Behind the grant monument to incredible mistakes that is the Cyprus crisis, lingers a long list of ominous and disturbing deeper questions. There is no doubt that Cyprus got it wrong for years. There is also very little doubt that the Eurogroup got it even more wrong two weeks ago.
The entire story, however, raises questions about the ECB itself on two levels: How well it’s actually run, and what its role is in the euro crisis. I’m not going to talk about the QE questions, the support is provides the euro, bond buybacks, exit strategies or even the EBU and all that it entails to function properly- if it ever does.
The quality of the ECB can no longer stand beyond doubt. The reality in Cyprus is that a SIFI, Laiki Bank which controlled 17% of market shares a year ago, has been falling into an illiquidity spiral with no end. Its NPL levels have been rising out of control and by our reckoning stand well over 40% today overall, and over 50% in the Greek market.
Sleeping at the wheel
Shut off from Frankfurt’s liquidity operations, Laiki started supporting its liquidity through the doubtful practice of ELA support -a trick the ECB allows to exist, by which the Eurosystem can extend liquidity against doubtful collateral, through its member central banks.
But Laiki got out of control rather quickly. Immediately after being bailed out for 1.8 billion euro (while holding about 4 billion in ELA support) the bank recorded a massive increase of 10% in outstanding loans, attributed by Laiki senior cadre to “recalculations of interest due”. In other words, they recorded a massive credit growth by re-adding NPLs to outstanding credits. These were amounts overdue, but never received from distressed lending. This is what the Home Bank of Canada had done in the late 1910s, by the way.
And, this should have sounded alarm bells, but it didn’t.
Soon enough, and against this massive growth in credits, the bank was shedding deposits. Naturally, ELA assistance from the Central Bank of Cyprus continued to increase even as Laiki started using real estate as collateral. When the “Laiki Sporting Club” was used as collateral for ELA (no kidding), it was clear that Laiki was in trouble: This was no longer a traditional liquidity problem; this thing started smelling too much like insolvency.
And, again, no alarm bells went off in Frankfurt.
And the course continued, with Laiki’s ELA reaching, and soon surpassing 50% of Cyprus’ GDP in mid April last year. In the meantime, ELA maturing was being evergreened, or to put it nicely, rolled over.
And still no alarm bells went off, until the ECB mildly questioned Laiki’s solvency in a kind and tactful manner, towards the end of 2012. When the issue came to the fore, and when a letter from Frankfurt to the Central Bank of Cyprus was leaked, still nothing happened.
In fact, they all did whatever they could to hide the problem. I know this, because I was dragged to the offices of the Criminal Investigation Department of the Police to explain to investigators why I was writing that the bank is insolvent. The Central Bank had filed a complaint; they say because ECB asked them to. So, to clarify things, I had to face criminal investigators for writing what the ECB should have been yelling at the top of their lungs.
Now that alarm bells are going off, the ECB should explain why it took them so long, but also why they were so adamant, under the guise of bank confidentiality, to hide a problem they should have been dealing with all along.
This is not to say that the Central Bank of Cyprus is innocent; they are the prime culprit. And the failure in Cyprus is primarily a Cypriot failure. But confidence in Frankfurt is now justifiably shaken –they were sleeping at the wheel. One thinks “Italy”, and starts to worry right about now.
The second issue is precisely the role of National Central Banks in the eurosystem, and especially for Program countries.
They tend to negotiate “with the Troika” on several issues pertaining to banks. But what Cyprus is making clear in the last couple of weeks, is that this is hardly logical. Central Banks can’t be negotiating with the Troika; they are part of the Troika because they are essentially «branches» of the ECB.
This is not so much a warning about the ECB, but it makes clear that the system is problematic. In Cyprus the Troika (of which the ECB is a part, alongside the IMF and the European Commission) didn’t want to impose capital controls. Then it did, and now it’s overly strict about them, even though some of the robust banks are complaining that they have no problem with capital flight.
They don’t know what they are doing, really, and the case of the Central Bank of Cyprus is characteristic –it’s a branch of one member of the Troika and yet at the same time it pretends to be negotiating with the ECB on a variety of issues. Clearly, that will need to be sorted out before going to Italy, or for that matter, before continuing to talk with the other PIGS.
Whatever the case, the ECB has some explaining to do. Most importantly, because Frankfurt is the very heart of the stunned eurosystem, and more is expected of it.
P.S. By the way, where is Super Mario? How come Asmussen is running the show all alone?