would have had to argue that Cyprus was an utterly unique case.

In order to reach the necessary sum of €5.8bn 15% levy on the uninsured deposits would have done the trick. But on an island, which lives – and has lived well – from its off-shore status and the foreign funds it attracts the government baulked at taxing the non-guaranteed deposits too heavily so as not to drive these funds elsewhere. That was the cost of the Cypriot pact with the offshore devil.

Laiki: the core of the Cyprus problem

In the euro-crisis context the bail-in was a remarkable solution but as can be seen from the Anastasiades report it was, quite remarkably, not a new idea. It had been in the making for some time, at least from autumn 2012, and was closely connected to the core problem: Laiki. The report traces the drafting of a new bank resolution framework, which rested on using deposits in an insolvent bank in a bail-in.

The desperate state of the Cypriot economy was exposed when Cyprus lost market access in May 2011, much due to Laiki Bank owned and managed by Andreas Vgenopoulos. Laiki was diligently issuing bullet loans to Vgenopoulos’ companies. Bullet loans are familiar to those who have studied the operations of the Icelandic banks where they were issued to large shareholders and other favoured clients. The Icelandic bullet loans to these clients were either constantly rolled over or refinanced, rarely paid back. The bullet loan magic on a balance sheet is i.a. that in spite of not being paid back they are not non-performing.

One insistent question for Cypriots is why the CBC and other Cypriot authorities allowed Laiki to operate as it did and for so long. By summer 2012 the Cypriot authorities had run out of excuses and justifications for continued assistance to Laiki, to the ECB and others. Instead of investigating Laiki’s operations, the bank was nationalised, hook line and sinker and no questions asked.

It is a pertinent question when the CBC realised that Laiki was a dead bank. There were leaks in Cypriot and Greek media in autumn and winter 2012 on the severe state of Laiki, allegedly known to the CBC. Even sending staff to be questioned by a prosecutor CBC focused on investigating the leaks, not the issues they raised.

Nationalising Laiki increased the state’s liabilities; the EU and the IMF were uneasy, as expressed at a Eurogroup meeting 12 September 2012 in Cyprus. Laiki was in a sorry state and it was dragging down another weak bank, Bank of Cyprus. The government continued its delay-tactic, thereby taking the entire banking sector hostage.

The Troika held a meeting 9 November 2012 in Cyprus but could not reach an agreement with Cyprus. By now, Cyprus was, quite literally, living on borrowed money, straight from the ECB: on 15 November 2012 ECB’s Emergency Liquidity Assistance, ELA, to Cypriot banks, i.e. Laiki, amounted to €11.9bn, around 65% of GDP.

The Troika’s patience was evaporating fast: when president Demetris Christofias visited Brussels 22 November he was informed the ECB would stop the ELA immediately. The following day finance minister Vassos Shiarly said the government had now agreed to the terms of the “Memorandum of Understanding on Specific Economic Policy Conditionality.”

The birth of a brutal and unfair solution

The November 2012 MoU was full of good intentions. But the direction taken was not new. During the Troika meeting in Cyprus in June 2012 those present had agreed that the core of the Cypriot problem was an over-extended financial sector, which the feeble island economy could not support. Consequently, an alternative way to recapitalisation had to be found but the question was how.

In a 2 July 2012 letter ECB stated, referring to its opinion on legal support for Laiki, that the best way was to use a fully-fledged bank resolution tool, as outlined in Directive proposal, COM (2012) 280 final adopted in June 2012, for bank resolution where the cost was not being borne by tax payers, adopted in June 2012 and later developed into a Bank Recovery and Resolution Directive.

Hence, amongst those working on the coming Cyprus banking rescue operation it was already clear by the summer of 2012 that Cyprus could not expect anything like the other troubled euro countries. The assessment circulating, i.a. from Fitch, was that Cyprus needed €10bn in financial aid, 60% of GDP.

The three key objectives of the MoU were “to restore the soundness of the Cypriot banking sector by thoroughly restructuring, resolving and downsizing financial institutions, strengthening of supervision, addressing expected capital shortfall and improving liquidity management; to continue the on-going process of fiscal consolidation in order to correct the excessive general government deficit” by reducing current primary expenditure, maintaining fiscal consolidation i.a. by increasing the efficiency of public spending, enhancing tax collection and improve the functioning of the public sector; structural reforms to support competitiveness.

As the MoU shows Cyprus was not stingy with its promises, i.a. : “With the goal of minimising the cost to tax payers, bank shareholders and junior debt holders will take losses before state-aid measures are granted. Before any state recapitalisation is granted, the Central Bank of Cyprus will require a conversion of any outstanding junior debt instruments into equity for the purpose of protecting the public interest in financial stability, including by implementing voluntary or, if necessary, mandatory subordinated liability exercises (SLE)… the necessary legislation will be introduced no later than [January 2013]. The Central Bank of Cyprus together with the EC, the ECB and the IMF will monitor any operation converting junior debt instruments into equity.”

The innocent-looking clause in the November 2012 MoU, which the Cypriot government was arm-twisted into accepting, was a further foreboding of the bail-in to come: The authorities will introduce legislation establishing a comprehensive framework for the recovery and resolution of credit institutions, drawing inter alia on the relevant proposal of the European Union.

