Cyprus mess: An insider’s view

None of this was a surprise. Cyprus, after years of deliberate efforts to secure a stable and growing economy, found that it was too easy to borrow, too easy to make profits and too easy to grow. Banks had been lending against collateral –in fact the collateral was often the very subject of the loan: lenders extended funds for the acquisition of equity, and the equity was the only collateral committed for the loan. After this bubble burst in 2000-2001, we turned to lending for real estate development or the purchase of holiday homes, with the very same real estate acting as collateral.

As the real estate boom continued, real estate became the only basis for borrowing, even on special lending products. Schemes were everywhere; as long as borrowers could present ownership of some sort of real estate, they could get any number of “special loans” to buy cars, to have cosmetic surgery, to spend a weekend in Athens, to go to London for shopping.

So it should come as little surprise that the boom burst. We’ve seen this game played over and over and pretended that nothing was happening. Even when the international crisis made visible the problems, yours truly started expressing concerns about the ELA (Emergency Liquidity Assistance) extended to Laiki Bank, which at one point reach as high as 10 billion euro, almost 60% of the country’s GDP. The pressure on advertising and the complaints made by the Central Bank landed me in an interrogator’s office in national police HQ.

As we were spending happy times with easy credit, the state was becoming increasingly heavy, slow and unwieldy. Designed as a machine that would allow Cyprus to squeak through its independence from being a colony in 1960, the state remained antiquated for years and meaningful reform of the state never happened. Growth was still easy, and even the eroding productivity could be ignored.

Thence Cyprus ended in a quicksand with banks rapidly becoming not only illiquid, but largely insolvent, as well. Laiki, at least, can’t be opened again after this bank holiday.

This is how you take a country from affluence to the indignity of a depositor bail-in: Don’t do anything, close the door and pretend the house is not on fire, and (perhaps above all) ignore and attack those expressing concern.

After the mess hit home, however, the game changed and important details should be made clear – lessons for the Eurozone and the EU, but also concerns for its future:

ELA  παίξε με
Still got me some options, still

1)      Cyprus is not Greece

Cyprus dragged its feet on its own bailout and avoided making even the most fundamental reforms. But then again the government that maintained this “no-do” policy was ousted in an emphatic manner, with Cypriots giving a reformist a resounding 57% of the vote, the largest margin of victory since the 1980’s.

On top of that, Cyprus accepted essentially all that was asked of it : Civil Service reform, pension and salary cuts, tax hikes, a privatization program and extensive reform and downsizing of its banking sector. Sure, there was strong social opposition to these, and even political parties were against it, but the fact of the matter was that Cyprus needed this reform (and more, still) for its own good. These reforms should not be abandoned now; they should be implemented as a starting point for even more reforms.

Faced with not altogether unreasonable (although largely unfair- ahem, Delaware?) concerns about money laundering, Cyprus also moved to accept a MoneyVal investigation, with a parallel bottom-up check of bank accounts by a private firm, and committed to implement any recommendations.

In fact, 19 pieces of legislation were voted in almost unanimously last December, implementing parts of the MOU for a bailout, even though the MoU hasn’t yet been signed.

2)      The deal wasn’t only unwise and ill-conceived, it was unfair

The depositor bail-in shocked everyone who thought that the deposit guarantee scheme was sacrosanct and that the EU would never move to such a decision. After repetitions, ad nauseam, that the Greek PSI was a “once-off” option, tailored to the “specific conditions” of a “specific” and “extraordinary” problem, now the EU has come up with a second extraordinary option that violates an even more fundamental and sacred principle of confidence in banking.

Naturally, people are wondering what might be in store for Italy, or even Spain, not to mention more “options” for Greece. This was unwise.

At the same time  it was ill-conceived. Banks collapsed at the news, so if the effort was to achieve what is needed in banking crises –a restoration of confidence- then it  failed completely. International markets may not have panicked, and the euro was supported, but confidence was damaged in eurozone and shattered in Cyprus.

In fact, one of the few things than can now be said for certain, is that the original size of the bailout for Cyprus is no longer enough, after the blow struck in the Eurogroup meeting.

On top of that, the deal was random, badly planned and amateurish. Small depositors took a blow that was heavier that the one struck at Russian oligarchs, who were the ostensible target of the bail-in. Some depositors’ money in the banks, are loans they received from banks and deposited for use. Others have non-interest bearing client accounts, with orders for transactions in stock markets, already placed but not completed.

Such details were hardly pondered, and at the very least, they should have been considered before forcing a vague “depositor bail-in”.

