Cronies redux -Cypriot chaebols

In many ways, none of this is new. The Japanese have felt the pain of connected lending and zaibatsu inbreeding, as have the Koreans with their chaebol. I’m reading that the terms are actually very well chosen- their transliterations apparently mean something along the lines of “financial clique” and “wealthy clan”.

This, of course, is neither a Japanese nor a Korean phenomenon. Hongs, keiretsus, the “military industrial complex” and other “big business” are all to be found well beyond Asia. And, the problems created by this quasi-formal cronyism are nothing new, either.

Central Bank: Independent to choose its own cronies

Central Bank: Independent to choose its own cronies

Cyprus brings to the fore (yet) another series of more profound questions that beg to be answered.

First, this cronyism is much more widespread than most of us care to admit, and there are always some pretty convincing arguments in favour of cronyism: Cyprus is now suffering from the same type of crony capitalism that ruined many an economy in the past. And, forget Korea where this was a much-discussed issue during the Asian crisis; Ireland, Greece, Spain, most of Latin America, Wall Street, the City, even China all show varieties of the same pathology. Some were forced into a crisis. Others are increasingly troubled over increasingly shaky foundations.

Each time, those most intimately involved comment that there is something “exceptional”, something “particular” about their own economy and their own culture that justifies economic inbreeding. Family connections and clan loyalty, national exceptionalism, geopolitical necessity, national interest, have all been staples of such justifications.

Cyprus has been working over this fault line for a while, too. Bankers have always insisted that connected lending is inevitable because of the small size of the economy. Much like Iceland, the point made was that everyone is everyone’s cousin, in-law, partner or brother-in-law. Hence, connected lending is “natural”. On top of this, another argument, more “anglo-saxon” this time, was that the particulars of national defence and geopolitical concerns make such decisions necessary. Cypriot leaders have cited the occupation of the northern part of the island by Turkish forces as reason to avoid the privatization of Cyta, a national telephony near-monopoly whose loss-making tv carrier branch, Cytavision regularly sponsors organizations which are intimately connected to political parties.

Second, this is “business as usual” for most of those involved. They don’t go out to make deals thinking “now I will be corrupt”; indeed, most of the time they see nothing wrong in what they are doing.

In a recent tv interview, Andreas Vgenopoulos, former boss of Marfin-Laiki bank, made a startling argument as to why bad loans became bad loans in the bank immediately after he relinquished control. “The reason”, he said, “was that the management stopped talking to customers”. If you have an armateur with a 90 million euro loan, he insisted, you need to be talking to him about rescheduling his loans, he commented.

His point was that loan rescheduling, restructuring, even write-downs are a part of normal business practice, not something you do to loans that are by definition troubled. Frustratingly, he ha no comment to the reply that “you don’t give loans that you expect to be rescheduling after a while”. More simply, the point was that first you extend credit, and they you worry about the soundness of the loan.

In Cyprus’ second troubled bank, Bank of Cyprus, which is “temporarily” under Central Bank management, similar pathologies abound. Called to appoint an interim Board, the Central Bank continues to insist on appointing people who were members of the previous board- the one that brought the bank to the point of being bailed in and managed by its regulator. In fact, the Governor is even pushing for the appointment of former members of the Laiki Board, who threw their former bank into bankruptcy and liquidation.

There is nothing wrong with this, according to the Central Bank. That overwhelming majority of the Board had served for a couple of decades, or more, and that they can all be traced back to two single families, doesn’t bother the Central Bank.

Even the Central Bank –under strong influence from the political opposition in Cyprus- fails to see that there is anything even vaguely inappropriate about re-appointing a failed board.

In fact, the Central Bank had continued extending emergency liquidity to Laiki even though it was manifestly insolvent. The Central Banker was unequivocal: “Elections had to take place so that the new government could make decisions” about Laiki’s failure. So he loaded the bank with ELA, against ECB rules. That the ECB watched idly, by the way, is another issue.

This brings us to a third point; we really don’t have institutional safeguards against this. Yes, there are limits to connected lending, but it’s absurdly easy to by-pass these rules. Yes, we have rules against lending to Board Members, but these are mostly empty shells. We even have strong rules for Central Bank independence, but while this is a sacred rule, it is widely accepted that political considerations are “logical”.

That the European Central Bank didn’t even blink when a member of its Governing Council extended 9 billion euro (later to increase to 11.5 billion) in emergency liquidity to an insolvent bank “so there could be elections”, is a sign of how well political connections are accommodated when this is convenient.

The course of events in Cyprus since the Ides of March last month, is further proof of how catastrophic this can be.

Cronyism is neither rare, nor particular to troubled economies. And, while local and national cultural factors are largely a missing part of economic theory (as Fukuyama convincingly argues in “Trust”), at the same time this is not an excuse for near-corruption.

What the Cyprus meltdown begs, right now –and what most analysts and regulators are still not talking about- is a new approach to regulation. With existing rigid rules proving increasingly ineffective, perhaps a new approach should turn more towards procedural robustness, looking more at how decisions are made and less at the decisions themselves.

This needs to be elaborated separately, however, and it should be talked about at greater depth.

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