The Anastasiades secret report concludes that it was clear from summer 2012 that the legal tools being forged would prevent a bail-out, forcing Cyprus to rescue its financial system with own resources, i.e. a bail-in:

“However, the perception which prevailed was that neither the government nor the CBC adequately understood this context. Moreover, no one admitted to know or have heard about the bail-in before the Eurogroup of 15 March 2013. The fact that the government, the state and its institutions acted as if they could not comprehend what was going on in order to disguise their inadequacy… ultimately proved to be a very effective policy to avoid taking responsibility. The reality is that as early as 6 November 2012, the CBC Governor, Panicos Demetriades, informed the ECB President, Mario Draghi that the resolution law was almost done, three whole weeks before the MoU of 25 November. …

From the moment the two major banks would pass into the hands of the Resolution Authority, the CBC should have to act within the given legislative framework and to provide solutions which would not bear any burden to the taxpayer. The law in itself was prohibiting the bail out and was legalizing the bail-in.“

The law, legalising a bail-in, was supposed to be passed in January 2013 but the Cypriot government and the CBC continued the delay game. After being reassured that short-term financing need was covered, the Eurogroup finally accepted to wait; it seemed clear that the final agreement on a programme would have to wait until after the election in February.

When the Anastasiades government came into power March 1 2013 neither the out-going government nor the CBC presented it with the draft for the resolution law. Accordingly, the new government seems to have intended to negotiate a bail-out as in previous Eurozone crisis countries. The old powers and the CBC kept quiet, making it look as if the bail-in was all the work/fault of the new government – or that is at least how the story is told in the Anastasiades report. The Resolution of Credit and Other Institutions Law of 2013 was published 22 March 2013 as part of the crisis measures.

The Anastasiades report shows that though panicky the decisions taken over the fateful days in mid March were no last-minute solutions. The Christofias government had been planning a bail-in, i.e. a self-financed salvation or refinancing of the banking system – and it was vehemently against entering a Troika programme.

The “punishment for the Russian connection” theory and other speculations

In hindsight – always a great vantage point – a one-off levy on deposits, even a tiny sliver on guaranteed deposits, would have been a lot less painful to Cypriots in this time of great crisis. But the political reaction in Cyprus was such that the government stepped back and abandoned any general levy. “The measures chosen did not punish risk-takers but made some people poorer completely by chance,” one source said.

“The solution was to treat deposit holders as investors,” as one Cypriot put it. Indeed, but only deposit holders in two banks took the hit for everyone else; a much more brutal and arguably a less fair measure than a levy.

In the weeks following the Cypriot bail-in there were speculation that the anomalous outcome had been dictated by a lack of trust in Cyprus for allowing Russian funds to flow so freely through the country’s banking system. It is alleged that 20% of Cypriot deposits are Russian; considering the long-standing connections between Russia and Cyprus this does not seem shockingly much.

In addition there are rumours, strenuously denied by Cypriot authorities, that the island’s financial system had been facilitating money laundering. According to persistent rumour the German authorities had commissioned a secret report that showed as much. However, nothing concrete did ever materialise and certainly no German report.

Cypriot officials were very much aware of these rumours and visited some European capitals in January 2013, i.a. Den Haag, to rebut the rumours and explain measures taken in Cyprus against money laundering.

The IMF viewed Cyprus as a unique case because of the size of its banking sector. Germany was in no mood for a bail-out. “Cyprus had irritated the Troika so much,” one source said. The ECB press release on ELA 21 March 2013 proves the point. Christofias had publicly spoken badly of the IMF; his attempts to get loans from China and Russia were not successful.

Essentially, a bail-in had been in the making for a while and seems to be what Christofias and his government had in mind. “It was clear that Cyprus would indeed be different,” on source said. “The obstacles were mostly political.”

Why the Christofias government did aim at a bail-in can only be clarified in a Cypriot SIC report. Perhaps the government saw that as a good way to keep the Laiki story buried, a continuation of the fact that Laiki had been nationalised but neither restructured nor scrutinised. And/or Christofias the communist was content to nationalise it to prove a political point. Fundamental question on the March 2013 events can only be answered in a thorough report. Sadly, it seems that very few Cypriots believe that such a tell-all report is possible on their little island.

No appetite for investigations

The Anastasiades report bears the telling title: Laiki Popular Bank – How a bank’s mismanagement toppled an economy. Laiki was not the only problem in the Cypriot economy but it was the crystallisation of many problems. Some advisers had recommended action on Laiki already when Cyprus lost market access in May 2011 but to no avail. As one source said: “It was a grave mistake not to take Laiki over earlier.”

The Anastasiades report was not intended for publications. It was not the first investigation into the Cypriot banking mess. There was an earlier planned investigation, which as the Anastasiades report stated, “didn’t happen.”

In August 2012 the CBC assigned Alvarez & Marsal, a management and restructuring consultancy, to examine why Laiki and Bank of Cyprus had requested state support, which they got, in total €1.8 bn. The following four points were to be investigated:

1. Bank of Cyprus’ losses from investing in Greek bonds
2. The purchase of shares of the Romanian bank Banca Transilvania
3. The acquisition by the Bank of Cyprus of the Russian bank Uniastrum
4. The merger of Marfin Laiki with Egnatia and in specific the conversion of Egnatia from a subsidiary of Marfin Laiki to a Cypriot bank

In October 2013 this assignment was in the news, not for the firm’s findings but for its fees: on top of €4.5m it turned out that CBC governor Panicos Demetriades had, without the CBC knowledge, agreed to a further fee of €11m. Nothing has been heard of the report and regrettably the four items above remain unexplained.