The deal was also unfair, not only for the above reasons, but also because it tried to achieve its targets in the most violent way possible. Germany made it abundantly clear that what they want was for the Russian money to leave Cyprus. Whatever the merits of this demand, doing it overnight was unfair in an economy that was ruined so that CDU could win a few minor points over the socialists in the September elections.


3)      The EU has failed to provide a solution.

Ordinary Cypriots are feeling betrayed. Even demonstrators outside the Parliament concentrated on three slogans: a) We feel betrayed by our friends, with Germans at the top of the list; b) We were treated as a guinea pig for testing the silly idea of depositor bail ins, and c) Solidarity in the EU is a dead letter if small countries in need are pushed over the cliff rather than helped in its darkest hour.

But let’s put this aside. Whatever Cypriots feel, the EU has failed to provide a solution. We need to acknowledge the delays caused by the late government of Cyprus, but options were still on the table, even on Friday night.

One question is why the ECB has tolerated keeping alive –and shovelling liquidity into- an insolvent bank. The mistake belongs in Nicosia, no doubt, but then again the ECB ferried 9 billion euro in the form of ELA funding even though the insolvency of the bank was clear for a while.

Instead of moving to an ordinary winding up of the bank, and instead of letting it fail in an orderly manner, Germany and the ECB had a very simple message: Bail in your depositors or we will ruin Laiki Bank and Bank Of Cyprus when they next open. Consider this: Banking Sector needs were always estimated at around 10 billion euro. But this entailed that the two Cypriot SIFIs would have to be recapped at 9% Core tier I.

At least one of these SIFIs was insolvent and would never be recapped at 9%; it would have to be wound up, at a cost much lower than the 4 billion euro estimated, probably half that amount. Just 2 billion euro, you say? Yes, that’s more than 10% of GDP.

The most important question to ask is, why are they pushing Cyprus so hard to fall into the arms of Russia? The effort to push Russian depositors out of Cyprus was done in such a way, that Cyprus is now pondering replacing Russian depositors by Russian shareholders and board members: Not only in its banks, but also in its strategically important Natural gas sector.

And this, while the country is run by a group of leaders who are more than committed to the country’s European vocation, who announced a PfP application in the face of a certain Turkish veto on the very night of the elections, and who have criticised publically (and in private) the former government for choosing Moscow over Brussels.

4)      Back to the options

Other options were also there. I’ve never supported a bailout based on the baseline scenarios, as basing it on the adverse scenario is much wiser. At the same time, however, projected natural gas revenues were never taken into account on debt sustainability exercises. Spending cuts were also put aside in the estimates made, especially from the necessary austerity that was already underway.

And, long-term reforms in the civil service were never put on the table, except in the most vague manner: There is one department that employs some two-dozen architects at eye-watering salary levels so they’ll build dams for the water problem of Cyprus. But Cyprus hasn’t built any dams in at least 2 decades. Regular pay-hikes, promotions and a string of benefits –not to mention impressive pensions with no contributions- continue to be offered as if they were actually working for 20 years. Lump sum retirement bonuses strike numbers frequently above 200.000 euro. And this is one of an endless stream of such departments. Other problems are plain to see, like the primitive (at best) computerization of tax collecting systems and the legislated but impossible cross-connection of departments like DMV, Social Security, Land Registry and IRS departments to combat tax evasion. Some of these barely have computers, and those who do are so old, they can’t frankly be called “useful”.

As far as the financing is concerned, there, too, existed loads of more orthodox options: Some tax hikes do make sense and the pension funds alone could provide some 4.2 billion out of the 5.8 billion estimated from the bail-in.


  1. I agree with your analysis. The deal isn’t fair (at the very least in a horizontal sense of fairness AMONG Cypriots). But many reasons now speak for a contribution from Cyprus to the bail-out. That’s the only imponderable. Everything else is back on the table, but needs to be decided quickly, at least before banks open (or deposits are un-frozen, whichever is later).

    My views in detail are on

  2. the only thing is: don’t touch pension funds. That surely would be worse than touching deposits. Deposits were leant to private institutions (banks), and beyond the 100,000 guarantee can therefore never be considered 100% sacrosanct or government-backed. Pensions aren’t leant to anyone, and have a clear owner. They are not debt, and there is no issuer who can go bankrupt.

    If you meant «lower implicit pension liabilities of the government», that’s different. That is clearly an option. But not pension FUNDS!

  3. Hi there just wanted to give you a brief heads up and let
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