As the Anastasiades report states: Now we know why: An investigation into the reasons why the Cyprus Popular Bank requested state support of €1.8 bln, would reveal the disastrous decision taken by the Christofias government to nationalize the Cyprus Popular Bank and this was achieved in collaboration with both CBC Governors, initially Orphanides and later on Demetriades.

The Anastasiades report comes to its own conclusions:

The Cyprus Popular Bank, was insolvent before the haircut of the Greek bonds. After the haircut, the Bank had little chance to survive. The only realistic option for a successful recapitalization was through the EFSF. However, it was impossible to receive funding from the EFSF without entering a programme. Christofias’ government followed a policy of avoiding the programme at all costs. By refusing the programme, Christofias’ government led the entire banking sector into captivity.

What the Anastasiades report spells out quite clearly is how Cypriot authorities, from autumn 2011, led by the various ministers of finance and governors of the CBC kept convincing the ECB that all was well and fine with Laiki. When it was no longer possible to dress the bank up as a solvent company the bank was nationalised. In March 2013 it was no longer possible to plaster over the cracks, the bank was restructured and merged with Bank of Cyprus – at the cost of €5.8bn from deposits in the two banks.

According to the New York Times, Benoît Coeuré executive board member of the ECB was also instrumental in coming up with a collateral plan when there were seemingly no collateral left to support further ELA for Laiki. Cypriot authorities, led by the CBC, conspired to thwart suspicious ECB. This whole exercise left the Cypriot state with €10bn of ELA debt, apparently the cost of trying to save a failed bank.

After the events in March 2013 president Anastasiades set up an investigative committee to examine possible civil, criminal and political liabilities regarding the development in the Cypriot economy and financial sector. The six members were all elderly judges with long careers.

Their report was handed over to the cabinet end of September 2013. It has not been made public. The documents leaked by the New York Times indicate that there is plenty of material that the commission did not make use of. Since this report has not been published it is impossible to say how thorough it is but the general feeling is that the 280 pages did not reveal anything much. The attempts to investigate the events leading up to March 2013 and the aftermath have so far been futile exercises.

Based on available material it seems logical to conclude that the bail-in was part of the Christofias government plan to avoid a Troika programme and possibly the scrutiny that might follow. If the latter was the case all fears have been groundless: regrettably, the Troika has never pushed for an investigation to clarify events.

The fact that Cypriot authorities did everything to hide and deny the dire situation from May 2011 had hardly mellowed the Troika in March 2013 when action could no longer be postponed. But it does not explain the attempt to put a levy on insured deposits.

Being a gateway to offshore structures may not have helped Cyprus. That said, EU and IMF officials are hardly squeamish in these matters: Luxembourg and Malta offer similar environment not to mention the tax structures provided by Ireland and the Netherlands.

What Cyprus needs

The ECB is trying to strengthen trust in the European banking sector. In general, an important step towards creating confidence “is to recognize loans that are bad and write them off, ” according to William White, former economic adviser to the Bank for International Settlements. Non-performing loans have been a major problem in the Cypriot financial sector. I heard in December that with a new insolvency or foreclosure framework this would be resolved.

I therefore find it both surprising and worrying that according to Eurogroup remarks 16 February 2015 the foreclosure framework has still not been finalised but is much needed in order to enable banks to clean their balance sheet and start lending again. This is now the main hurdle in the recovery program for Cyprus.

Household debt is a problem – Cyprus could do with some general measures similar to the Icelandic “110% way” where mortgages were written down to 110% of the estimated value of the property to pull households out of the doldrums of negative equity.

“Confidence in the Cypriot banking sector has not been restored,” one source pointed out. That can i.a. be seen from the fact that many prefer to keep cash at home; as much as 6% of GDP could be under pillows and mattresses.

As so often in countries plagued by corruption everyone is aware of it but it is rarely mentioned except when it surfaces in news. But is indeed a huge problem as can be seen from EU Anti-Corruption Report 2013: 78 % of Cypriot Eurobarometer respondents claim corruption is widespread, EU average is 76 %; 92 % say that bribery and good connections is the easiest way to access certain public services, EU average is 73 %. Among Cypriot business people 64% say corruption is a problem compared EU average of 43 %. And most seriously, 85 % of entrepreneurs think that favouritism and corruption hamper business competition in Cyprus when EU average is 73 %.

Cypriots need to know exactly what happened and when – and so does Europe, if any lessons are to be drawn from the crisis. But most of all, Cyprus needs hope. Parents need to believe there is future for their children on the island. Young people have to see a reason for staying after their education or returning there after studying abroad. A country marred by untold stories, unexplained action and corruption is simply not a good country for growth and optimism – the necessary prerequisite for hope.

*My oral sources are all from Cyprus. In agreement with them they are not identified by position since Cyprus is a small country. – This blog is cross-posted on A Fistful of Euros.

 

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“The results today shows that it is possible to bring complicated financial cases to court and get conviction,” Ólafur Hauksson head of Office of the Special Prosecutor said to Icelog, now that the Supreme Court has ruled in one of the OSP’s major cases, the al Thani case. “Building up the expertise has been a long process but the ruling today demonstrates that setting up an office, which didn’t exist earlier, was fully justified. No society can tolerate that certain parts of it are beyond law and justice.”

Those four charged were Sigurður Einarsson chairman of Kaupthing board, Magnús Guðmundsson manager of Kaupthing Luxembourg, Kaupthing CEO Hreiðar Már Sigurðsson and Ólafur Ólafsson the bank’s second largest shareholder. Reykjavík District Court had earlier ruled in the case where Einarsson was sentenced to 5 years in prison, Guðmundsson 3 years, Sigurðsson 5 1/2 years and Ólafsson 3 1/2 years. The Supreme Court has confirmed the ruling over Sigurðsson whereas Ólafsson has now been sentenced to 4 1/2 years, Einarsson to 4 years instead of 5 years and Guðmundsson to 4 years.

As detailed in an earlier Icelog the core of the al Thani case were loans to Ólafsson and Sheikh Mohammed bin Khalifa al Thani, a Qatari investor from the country’s ruling family. It is important to notice that the issuing of these loans was the criminal deed in the case – the three Kaupthing managers broke law by doing it and Ólafsson was complicit in that criminal deed.

The story behind the case is that in in September 2008 Kaupthing made much fanfare of the fact that Sheikh al Thani bought 5.1% of Kaupthing’s shares. The 5.1% stake in the bank made al Thani Kaupthing’s third largest shareholder, after Olafsson who owned 9.88%. This number, 5.1%, was crucial, meaning that the investment had to be flagged – and would certainly be noticed. Einarsson, Sigurðsson and Ólafsson all appeared in the Icelandic media, underlining that the Qatari investment showed the bank’s strong position and promising outlook.

What these three didn’t tell was that Kaupthing lent al Thani the money to buy the stake in Kaupthing – a well known pattern, not only in Kaupthing but in the other Icelandic banks as well. A few months later, stories appeared in the Icelandic media indicating that al Thani was not risking his own money. More was told in SIC report and the SIC recount indicated a fraudulent behaviour. The ruling today has confirmed the doubts, which have surrounded this investment from early on.

Although the case draws its name from Sheikh al Thani he has not been accused of any wrongdoing. He was one of the witness in the case, gave a statement over the phone.

As I have pointed out earlier there is an echo of this investment story in the ongoing investigation into Qatari and Middle East investment in Barclays, which saved the bank from seeking state support in autumn 2008.

The ruling in Iceland is i.a. in stark contrast to how Irish courts have tackled financial crimes related to the Irish collapsed banks. In April last year a court ruled that two former Anglo Irish managers, who had been convicted of issuing loans to prop up the bank’s share price, should not be imprisoned in spite of being found guilty. The judge ruled it was unjust they should go to prison for a criminal deed because they believed they had acted lawfully. Sean FitzPatrick, the bank’s former chairman, was cleared in this case. I find this Irish ruling truly incredible. This loan saga – loans to the so-called “Golden Circle” – has striking parallels in other Icelandic cases, which are being processed.

Icelandic law on financial fraud is in most respect similar to law on these issues in Northern Europe. There is nothing special about the Icelandic situation – except the will to carry out investigations and bringing cases to court. As Hauksson pointed out financial crimes need not be too complicated to be successfully prosecuted – and no part of society should be beyond the reach of the law.

*Update: I have seen some comments that because the four sentenced to prison in the al Thani case are living abroad they are unlikely to go to prison. That is not correct: the fact that they live abroad – in London, Switzerland and Luxembourg – will apparently not change anything. Ólafsson has already said he will come when called to go to prison. That is an unavoidable consequence of the sentencing. 

*Update 25.2. 2015: Ólafsson asked to start his sentencing as soon as possible. According to Icelandic media he is now already in prison at Kvíabryggja, Snæfellsnes, where this sentenced in earlier banking collapse cases have been sent to jail (see here for details of this prison).

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One of the things that the HSBC whistleblower Hervé Falciani has pointed out is the mess the HSBC computer system was with all the inherent safety risks involved, not to mention that it made it difficult for the bank to have any meaningful overview.

There are several reasons why Falciani’s statement does not come as a surprise. The Anton Valukas’ report on Lehman tells i.a. the story of a big bank with a patchwork of computer systems and applications. And there have been several spectacular IT failures in banks, i.a. at the RBS in December 2013 when the bank admitted to underinvestment in IT “For decades…”

Also, over the years sporadically talking to people working on IT in banks, I got the clear idea that IT costs were a source of irritation for many managers: many of them found it difficult to understand the costs and what benefit could be derived from the suggested improvements. IT people are or at least were low in the banking pecking order.

Lehman – a patchwork of over 2600 computer systems

The share size of the Lehman system was staggering: “The available universe of Lehman e‐mail and other electronically stored documents is estimated at three petabytes of data – roughly the equivalent of 350 billion pages.” 

When Valukas set about to organise the operation of mining the Lehman system for his report he was faced with the daunting task of extracting information from a patchwork of over 2600 computer systems and applications. The way the report deals with this attempt and success in mastering the material feels to be a story told with some understatement. But the share size was only part of the problem (emphasis mine):

Many of Lehman’s systems were arcane, outdated or non‐standard. Becoming proficient enough to use the systems required training in some cases, study in others, and trial and error experimentation in others. In numerous instances, the Examiner’s professionals would request access to a particular system, expend the time necessary to learn how to use the system and only then discover that access to two or three additional systems was required to answer the necessary questions. Lehman’s systems were highly interdependent, but their relationships were difficult to decipher and not well documented. It took extraordinary effort to untangle these systems to obtain the necessary information. 

This was the system in a big bank where nothing was spared when it came to bonuses and pay. In a sense Lehman was like a palace with shitty basement toilets, which no one cared about because they were out of sight anyway. Except of course that an “arcane, outdated and non-standard” computer system poses a real security risk, which a ditto toilet does not.

IT staff – low in the banking pecking order

I have heard computer system staff in banks complain about the lack of IT understanding among those who hold the spending power. Those with such power were seen to weigh spending according to parameters of immediate visible effect. Spelling out the disasters that might happen, when nothing has happened for a long time or ever, can be a difficult bargaining position.

A case in point was the RBS computer glitch, which severely affected clients in December 2013. Following the incident RBS admitted the following: “For decades, RBS failed to invest properly in its systems… It will take time, but we are investing heavily in building IT systems our customers can rely on.” – It would be interesting to know exactly what was done and if this has been a sustained process.

This too late – and often too little – has unfortunately very much been the pattern: the promises to do better and invest in IT have come only after the public incidents. It would be interesting to know if the RBS IT staff had been fully aware of the problems and how much it had tried to avert senior managers to the problem.

From IT employees in banks I have over the years heard loud complaints about senior managers who have little understanding for the importance of keeping the systems up to date and investing in the proper IT infrastructure. Asking for funds for IT was (is?) normally met with complaints about costs.

One employee told me that managers were normally reluctant agreeing to costs for things unless they understood the issue at stake themselves and which could be shown to increase profits. Since the level of IT understanding among senior managers was generally low IT was generally seen as only cost.

Banking – where the science of big data has not been appreciated

As many banks in particular those that aim at speedy international growth, HSBC grew by i.a. buying banks. Its Swiss operation where Falciani worked had been bought; the same with the Mexican branch where HSBC was found to have facilitated money laundering for drug lords, resulting in fines of $1.9bn in December 2012.

Banks are in enterprises with old roots and many of them seem to suffer from lack of technical insight among their highest echelon of power. Many senior bank managers in their fifties and older have never been exposed to much technological stuff other than their smart phones.

Over the last many years many big banks seem to have been focusing on growth and inventing new financial products. The feeling is that RBS and Lehman are not the only banks where IT systems have lagged behind, not only in terms of security but also in terms of how to have the best systems for overview. How can internal audit i.a. be meaningful in an international bank with 2600 systems, some of which are “arcane, outdated and non-standard”? Or in a bank with IT underinvestment for decades?

If senior HSBC managers did not know at the time as they have insisted of the bank’s massive failures, both in Switzerland and Mexico, it is also because the proper technology was not in place and probably had not been thought to matter.

Big data, the ability to sift through and derive information from a large set of data can of course be used in many ways within a bank. One of many uses should be to keep track of behaviour that could potentially be criminal. With the kind of patchwork system Lehman had that would hardly have been possible.

True, Lehman collapsed over six years ago, Falciani was working at HSBC eight years ago but the RBS glitch happened only just over a year ago. Banks might have worked miracles on their IT systems lately but the doubt lingers on especially because the IT insight and understanding might still be lacking at the top.

*This post has been cross-posted with Fistful of Euros

 

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– Forget economics, politics is key to understanding the Eurozone

The cries of the Grexit criers lately have mostly been a repetition of an earlier discourse: in February 2012 Citi’s economists Willem Buiters and Ebrahim Rahbari coined the term “Grexit,” by July 2012 estimating its likelihood to 90%. Cheered on by the media, economists have taken over the debate of the Eurozone which is why much of it has been such a futile exercise: it is not economics, which ties the Eurozone together but the political determination of its leaders to make the euro work. With political will likelihood of any exit is 0. Ergo, Grexit is as unlikely now as it has always been in spite of the EU brinkmanship. One route Greece seems to be exploring is a tried and tested one: the “bisque clause” from 1946.

In December 2009 the European Central Bank, ECB, published a working paper, Withdrawal and expulsion from the EU and EMU; some reflections (recommended read, clear and intelligent), by Phoebus Athanassiou. As Athanassiou pointed out, talk of ‘secession’ from the European Union, EU and European Monetary Union, EMU would earlier “have been next to absurd, considering the EU’s contribution to lasting peace and stability in Europe,” not forgetting successful enlargement. Athanassiou concluded that “negotiated withdrawal from the EU would not be legally impossible… a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that … a Member State’s expulsion from the EU or EMU, would be legally next to impossible.” – But legal aspects are one thing, economics another and politics yet a separate aspect.

The eurocrisis has hit EU’s economy; economists and the financial media have led the crisis discourse. But the euro is a political construction, built on political will and at the root of the crisis there are politics: there has been a political unwillingness in the EU to be more than fair-weather friends. Fearing loss of sovereignty ministers have been unwilling to yield power to the various EU institutions (Athanassiou has some intriguing observations on sovereignty). – This is in essence what Mario Monti wrote in the summer of 2011 in a timely Financial Times article where he partly blamed the eurocrisis on the EU being too deferential and too polite to its member states.

With the crisis and hesitant action it has been ever more difficult to portray the EU as a success in spite of earlier glory. Much of the political demagogy on the left and right ends of the political spectrum in Europe is nourished by politicians from the established parties who have been far too willing to blame the EU for their own failures.*

Now Greece has voted in a new government who though critical of how the Troika, i.e. EU Commission, European Central Bank, ECB and the International Monetary Fund, IMF, has dealt with Greece makes no mention of Grexit and claims it wants to repay its debt. In a BBC interview minister of finance Yanis Varoufakis stressed that Greece was not going to toy with “loose or fast talk of Grexit” and fragmentation, which would only unleash destructive forces.

“Grexit is not on the cards,” Varoufakis said. At the same time, the government is hell-bent on finding a way to tackle what Varoufakis has called a “humanitarian crisis” in Greece, in addition to scutinising earlier privatisation and renegotiating, perhaps with an eye on the so-called “bisque-clause” from 1946.

Renegotiating, or whatever term will be found, is no mean feat also because all solutions are bound to be relevant for other problem countries. The Irish found a clever way though with their Promissory Notes, did it unilaterally with the ECB governor Mario Draghi commenting dryly that the ECB “took note” of it. – EU has always been brilliant at finding compromises though arguably its comprises have not always been brilliant.

The changing euro sentiment

On August 14 2007 ECB governor Jean-Claude Trichet stated that the bank was paying great attention to developments in the market, i.e. nervousness, increased volatility and ‘significant re-appreciation of risks’ which could be ‘interpreted as a normalisation of the pricing of risk.’ The bank had provided liquidity ‘needed to permit an orderly functioning of the money market… We are now seeing money market conditions that have gone progressively back to normal,” was Trichet’s reassuring conclusion.

Two years and some months later, in December 2009, it was clear that Trichet’s hopeful words were just that: hopeful. Ireland was under crisis clouds after the Irish government had been forced to fulfil its blanket guarantee of the banking sector. The situation in Portugal and Spain looked ominous not to mention Greece. All of this made Athanassiou’s paper a timely one.

Fast forward from Trichet’s 2007 statement to the ECB’s recent statement of a monthly asset purchase amounting to €60bn, at least until September 2016. ECB governor Mario Draghi has repeatedly stressed that the bank alone will not pull the EZ out of stagnation and slow growth. The political appetite for growth stimulus and the structural reforms needed has been negligible and attempts to challenge growth-quenching corruption, where needed, even less. It might even be argued that with the asset purchase, aka “quantitative easing,” into austerity-ruled EU the Union is like a boat rowing in opposite directions.

“The boom, not the slump, is the right time for austerity at the Treasury”

Jean-Claude Juncker’s €315bn fund is too little too late; a nod in the stimulus-direction rather than a real u-turn. After over six years of austerity the EU seems slow in revising on the 1930s lesson that the state has to step in when the private sector is sluggish. Greece now seems to want a realistic solution. Although only 2% of the EZ GDP it might inject new ideas into the Troika solutions, i.e. forcing reality instead of unsustainable solutions – effectively, earlier measures for Greece did not solve the problem and everyone involved knew it.

Simon Wren-Lewis’ summary of the obvious lessons from the Great Recession is: “Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity.” Further, Wren-Lewis has recently summed up the necessary lessons from earlier attempts to debt restructuring, with a timely focus on Greece, saying the “Troika should welcome the opportunity to put right earlier mistakes.”

Yet and yet, austerity was the first and still is the strongest reaction to the eurocrisis. The IMF, for its part, has to a certain degree acknowledged its part in the mistaken routes chosen. For Greece there was a certain woeful blindness as to what the measures in 2012 would achieve in terms of growth, inflation, fiscal effort and social cohesion; this should not happen again as Reza Moghadam former head of the IMF European department wrote recently in the Financial Times, admitting to his share of the responsibility since he was part of Troika discussions 2010 to 2014 and pleading for halving Greek debt.

The new Greek government has plenty of research to bolster its case. In a 2013 paper, Òscar Jordà and Alan M. Taylor have shown “that austerity is always a drag on growth, and especially so in depressed economies: a one percent of GDP fiscal consolidation translates into 4 percent lower real GDP after five years when implemented in the slump rather than the boom.” And as John Maynard Keynes wrote in 1937, quoted by Jordà and Taylor: “The boom, not the slump, is the right time for austerity at the Treasury.”

To a certain degree the faith in austerity has been steered by predictable party politics as Simon Wren-Lewis covers here. Not surprisingly Wolfgang Schäuble claims that “austerity is the only cure for the eurozone.” With policies earlier belonging to the political right having to a great degree permeated the left, New Labour being the arch-example, there has been remarkably little left opposition to austerity. The political antagonism within the crisis countries has tended to be between parties in power, enforcing austerity and the opposition, opposing austerity so as to gain from the unpopular austerity measures.

Austerity is the easy route – structural reforms the really difficult one

But the last few years of austerity in Europe have also shown that although austerity is a tough path to follow, structural reforms are even harder. The Troika prescriptions for program-countries have all come with a list of structural reforms, which have been far tougher to fulfill. Though the structural reforms advised have often been sensible domestic politics and interest groups block them. The latest IMF review on Greece, from June 2014, lists the tough reforms still lacking, i.a. tax administration and public sector reforms.

The fact that there has often been little ownership of measures in the program countries has been part of the problem. One reason why Iceland sailed relatively smoothly through its IMF program was Iceland’s strong ownership of the program. Execution will be easier if the Greek government can renegotiate a sustainable plan it believes in contrary to earlier measures, which all involved knew was to a certain extent little but wishful thinking.

Consequently, scrutinising Troika programs it seems that although a tough path to follow austerity has been the easy route compared to structural changes where strong interest groups and politics clash.

Corruption – the dirty porn of EU politics

It is intriguing to note that the worst hit EZ countries are also countries where sentiment of corruption is high, as can be seen in the Eurobarometer. Yet, corruption has not been high on EU political agenda.

Only in 2011 did the EU Commission establish an Anti-Corruption report to monitor and assess efforts of individual EU countries to address corruption. The first report was published in 2014; reports will now be published every two years.

Given the fact that the cost of corruption is assumed to be 5% of GDP on a world scale, and clearly higher in corrupt countries, it has taken the EU scarily long to turn its attention to this problem. Again, that is no doubt partly due to the politeness Mario Monti had in mind – corruption is an embarrassing and dirty word in the EU, truly the dirty porn of EU politics.

Foreign media mostly focused on Syriza’s presumed anti-EU sentiments even though majority of Greeks want to stay in the EU and the euro. But Greeks noticed that Syriza broke with the norm of silence on corruption and campaigned on fighting it. Any step in that direction will be a great political achievement – and an example to follow for other countries. The fact that Syriza campaigned on the issue of corruption is already inspiring other countries, most notably the Spanish Podemos party.

It has caused some concern abroad that Syriza is going to stop or review the on-going privatisation. There is however indication that assets have been sold not on best price but best connection; something the Troika should not be too politie about, not least in a country with the sorry reputation of corruption. Privatisation will not be popular in Greece if people see state assets sold in a corrupt way.

Demagogues and the German problem

In 2009 it was easy for Athanassiou to refer to the success of the EU and the euro. Now the story in many EU countries, even in stoic and earlier so staunchly pro-EU Finland, is the rise and rise of anti-EU demagogical parties. So far, these are fringe parties, very often indirectly nurtured by politicians blaming the EU of their own failings.

But it is equally worrying that German Chancellor Angela Merkel is increasingly irritating other EU leaders with her moralising on other countries. After almost a decade as the leader of EU’s most powerful country, Merkel seems to be falling pray to the inherent law of power: the longer time in power the more myopic a leader is, ever more occupied with his or her legacy. This has not proved positive for her European engagement.

Given her long time in power Merkel has followed the course of the crisis countries from well before the crisis. She has had ample opportunities to speak out or warn her colleagues. Greece had for example been running a budget deficit more or less uninterrupted since the early 1980s enabled by German banks financing much of this deficit.

German banks, though prudent at home (or rather, Germans are prudent borrowers) were large lenders not only in Greece but also in other crisis countries, also in Iceland. German banks have behaved like the kind of teenagers who are faultlessly polite at home but run wild when partying at friend’s place cutting up the furniture and peeing in the corners.

Merkel did not seem worried until the problems in Greece and elsewhere threatened German financial stability. With the Troika involvement the German risk migrated to public sector lenders and the German banks avoided facing their risky behaviour.

It’s not the economy stupid, it’s the politics

Merkel herself is aware of the political dimension of the euro, or rather the lack of its political anchor. Her predecessor Helmut Kohl and his contemporary European leaders constructed a monetary union without a proper political dimension. More could not be achieved at the time; the wishful thinking was that the missing political part would come later. According to a German official Merkel thinks the euro, with the political part missing, is “a machine from hell” that she is still trying to repair. – As things stand now the machine will hardly be repaired any time soon– the one legacy likely to elude Merkel.

All through the eurocrisis the politics have lagged behind. As shown convincingly by Philippe Martin and Thomas Philippon concerted action such as the Outright Monetary Transactions, OMT already in 2008 and not as late as 2012 would have made the world of difference, not least for Greece.

Those running the “machine from hell” were slow in figuring out how to deal with the crisis. Domestic politics in the EZ were pointing in all and sundry direction. Merkel’s way of tackling any problem is to move slowly, very slowly. Her sluggishness has cost the Greeks dearly. But since the destiny of Germany and Greece are tied together in the euro the German sluggishness certainly has come at a cost to the Germans themselves.

Apart from the lack of political union to back up the euro – or at least some mechanism to deal with crisis – the EU made bad uses of what little mechanisms in place. This is what Mario Monti, wiser after his time as a European commissioner, pointed out in 2011, i.a. regarding Greece: “As for politeness, would Greece have been able to run for years public deficits vastly above its officially published figures – until the excess became known in late 2009 – had Eurostat had the power to conduct serious investigations to check the adequacy of nationally produced statistics? Of course not.”

Had the ECB been allowed to react already in 2008 with some form of OMT (yes, wishful thinking but let us assume these measures were conceivable already then though clearly not politically palatable) it would have run into the problem of ELSTAT where gathering statistics has turned into a political thriller still running: as late as January this year an ELSTAT supervising commission, one of whose members is from Eurostat, expressed concern and disappointment that some officials tried to influence ELSTAT’s reassessment of debt and deficit figures Brussels had called for. – Tackling the problem of ELSTAT would strengthen the trustworthiness of the new government.

The price of politeness is also evident in EU’s unwillingness to acknowledge the problem and cost of corruption (as I have pointed out earlier); unwillingness, which in itself a political vice among the EU countries. The EU countries are in it together but shrink from sifting through their neighbours’ dustbins to come up with compromising material.

Greece – with appetite for “bisque”?

Yanis Varoufakis and his team have had ample time to study the best approach but time is limited. Deposits are flowing out of Greek banks and the present Troika program ends on February 28, which jeopardises i.a. the ECB’s Emergency Liquidity Assistance, ELA.

Proselytising on Greek debt makes little sense – the debt is there not only because of Greek appetite for debt but for banks’ willingness to lend. The banks have sold off their Greek debt, IMF and ECB gobbled it up. It is too late to punish the original lenders, now it is only the Greek borrower left. There are many ideas floating around, here is Fistful of Euros’ Alex Harrowell summing up some of these ideas.

The problem with Greece is not just its debt, but the fact that the country is ever more crippled by earlier non-solutions as Syriza has stressed. Yet, the new Greek leaders have emphasised that they want to repay its debts to its lenders, ECB and the IMF as Alexis Tsipras said in a statement January 31. Greece is clearly trying to come up with a route that might suit everyone but is at the same time adamant that it must be allowed to run expansionary policies at home. Hiring Lazard as adviser shows the government pays attention to the markets as well as expecting tough talks.

The Troika loans amount to €226.7bn, ca. 125% of GDP, roughly two-thirds of total public debt of 175% of GDP. As Syriza has pointed out the unfortunate thing here is that the GDP has been shrinking making the debt ever less sustainable. This is i.a. part of the vicious circle that is dragging Greece down.

One way of going about the Greek problem might be to learn from history. The Stiglitz report, Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, from 2009 refers to the so-called “bisque-clause” from 1946:

There might also be alternative ways of ensuring flexible payment arrangements that would allow automatic adjustment for borrowers during bad times. For instance, one possibility is for coupon payments to remain fixed and for the amortization schedule to be adjusted instead. Countries would postpone part or all of their debt payments during economic downturns and would then make up by pre-paying during economic upswings. A historical precedent was set by the United Kingdom when it borrowed from the United States in the 1940s. The 1946 Anglo-American Financial Agreement included a “bisque clause” that provided a 2 percent interest payment waiver in any year in which the United Kingdom’s foreign exchange income was not sufficient to meet its pre-war level of imports, adjusted to current prices.

Sources have mentioned to me that the “bisque-clause” has inspired the approach being advocated by the new Greek government.

The “erroribus” of exit

“The world works thus that some help erroribus to circulate and others then try to erase it – and thus, both have something to do,” professor of antiquity at the University of Copenhagen Árni Magnússon (1663-1730) wrote.

Athanassiou’s conclusion was that “negotiated withdrawal from the EU would not be legally impossible even prior to the ratification of the Lisbon Treaty, and that unilateral withdrawal would undoubtedly be legally controversial; that, while permissible, a recently enacted exit clause is, prima facie, not in harmony with the rationale of the European unification project and is otherwise problematic, mainly from a legal perspective; that a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible. This paper concludes with a reminder that while, institutionally, a Member State’s membership of the euro area would not survive the discontinuation of its membership of the EU, the same need not be true of the former Member State’ s use of the euro.”

For those who have nailed their professional reputation to Grexit it might be hard to swallow that nope, Grexit is apparently not on the agenda – not for the new Greek government, not for the German government and, so far, no other EU government. German politicians may talk bravely about contained contagion from Grexit but dream on, who is willing to test the containment?

In order to understand the eurocrisis and find sustainable solutions forget the economics and focus instead on the politics. After all, the euro is a political construction, based on political will and as long as this will is there among Europe’s leaders there will be no Grexit or any other exit. Neither the ECB nor any EU institution will pull the rug from under Greece – this is not a question of some technical trick to force an end no government in Europe wishes for.

The euro is not just a currency, but the tangible sign of a union in which the earlier success of the internal market and enlargement was to be joined and entwined. For a few years it worked well, further cementing earlier progress. There are those who say it could never have worked and they are among the loudest in the Grexit choir as is, unsurprisingly, part of the UK media.

So far, the EZ countries have solved one problem after the other – yes, (too) often it has been too little too late, not always glorious. However, the political will to solve EZ troubles has been there and still is. Which is why it would be more fruitful to focus on the possible solutions – as the Greek government seems to be trying to do – rather than fable about Grexit.

* Earlier, Þórólfur Matthíasson professor at the University of Iceland and I have argued that the eurocrisis has to a large degree been symptom of underlying problems in the crisis-countries, ignored or not solved in time, to be solved at national level.

Cross-posted on Fistful of Euros

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